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Consolidated Industries’ Hammer Forge
Consolidated Industries represents one of the thousands of small manufacturers that exist throughout the United States. It has been in business for more than sixty years, specializing in the forging of ferrous, nonferrous, and exotic materials. Its prime customer base has been the aerospace industry, but it has also expanded into other industrial customers.
Originally a family business, Consolidated Industries was sold to new owners in 1999. Once the owner reached retirement age, his children, a brother and sister, found it difficult to agree on the future direction of the company. This period of confusion was made more difficult when the head of sales died. Competitors exploited this situation. The new CEO—John Wilbur—immediately recognized that there had been some complacency about generating new customers, and the firm would not be able to survive in the long run merely on its backlog of orders. Wilbur began to aggressively deal with the firm’s problems and build its customer base. In ten years, he was able to take Consolidated Industries’ sales from \$8 million a year to \$30 million a year. He attributes much of this success to the firm’s commitment to business planning.
Soon after taking over the business, he started a comprehensive planning process. Given the pressing issues the firm was facing, the first plan had a one-year horizon. It was instrumental in gaining the support of Consolidated Industries’ bankers, which carried it through those difficult years. In the intervening years, the plan’s horizon was expanded to five years. Although Wilbur admitted that the projections may be “pipe dreams” after the first two years, he said it was important to maintain the five-year horizon to force the business to think about the future. The main goals of the plan had been to examine ways to lower costs and expand the customer base, particularly outside the aerospace industry.
The plan would be constantly evolving; detailed metrics would provide guidance to the various units throughout the firm. These metrics were broken down on a quarterly basis and were color coded to allow the various units to see how well they were progressing toward the achievement of the goals and the objectives. It had a detailed sales plan that emphasized developing new customers in new industries. To this end, it significantly focused on developing new products. In the past few years, the number of new products increased from six per year to seventy-seven per year. This meant an enlargement of the engineering staff, but it is also meant a much closer relationship with customers. Wilbur estimated that 50 percent of the new products were a codesign with customers. The planning process also enabled the business to incorporate technology in new ways. The firm used videoconferencing to communicate with both customers and sister units. Another important element of the plan was the concept of succession planning. As vital as the planning process was, Wilbur said that “it is all about people. Any plan to improve the firm has to bring people into the process and bring them together.”
5.02: Developing Your Strategy
Learning Objectives
1. Understand the term strategy and why it is important for small business.
2. Define the four generic strategies identified by Porter.
3. Evaluate the ramifications of each generic strategy for the operations of a small business.
Without a strategy, the organization is like a ship without a rudder, going around in circles. -Joel Ross and Michael Kami
As mentioned in"Your Business Idea: The Quest for Value", it is critically important for any business organization to be able to accurately understand and identify what constitutes customer value. To do this, one must have a clear idea of who your customers are or will be. However, simply identifying customer value is insufficient. An organization must be able to provide customer value within several important constraints. One of these constraints deals with the competition—what offerings are available and at what price. Also, what additional services might a company provide? A second critically important constraint is the availability of resources to the business organization. Resources consist of factors such as money, facilities, equipment, operational capability, and personnel.
Here is an example: a restaurant identified its prime customer base as being upscale clientele in the business section of a major city. The restaurant recognized that it has numerous competitors that are interested in providing the same clientele with an upscale dining experience. Our example restaurant might provide a five-course, five-star gourmet meal to its customers. It also provides superlative service. If a comparable restaurant failed to provide a comparable meal than the example restaurant, the example restaurant would have a competitive advantage. If the example restaurant offered these sumptuous meals for a relatively low price in comparison to its competitors, it would initially seem to have even more of an advantage. However, if the price charged is significantly less than the cost of providing the meal, the service in this situation could not be maintained. In fact, the restaurant inevitably would have to go out of business. Providing excellent customer service may be a necessary condition for business survival but, in and of itself, it is not a sufficient condition.
So how does one go about balancing the need to provide customer value within the resources available while always maintaining a watchful eye on competitors’ actions? We are going to argue that what is required for that firm is to have a strategy.
The word strategy is derived from the Greek word strategos, which roughly translates into the art of the general, namely a military leader. Generals are responsible for marshaling required resources and organizing the troops and the basic plan of attack. Much in the same way, executives as owners of businesses are expected to have a general idea of the desired outcomes, acquire resources, hire and train personnel, and generate plans to achieve those outcomes. In this sense, all businesses, large and small, have strategies, whether they are clearly written out in formal business plans or reside in the mind of the owner of the business.
There are many different formal definitions of strategy with respect to business. The following is a partial listing of some of the definitions given by key experts in the field:
A strategy is a pattern of objectives, purposes or goals and the major policies and plans for achieving these goals, stated in such a way as to define what business the company is in or is to be in and the kind of company it is or to be.Kenneth Arrow, The Concept of Corporate Strategy (Homewood, IL: Irwin, 1971), 28. -Kenneth Arrow
The determination of the long-run goals and objectives of an enterprise, and the adoption of courses of action and the allocation of resources necessary for carrying out these goals. Alfred Chandler, Strategy and Structure (Cambridge, MA: MIT Press, 1962), 13. -Alfred Chandler
What business strategy is all about, in a word, is competitive advantage.Kenichi Ohmae, The Mind of the Strategist (Harmondsworth, UK: Penguin Books, 1983), 6. -Kenichi Ohmae
We define the strategy of a business as follows: A firm’s strategy is the path by which it seeks to provide its customers with value, given the competitive environment and within the constraints of the resources available to the firm.
Whatever definition of strategy is used, it is often difficult to separate it from two other terms: strategic planning and strategic management. Both terms are often perceived as being in the domain of large corporations, not necessarily small to midsize businesses. This is somewhat understandable. The origin of strategic planning as a separate discipline occurred over fifty years ago. It was mainly concerned with assisting huge multidivisional or global businesses in coordinating their activities. In the intervening half-century, strategic planning has produced a vast quantity of literature. Mintzberg, Lampel, Ahlstrand, in a highly critical review of the field, identified ten separate schools associated with strategic planning.Henry Mintzberg, Joseph Lampel, and Bruce Ahlstrand, Strategic Safari: A Guided Tour through the Wilds of Strategic Management (New York: Free Press, 1998). With that number of different schools, it is clear that the discipline has not arrived at a common consensus. Strategic planning has been seen as a series of techniques and tools that would enable organizations to achieve their specified goals and objectives. Strategic management was seen as the organizational mechanisms by which you would implement the strategic plan. Some of the models and approaches associated with strategic planning and strategic management became quite complex and would prove to be fairly cumbersome to implement in all but the largest businesses. Further, strategic planning often became a bureaucratic exercise where people filled out forms, attended meetings, and went through the motions to produce a document known as the strategic plan. Sometimes what is missed in this discussion was a key element—strategic thinking. Strategic thinking is the creative analysis of the competitive landscape and a deep understanding of customer value. It should be the driver (Figure \(1\)) of the entire process. This concept is often forgotten in large bureaucratic organizations.
The three gears of strategy, thought, planning and managment
Strategic thinkers often break commonly understood principles to reach their goals. This is most clearly seen among military leaders, such as Alexander the Great or Hannibal. Robert E. Lee often violated basic military principles, such as dividing his forces. General Douglas MacArthur shocked the North Koreans with his bold landings behind enemy lines at Inchon. This mental flexibility also exists in great business leaders.
Solomon and Friedman recounted a prime example of true strategic thinking.Paul Solman and Thomas Friedman, Life and Death on the Corporate Battlefield: How Companies Win, Lose, Survive (New York: Simon and Schuster, 1982), 24–27. Wilson Harrell took a small, closely held, cleaning spray company known as Formula 409 to the point of having national distribution. In 1967, the position that Formula 409 held was threatened by the possible entry of Procter & Gamble into the same spray cleaning market. Procter & Gamble was a huge consumer products producer, noted for its marketing savvy. Procter & Gamble began a program of extensive market research to promote its comparable product they called Cinch. Clearly, the larger firm had a much greater advantage. Harrell knew that Procter & Gamble would perform test market research. He decided to do the unexpected. Rather than directly confront this much larger competitor, he began a program where he reduced advertising expenditures in Denver and stopped promoting his Formula 409. The outcome was that Procter & Gamble had spectacular results, and the company was extremely excited with the potential for Cinch. Procter & Gamble immediately begin a national sales campaign. However, before the company could begin, Harrell introduced a promotion of his own. He took the Formula 409 sixteen-ounce bottle and attached it to a half-gallon size bottle. He then sold both at a significant discount. This quantity of spray cleaner would last the average consumer six to nine months. The market for Procter & Gamble’s Cinch was significantly reduced. Procter & Gamble was confused and confounded by its poor showing after the phenomenal showing in Denver. Confused and uncertain, the company chose to withdraw Cinch from the market. Wilson Harrell’s display of brilliant strategic thinking had bested them. He leveraged his small company’s creative thinking and flexibility against the tremendous resources of an international giant. Through superior strategic thinking, Harrell was able to best Procter & Gamble.
Video Clip \(1\)
What Is Strategy?
Michael Porter of Harvard Business School provides a brief discussion of what strategy is.
Video Clip \(2\)
Strategic Thinking and the Definition of Strategy
A Center for Management Organization and Effectiveness (CMOE) discussion of strategy; it leads to other similar videos.
Video Clip \(3\)
Strategic Thinking—Develop Strategic Thinking Skills to Give Yourself a Competitive Edge
Follow-up CMOE video on strategic thinking.
Video Clip \(4\)
Strategic Thinking and Management for Competitive Advantage
(
Two Wharton professors discuss how strategic thinking is critical to the acquisition of competitive advantage.
Video Clip \(5\)
Mastering Strategic Thinking Workshop
A professor discusses the importance of strategic thinking for leadership.
Video Clip \(6\)
From Strategic Thinking to Planning
A speaker illustrates that successful plans are tied to strategic thinking.
Do You Have a Strategy and What Is It?
We have argued that all businesses have strategies, whether they are explicitly articulated or not. Perry stated that “small business leaders seem to recognize that the ability to formulate and implement an effective strategy has a major influence on the survival and success of small business.”Stephen C. Perry, “A Comparison of Failed and Non-Failed Small Businesses in the United States: Do Men and Women Use Different Planning and Decision Making Strategies?,” Journal of Developmental Entrepreneurship 7, no. 4 (2002): 415.
The extent to which a strategy should be articulated in a formal manner, such as part of a business plan, is highly dependent on the type of business. One might not expect a formally drafted strategy statement for a nonemployee business funded singularly by the owner. One researcher found that formal plans are rare in businesses with fewer than five employees. Stephen C. Perry, “An Exploratory Study of U.S. Business Failures and the Influence of Relevant Experience and Planning,” (PhD diss., George Washington University, 1998; dissertation available through UMI Dissertation Services, Ann Arbor, MI), 42. However, you should clearly have that expectation for any other type of small or midsize business.
Any business with employees should have an articulated strategy that can be conveyed to them so that they might better assist in implementing it. Curtis pointed out that in the absence of such communication, “employees make pragmatic short-term decisions that cumulatively form an ad-hoc strategy.”David A. Curtis, Strategic Planning for Smaller Businesses: Improving Corporate Performance and Personal Reward (Cambridge, MA: Lexington Books, 1983), 29. These ad hoc (realized) strategies may be at odds with the planned (intended) strategies to guide a firm.Henry Mintzberg, The Rise and Fall of Strategic Planning (New York: Free Press, 1994), 46. However, any business that seeks external funding from bankers, venture capitalists, or “angels” must be able to specify its strategy in a formal business plan.
Clearly specifying your strategy should be seen as an end in itself. Requiring a company to specify its strategy forces that company to think about its core issues, such as the following:
• Who are your customers?
• How are you going to provide value to those customers?
• Who are your current and future competitors?
• What are your resources?
• How are you going to use these resources?
One commentator in a blog put it fairly well, “It never ceases to amaze me how many people will use GPS or Google maps for a trip somewhere but when it comes to starting a business they think that the can do it without any strategy, or without any guiding road-map.”Harry Tucci, comment posted to the following blog: Rieva Lesonsky, “A Small Business Plan Doubles Your Chances for Success, Says a New Survey, Small Business Trends, June 20, 2010, accessed October 10, 2011, smallbiztrends.com/2010/06/business-plan-success-twice-as-likely.html.
Types of Strategies
In 1980, Michael Porter a professor at Harvard Business School published a major work in the field of strategic analysis—Competitive Strategy.Michael Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980), 21. To simplify Porter’s thesis, while competition is beneficial to customers, it is not always beneficial to those who are competing. Competition may involve lowering prices, increasing research and development (R&D), and increasing advertising and other expenses and activities—all of which can lower profit margins. Porter suggested that firms should carefully examine the industry in which they are operating and apply what he calls the five forces model. These five forces are as follows: the power of suppliers, the power of buyers, the threat of substitution, the threat of new entrants, and rivalry within the industry. We do not need to cover these five forces in any great detail, other than to say that once the analysis has been conducted, a firm should look for ways to minimize the dysfunctional consequences of competition. Porter identified four generic strategies that firms may choose to implement to achieve that end. Actually, he initially identified three generic strategies, but one of them can be bifurcated. These four strategies are as follows (see Figure 5.2 "Generic Strategies"): cost leadership, differentiation, cost focus, and differentiation focus. These four generic strategies can be applied to small businesses. We will examine each strategy and then discuss what is required to successfully implement them.
Low-Cost Advantage
A cost leadership strategy requires that a firm be in the position of being the lowest cost producer in its competitive environment. By being the lowest cost producer, a firm has several strategic options open to it. It can sell its product or service at a lower price than its competitors. If price is a major driver of customer value, then the firm with the lowest price should sell more. The low-cost producer also has the option of selling its products or services at prices that are comparable to its competitors. However, this would mean that the firm would have a much higher margin than its competitors.
Obviously, following a cost leadership strategy dictates that the business be good at curtailing costs. Perhaps the clearest example of a firm that employs a cost leadership strategy is Walmart. Walmart’s investment in customer relations and inventory control systems plus its huge size enables it to secure the “best” deals from suppliers and drastically reduce costs. It might appear that cost leadership strategies are most suitable for large firms that can exploit economies of scale. This is not necessarily true. Smaller firms can compete on the basis of cost leadership. They can position themselves in low-cost areas, and they can exploit their lower overhead costs. Family businesses can use family members as employees, or they can use a web presence to market and sell their goods and services. A small family-run luncheonette that purchases used equipment and offers a limited menu of standard breakfast and lunch items while not offering dinner might be good example of a small business that has opted for a cost leadership strategy.
Differentiation
A differentiation strategy involves providing products or services that meet customer value in some unique way. This uniqueness may be derived in several ways. A firm may try to build a particular brand image that differentiates itself from its competitors. Many clothing lines, such as Tommy Hilfiger, opt for this approach. Other firms will try to differentiate themselves on the basis of the services that they provide. Dominoes began to distinguish itself from other pizza firms by emphasizing the speed of its delivery. Differentiation also can be achieved by offering a unique design or features in the product or the service. Apple products are known for their user-friendly design features. A firm may wish to differentiate itself on the basis of the quality of its product or service. Kogi barbecue trucks operating in Los Angeles represent such an approach. They offer high-quality food from mobile food trucks. “Kogi Truck Schedule,” Kogi BBQ, accessed October 10, 2011, kogibbq.com. They further facilitate their differentiation by having their truck routes available on their website and on their Twitter account.
Adopting a differentiation strategy requires significantly different capabilities than those that were outlined for cost leadership. Firms that employ a differentiation strategy must have a complete understanding of what constitutes customer value. Further, they must be able to rapidly respond to changing customer needs. Often, a differentiation strategy involves offering these products and services at a premium price. A differentiation strategy may accept lower sales volumes because a firm is charging higher prices and obtaining higher profit margins. A danger in this approach is that customers may no longer place a premium value on the unique features or quality of the product or the service. This leaves the firm that offers a differentiation strategy open to competition from those that adopt a cost leadership strategy.
Focus—Low Cost or Differentiation
Porter identifies the third strategy—focus. He said that focus strategies can be segmented into a cost focus and a differentiation focus.
In a focus strategy, a firm concentrates on one or more segments of the overall market. Focus can also be described as a niche strategy. Focus strategy entails deciding to some extent that we do not want to have everyone as a customer. There are several ways that a firm can adopt a focus perspective:
• Product line. A firm limits its product line to specific items of only one or more product types. California Cart Builder produces only catering trucks and mobile kitchens.
• Customer. A firm concentrates on serving the needs of a particular type of customer. Weight Watchers concentrates on customers who wish to control their weight or lose weight.
• Geographic area. Many small firms, out of necessity, will limit themselves to a particular geographic region. Microbrewers generally serve a limited geographic region.
• Particular distribution channel. Firms may wish to limit themselves with respect to the means by which they sell their products and services. Amazon began and remains a firm that sells only through the Internet.
Firms adopting focus strategies look for distinct groups that may have been overlooked by their competitors. This group needs to be of sufficiently sustainable size to make it an economically defensible option. One might open a specialty restaurant in a particular geographic location—a small town. However, if the demand is not sufficiently large for this particular type of food, then the restaurant will probably fail. Companies that lack the resources to compete on either a national level or an industry-wide level may adopt focus strategies. Focus strategies enable firms to marshal their limited resources to best serve their customers.
As previously stated, focus strategies can be bifurcated into two directions—cost focus or differentiation focus. IKEA sells low-priced furniture to those customers who are willing to assemble the furniture. It cuts its costs by using a warehouse rather than showroom format and not providing home delivery. Michael Dell began his business out of his college dormitory. He took orders from fellow students and custom-built computers to their specifications. This was a cost focus strategy. By building to order, it almost totally eliminated the need for any incoming, work-in-process, or finished goods inventories.
A focus differentiation strategy concentrates on providing a unique product or service to a segment of the market. This strategy may be best represented by many specialty retail outlets. The Body Shop focuses on customers who want natural ingredients in their makeup. Max and Mina is a kosher specialty ice cream store in New York City. It provides a constantly rotating menu of more than 300 exotic flavors, such as Cajun, beer, lox, corn, and pizza. The store has been written up in the New York Times and People magazine. Given its odd flavors, Max and Mina’s was voted the number one ice cream parlor in America in 2004. Max and Mina’s Ice Cream, accessed October 10, 2011, www.maxandminasicecream.com.
Evaluating Strategies
The selection of a generic strategy by a firm should not be seen as something to be done on a whim. Once a strategy is selected, all aspects of the business must be tied to implementing that strategy. As Porter stated, “Effectively implementing any of these generic strategies usually requires total commitment and supporting organizational arrangements.”Michael Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980), 21. The successful implementation of any generic strategy requires that a firm possess particular skills and resources. Further, it must impose particular requirements on its organization (see Table \(1\)").
Even successful generic strategies must recognize that market and economic conditions change along with the needs of consumers. Henry Ford used a cost leadership strategy and was wildly successful until General Motors began to provide different types of automobiles to different customer segments. Likewise, those who follow a differentiation strategy must be cautious that customers may forgo “extras” in a downturn economy in favor of lower costs. This requires businesses to be vigilant, particularly with respect to customer value.
Table \(1\): Summary of Generic Strategies
Generic Strategy Required Activities Issues
Cost leadership
• Economies of scale
• Reduce overhead costs
• Lower cost of supplies
• Capital investment in technology to reduce cost
• Labor cost reduction through supervision, outsourcing, and work design
• Low-cost distribution
• Reduce cost of manufacturing or providing service
• Tight financial control
• Operate in lower cost environments
• Production-based incentives
• Product or service becomes a commodity with no brand loyalty
• Changing technology cuts your cost advantage
• New entrants can produce at even lower costs (e.g., China)
• Focus on cost reduction means that you miss changing customer tastes
Differentiation
• Unique or highly improved products or services
• Brand image
• Creative approach to marketing
• Reputation for quality and product or service innovation
• Ability to attract creative personnel
• Effective coordination among R&D, marketing, and operations
• Qualitative difference between you and low-cost producer may not be enough to sustain sales
• Differentiating factor may no longer be attractive to customers
• Imitation narrows perceived differences
Focus—low cost
• Reduce overhead costs
• Lower cost of supplies
• Labor cost reduction through supervision, outsourcing, and work design
• Low-cost distribution
• Tight financial control
• Operate in lower cost environments
• Production-based incentives
• Cost advantage of focused firms is lost with respect to broader competitors
• Differentiation advantage with a focused market is lost
• Competitors find even smaller markets to focus on
Focus—differentiation
• Unique or highly improved products or services
• Creative approach to marketing
• Reputation for quality and product/service innovation
• Ability to attract creative personnel
• Effective coordination among R&D, marketing, and operations
• Cost advantage of focused firms is lost with respect to broader competitors
• Differentiation advantage with a focused market is lost
• Competitors find even smaller markets to focus on
Video Clip \(7\)
Porter’s Strategies—Generic Strategies
Examples of generic strategies.
Video Clip \(8\)
The Five Competitive Forces That Shape Strategy
A long interview with Michael Porter discussing the five forces model.
KEY TAKEAWAYS
• Any firm, regardless of size, needs to know how it will compete; this is the firm’s strategy.
• Strategy identifies how a firm will provide value to its customers within its operational constraints.
• Strategy can be reduced to four major approaches—cost leadership, differentiation, cost focus, and differentiation focus.
• Once a given strategy is selected, all of a firm’s operations should be geared to implementing that strategy.
• No strategy will be successful forever and therefore needs to be constantly evaluated.
EXERCISES
1. As previously noted, Walmart competes on the basis of cost leadership. Show how a variety of local firms could successfully compete with Walmart by the correct selection of one of the generic strategies.
2. Identify five local businesses and talk to their owners. Ask them if they have a formal strategy. If they say no, ask how they compete. Try to determine if they have a strategy in place even if they cannot articulate one. (Look at Exercise 1 in Section 5.2 "The Necessity for a Business Plan" for some additional questions that you might want to ask these owners.) | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/05%3A_The_Business_Plan/5.01%3A_The_Business_Plan.txt |
Learning Objectives
1. Understand that the probability of running a successful business is significantly increased with a formal business plan.
2. Understand that although many small business owners express reasons for not planning, they do themselves a great disservice by not having a formal plan.
3. Understand that businesses that seek to secure external funding must produce a formal plan.
An intelligent plan is the first step to success. The man who plans knows where he is going, knows what progress he is making and has a pretty good idea of when he will arrive. Planning is the open road to your destination. If you don’t know where you're going, how can you expect to get there?
Basil Walsh
In "Foundations for Small Business", we discussed the issue of failure and small businesses. Although research on small business failure has identified many factors, one reason that always appears at the top of any list is the failure to plan. Interestingly, some people argue that planning is not essential for a start-up business, but they are in a distinct minority.Jason Cohen, “Don’t Write a Business Plan,” Building43, January 27, 2010, accessed October 10, 2011, www.building43.com/blogs/2010/01/27/dont-write-a -business-plan. The overwhelming consensus is that a well-developed plan is essential for the survival of any small (or large) business.T. C. Carbone, “Four Common Management Failures and How to Avoid Them,” Management World 10, no. 8 (1981): 38.,Patricia Schaeffer, “The Seven Pitfalls of Business Failure and How to Avoid Them,” Business Know-How, 2011, accessed October 10, 2011, www.businessknowhow.com/startup/business-failure.htm.,Isabel M. Isodoro, “10 Rules for Small Business Success,” PowerHomeBiz.com, 2011, www.powerhomebiz.com/vol19/rules.htm.,Rubik Atamian and Neal R. VanZante, “Continuing Education: A Vital Ingredient of the ‘Success Plan’ for Small Business,” Journal of Business and Economic Research 8, no. 3 (2010): 37. Perry found that firms with more than five people benefit from having a well-developed business plan.Stephen C. Perry, “A Comparison of Failed and Non-Failed Small Businesses in the United States: Do Men and Women Use Different Planning and Decision Making Strategies?,” Journal of Developmental Entrepreneurship 7, no. 4 (2002): 415.
A recent study found that there was a near doubling of successful growth for those businesses that completed business plans compared to those that did not create one. It must be pointed out that this study might be viewed as being biased because the founder of the software company whose main product is a program that builds business plans conducted the study. However, the results were examined by academics from the University of Oregon who validated the overall results. They found that “except in a small number of cases, business planning appeared to be positively correlated with business success as measured by our variables. While our analysis cannot say the completing of a business plan will lead to success, it does indicate that the type of entrepreneur who completes a business plan is also more likely to produce a successful business.”Rieva Lesonsky, “A Small Business Plan Doubles Your Chances for Success, Says a New Survey,” Small Business Trends, June 20, 2010, accessed October 10, 2011, smallbiztrends.com/2010/06/business-plan-success-twice-as-likely.html.
Basically, there are two main reasons for developing a comprehensive business plan: (1) a plan will be extraordinarily useful in ensuring the successful operation of your business; and (2) if one is seeking to secure external funds from banks, venture capitalists, or other investors, it is essential that you be able to demonstrate to them that they will be recovering their money and making a profit. Let us examine each reason in detail.
Many small business owners operate under a mistaken belief that the only time that they need to create a business plan is at the birth of the company or when they are attempting to raise additional capital from external sources. They fail to realize that a business plan can be an important element in ensuring day-to-day success.
The initial planning process aids the operational success of a small business by allowing the owner a chance to review, in detail, the viability of the business idea. It forces one to rigorously consider some key questions:
• Is the business strategy feasible?
• What are the chances it will make money?
• Do I have the operational requirements for starting and running a successful business?
• Have I considered a well-thought-out marketing plan that clearly identifies who my customers will be?
• Do I clearly understand what value I will provide to these customers?
• What will be the means of distribution to provide the product or the service to my customers?
• Have I clarified to myself the financial issues associated with starting and operating the business?
• Do I have to reexamine these notions to ensure success?
Possessing an actual written plan enables you to have people outside the organization evaluate your business plan. Using friends, colleagues, partners, or even consultants may provide you with an unbiased evaluation of the assumptions.
It is not enough to create an initial business plan; you should anticipate making the planning process an annual activity. The Prussian military theorist von Moltke once argued that no military plan survives the first engagement with the enemy. Likewise, no company evolves in the same way as outlined in its initial business plan.
Overcoming the Reluctance to Formally Plan
By failing to prepare, you will prepare them to fail.
Benjamin Franklin
Unfortunately, it appears that many small businesses do not make any effort to build even an initial business plan, let alone maintain a planning process as an ongoing operation, even though there is clear evidence that the failure to plan may have serious consequences for the future success of such firms. This unwillingness to plan may be understandable in nonemployee businesses, but it is inexcusable as a business grows in size. Why, therefore, do some businesses fail to begin the planning process?
• We do not need to plan. One of the prime reasons individuals fail to produce a business plan is that they believe that they do not have to plan. This may be attributable to the size of the firm; nonemployee firms that have no intention of seeking outside financing might sincerely believe that they have no need for a formal business plan. Others may believe that they so well understand the business and/or industry that they can survive and prosper without the burdensome process of a business plan. The author of Business Plan for Dummies, Paul Tiffany, once argued that if one feels lucky enough to operate a business successfully without resorting to a business plan, then he or she should forget about starting a business and head straight to Las Vegas.
• I am too busy to plan. Anyone who has ever run a business on his or her own can understand this argument. The day-to-day demands of operating a business may make it seem that there is insufficient time to engage in any ancillary activity or prepare a business plan. Individuals who accept this argument often fail to recognize that the seemingly endless buzz of activities, such as constantly putting out fires, may be the direct result of not having thought about the future and planned for it in the first place.
• Plans do not produce results. Small-business owners (entrepreneurs) are action- and results-oriented individuals. They want to see a tangible outcome for their efforts, and preferably they would like to see the results as soon as possible. The idea of sitting down and producing a large document based on assumptions that may not play out exactly as predicted is viewed as a futile exercise. However, those with broader experience understand that there will be no external funding for growth or the initial creation of the business without the existence of a well-thought-out plan. Although plans may not yield the specified results contained within them, the process of thinking about the plan and building it often yield results that the owner might not initially appreciate.
• We are not familiar with the process of formal planning. This argument might initially appear to have more validity than the others. Developing a comprehensive business plan is a daunting task. It might seem difficult if not impossible for someone with no experience with the concept. Several studies have indicated that small business owners are more likely to engage in the planning process if they have had prior experience with planning models in their prior work experience.H. Hodges and T. Kent, “Impact of Planning and Control Sophistication in Small Business,” Journal of Small Business Strategy 17, no. 2 (2006–7): 75. Fortunately, this situation has changed rather significantly in the last decade. As we will illustrate in Section 5.3 "Building a Plan", there are numerous tools that provide significant support for the development of business plans. We will see that software packages greatly facilitate the building of any business plan, including marketing plans and financial plans for small businesses. We also show that the Internet can provide an unbelievably rich source of data and information to assist in the building of these plans.
Although one could understand the reticence of someone new to small business (or in some cases even seasoned entrepreneurs), their arguments fall short with respect to the benefits that will be derived from conducting a structured and comprehensive business planning process.
Plans for Raising Capital
Every business plan should be written with a particular audience in mind. The annual business plan should be written with a management team and for the employees who have to implement the plan. However, one of the prime reasons for writing a business plan is to secure investment funds for the firm. Of course, funding the business could be done by an individual using his or her own personal wealth, personal loans, or extending credit cards. Individuals also can seek investments from family and friends. The focus here will be on three other possible sources of capital—banks, venture capitalists, and angel investors. It is important to understand what they look for in a business plan. Remember that these three groups are investors, so they will be anticipating, at the very least, the ability to recover their initial investment if not earn a significant return.
Bankers
Bankers, like all businesspeople, are interested in earning a profit; they want to see a return on their investment. However, unlike other investors, bankers are under a legal obligation to ensure that the borrower pledge some form of collateral to secure the loan.Tim Berry, “What Bankers Look for in a Business Plan…and What You Should Expect When Taking Your Business Plan to a Bank,” AllBusiness.com, November 7, 2006, accessed October 10, 2011, www.allbusiness.com/business-planning-structures/business-plans/3878953-1.html. This often means that banks are unwilling to fund a start-up business unless the owner is willing to pledge some form of collateral, such as a second mortgage on his or her home. Many first-time business owners are not in a position to do that; securing money from a bank occurs most frequently for an existing business that is looking to expand or for covering a short-term cash-flow need. Banks may lend to small business owners who are opening a second business provided that they can prove a record of success and profitability.
Banks will require a business plan. It should be understood that bank loan officers will initially focus on the financial components of that client, namely, the income statement, balance sheet, and the cash-flow statement. The bank will examine your projections with respect to known industry standards. Therefore, the business plan should not project a 75 percent profit margin when the industry standard is 15 percent, unless the author of the plan can clearly document why he or she will be earning such a high return.
Some businesses may raise funds with the assistance of a Small Business Administration (SBA) loan. These loans are always arranged through a commercial bank. With these loans, the SBA will pledge up to 70 percent of the total value of the loan. This means that the owner still must provide, at the very least, 30 percent of the total collateral. The ability to secure one of these loans is clearly tied to the adequacy of the business plan.
Venture Capitalists
Another possible source of funding is venture capitalists. The first thing that one should realize about venture capitalists is that they are not in it just to make a profit; they want to make returns that are substantially above those to be found in the market. For some, this translates into the ability to secure five to ten times their initial investment and recapture their investment in a relatively short period of time—often less than five years. It has been reported that some venture capitalists are looking for returns in the order of twenty-five times their original investment.Marc Mays, “Small Business Venture Capital Strategies,” eZine Articles, 2010, accessed October 10, 2011, ezinearticles.com/?Small-Business-Venture-Capital-Strategies &id=4714691.
The financial statement, particularly the profit margin, is obviously important to venture capitalists, but they will also be looking at other factors. The quality of the management team identified in the business plan will be examined. They will be looking at the team’s experience and track record. Other factors needed by venture capitalists may include the projected growth rate of the market, the extent to which the product or the service being offered is unique, the overall size of the market, and the probability of producing a highly successful product or service.
Businesses that are seeking financing from banks know that they must go to loan officers who will review the plan, even though a computerized loan assessment program may make the final decision. With venture capitalists, on the other hand, you often need to have a personal introduction to have your plan considered. You should also anticipate that you will have to make a presentation to venture capitalists. This means that you have to understand your plan and be able to present it in a dynamic fashion.
Angel Investors
The third type of investors is referred to as angel investors, a term that originally came from those individuals who invested in Broadway shows and films. Many angel investors are themselves successful entrepreneurs. As with venture capitalists, they are looking for returns higher than they can normally find in the market; however, they often expect returns lower than those anticipated by venture capitalist. They may be attracted to business plans because of an innovative concept or the excitement of entering a new type of business. Being successful small business owners, many angel investors will not only provide capital to fund the business but also bring their own expertise and experience to help the business grow. It has been estimated that these angel investors provide between three and ten times as much money as venture capitalists for the development of small businesses.“The Importance of Angel Investing in Financing the Growth of Entrepreneurial Ventures,” Small Business Notes, September 2008, accessed October 10, 2011, www.smallbusinessnotes.com/aboutsb/rs331.html.
Angel investors will pay careful attention to all aspects of the proposed business plan. They expect a comprehensive business plan—one that clearly specifies the future direction of the firm. They also will look at the management team not only for its track record and experience but also their (the angel investor’s) ability to work with this team. Angel investors may take a much more active role in the management of the business, asking for positions on the board of directors, taking an equity position in the firm, demanding quarterly reports, or demanding that the business not take certain actions unless it has the approval of these angel investors. These investors will take a much more hands-on approach to the operations of a firm.
KEY TAKEAWAYS
• Planning is a critical and important component of ensuring the success of a small business.
• Some form of formal planning should not only accompany the start-up of a business but also be a regular (annual) activity that guides the future direction of the business.
• Many small business owners are reluctant to formally plan. They can produce many excuses for not planning.
• Businesses may have to raise capital from external sources—bankers, venture capitalists, or angel investors. Each type of investor will expect a business plan. Each type of investor will be more or less interested in different parts of the plan. Business owners should be aware of what parts of the plan each type of investor will focus on.
EXERCISE
1. In Exercise 2 in Section 5.1 "Developing Your Strategy", you were asked to interview five local business owners. In addition to asking them questions about strategy, ask them the following questions about planning: (a) When you began the business, did you have a formal plan? (b) If not, why not? (c) Do you conduct some form of planning regularly? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/05%3A_The_Business_Plan/5.03%3A_The_Necessity_for_a_Business_Plan.txt |
Learning Objectives
1. Understand that before starting a business and before writing a formal plan, individuals should ask themselves some specific questions to see if they are ready for the challenges of small business ownership.
2. Understand that any solidly written plan will require information about the competitive environment. There are many publicly available sources of such information.
3. Understand that plans are future-oriented documents that require forecasts. Forecasting can be done through a variety of methods. Planners should be familiar with a variety of forecasting methods.
4. Understand that formal business plans should contain specific sections.
5. Know that scenario planning should help businesses prepare for low-probability events that might have a significant impact on the firm.
6. Know that there are many computer software packages that can assist in building a formal business plan.
Before talking about writing a formal business plan, someone interested in starting a business might want to think about doing some personal planning before drafting the business plan. Some of the questions that he or she might want to answer before drafting a full business plan are as follows:
• Why am I going into this business?
• What skills and resources do I possess that will help make the business a success?
• What passion do I bring to this business?
• What is my risk tolerance?
• Exactly how hard do I intend to work? How many hours per week?
• What impact will the business have on my family life?
• What do I really wish from this business?
• Am I interested in financial independence?
• What level of profits will be required to maintain my personal and/or family’s lifestyle?
• Am I interested in independence of action (no boss but myself)?
• Am I interested in personal satisfaction?
• Will my family be working in this business?
• What other employees might I need? Melinda Emerson, “Life Plan before Business Plan,” Small Business Trends, March 22, 2010, accessed October 10, 2011, smallbiztrends.com/2010/03/life-plan -before-business-plan.html.
Having addressed these questions, one will be in a much better position to craft a formal business plan.
Video Clip \(1\):
How to Write a Business Plan
Cartoon introduction to building a business plan.
Video Clip \(2\):
How to Write a Business Plan in 6 Minutes—Template
Voiceover PowerPoint video.
Video Clip \(3\):
How to Start a Business: How to Write a Business Plan
A video from Startupdaddy.com that emphasizes the need for a business plan.
Gathering Information
Building a solid business plan requires knowing the economic, market, and competitive environments. Such knowledge transcends “gut feelings” and is based on data and evidence. Fortunately, much of the required information is available through library resources, Internet sources, and government agencies and, for a fee, from commercial sources. Comprehensive business plans may draw from all these sources.
Public libraries and those at educational institutions provide a rich resource base that can be used at no cost. Some basic research sources that can be found at libraries are given in this section—be aware that the reference numbers provided may differ from library to library.
Background Sources
• Berinstein, Paula. Business Statistics on the Web: Find Them Fast—At Little or No Cost (Ref HF1016 .B47 2003).
• The Core Business Web: A Guide to Information Resources (Ref HD30.37 .C67 2003).
• Frumkin, Norman. Guide to Economic Indicators, 4th ed. (Ref HC103 .F9 2006). This book explains the meanings and uses of the economic indicators.
• Solie-Johnson, Kris. How to Set Up Your Own Small Business, 2 volumes (Ref HD62.7 .S85 2005). Published by the American Institute of Small Business.
Company and Industry Sources
• North American Industry Classification System, United States (NAICS), 2007 (Ref HF1042 .N6 2007). The NAICS is a numeric industry classification system that replaced the Standard Industrial Classification (SIC) system. An electronic version is available from the US Census Bureau.
• Standard Industrial Classification Manual (Ref HA40 .I6U63 1987). The industry classification system that preceded the NAICS.
• Value Line Investment Survey (Ref HG4751 .V18). Concise company and industry profiles are updated every thirteen weeks.
Statistical Sources
• Almanac of Business and Industrial Financial Ratios (Ref HF5681 .R25A45 2010).
• Business Statistics of the United States (Ref HC101 .A13123 2009). This publication provides recent and historical information about the US economy.
• Economic Indicators (1971–present). The Council of Economic Advisers for the Joint Economic Committee of Congress publishes this monthly periodical; recent years are in electronic format only. Ten years of data are presented. Electronic versions are available in ABI/INFORM and ProQuest from September 1994 to present and Academic OneFile from October 1, 1991.
• Industry Norms and Key Business Ratios (Dun & Bradstreet; Ref HF5681 .R25I532 through Ref HF5681 .I572 [2000–2001 through 2008–2009]).
• Rma Annual Statement Studies (Ref HF5681 .B2R6 2009–2010). This publication provides annual financial data and ratios by industry.
• Statistical Abstract of the United States (Ref HA202 .S72 2010). This is the basic annual source for statistics collected by the government. Electronic version is available at www.census.gov/compendia/statab.
• Survey of Current Business (1956–present). The Bureau of Economic Analysis publishes this monthly periodical; recent years are in electronic format only.
At some libraries, you may find access to the following resources online:
• Mergent Webreports. Mergent (formerly Moody’s) corporate manuals are in digitized format. Beginning with the early 1900s, the reports include corporate history, business descriptions, and in-depth financial statements. The collection is searchable by company name, year, or manual type.
• ProQuest Direct is a database of general, trade, and scholarly periodicals, with many articles in full text. Many business journals and other resources are available.
• Standard and Poor’s Netadvantage is a database that includes company and industry information.
Internet Resources
In addition to government databases and other free sources, the Internet provides an unbelievably rich storehouse of information that can be incorporated into any business plan. It is not feasible to provide a truly comprehensive list of useful websites; this section provides a highly selective list of government sites and other sites that provide free information.
Government Sites
• US Small Business Administration (SBA). This is an excellent site to begin researching a business plan. It covers writing a plan, financing a start-up, selecting a location, managing employees, and insurance and legal issues. A follow-up page at http://www.sba.gov provides access to publications, statistics, video tutorials, podcasts, business forms, and chat rooms. Another page—http://www.sba.gov/about-offices-list/2—provides access to localized resources.
• SCORE Program. The SCORE program is a partner of the SBA. It provides a variety of services to small business owners, ranging from online (and in-person) mentoring, workshops, free computer templates, and advice on a wide range of small business issues.
In developing a business plan, it is necessary to anticipate the future economic environment. The government provides extensive statistics online.
• Consumer Price Index. This index provides information on the direction of prices for industries and geographic areas.
• Producer Price Index. Businesses that provide services or are focused on business-to-business (B2B) operations may find these data more appropriate for estimating future prices.
• National Wage Data. This site provides information on prevailing wages and can be broken down by occupation and location down to the metropolitan area.
• Consumer Expenditures Survey. This database provides information on expenditures and income. It allows for a remarkable level of refinement by occupation, age, or race.
• State and Local Personal Income and Employment. These databases provide a breakdown of personal income by state and metropolitan area.
• GDP by State and Metropolitan Region. This will provide an accurate guide to the overall economic health of a region or a city.
• US Census. This is a huge site with databases on population, income, foreign trade, economic indicators, and business ownership.
There are nongovernment websites, either free or charging a fee, that can provide assistance in building a business plan. A simple Google search for the phrase small business plan yields more than 67 million results. Various sites will either help with writing the plan, offer to write the plan for a fee, produce reports on industries, or assist small businesses by providing a variety of support services. The Internet offers a veritable cornucopia of information and support for those working on their business plans.
Forecasting for the Plan
Prediction is very difficult, especially about the future.
Nils Bohr, Nobel Prize winner
Any business plan is a future-oriented document. Business plans are required to look between three and five years into the future. To produce them and accurately forecast sales, you will need estimates of expenses and other items, such as the required number of employees, interest rates, and general economic conditions. There are many different techniques and tools that can be used to forecast these items. The type of techniques used will be influenced by many factors, such as the following:
• The size of the business. Smaller businesses may have fewer resources to apply a wide variety of forecasting techniques.
• The analytical sophistication of people who will be conducting the forecast. The owner of a home business may have no prior experience with forecasting techniques.
• The type of the organization. A manufacturing concern that sells to a stable and relatively predictable environment that has been in existence for years might be able to employ a variety of standard statistical forecasting techniques; however, a small firm operating in a new or a chaotic environment might have to rely on significantly different techniques.
• Historical records. Does the firm have historical records for sales that can be used to project into the future?
There is no universal set of forecasting techniques that can be used for all types of small and midsize businesses. Forecasting can fall into a fairly comprehensive range of techniques with respect to level of sophistication. Some forecasting can be done on an intuitive basis (e.g., back-of-the-envelope calculations); others can be done with standard computer programs (e.g., Excel) or programs that are specifically dedicated to forecasting in a variety of environments.
A brief review of basic forecasting techniques shows that they can be divided into two broad classes: qualitative forecasting methods and quantitative forecasting methods. Actually, these terms can be somewhat misleading because qualitative forecasting methods do not imply that no numbers will be involved. The two techniques are separated by the following concept: qualitative forecasting methods assume that one either does not have historical data or that one cannot rely on past historical data. A start-up business has no past sales that can be used to project future sales. Likewise, if there is a significant change in the environment, one may feel uncomfortable using past data to project into the future. A restaurant operates in a small town that contains a large automobile factory. After the factory closes, the restaurant owner should anticipate that past sales will no longer be a useful guideline for projecting what sales might be in the next year or two because the owner has lost a number of customers who worked at the factory. Quantitative forecasting, on the other hand, consists of techniques and methods that assume you can use past data to make projections into the future.
Table \(1\): provides examples of both qualitative forecasting methods and quantitative forecasting methods for sales forecasting. Each method is described, and their strengths and weaknesses are given.
Table \(1\): Overview of Forecasting Methods
Technique Description Strength Weakness
Qualitative Sales Forecasting Methods
Simple extrapolation This approach uses some data and simply makes a projection based on these data. The data might indicate that a particular section of town has many people walk through the section each day. Knowing that number, a store might make a simple estimate of what sales might be. An extremely simple technique that requires only the most basic analytical capabilities. Its success depends on the “correctness” of the assumptions and the ability to carry them over to reality. You might have the correct number of people passing your store, but that does not mean that they will buy anything.
Sales force In firms with dedicated sales forces, you would ask them to estimate what future sales might be. These values would be pieced together with a forecast for next year. The sales force should have the pulse of your customers and a solid idea of their intentions to buy. Its greatest strength is in the B2B environment. Difficult to use in some business-to-customer (B2C) environments. Sales force members are compensated when they meet their quotas, but this might be an incentive to “low-ball” their estimates.
Expert opinion Similar to sales force approach, this technique ask experts within the company to produce estimates of future sales. These experts may come from marketing, R&D, or top-level management. Coalescing sales forecasts of experts should lead to better forecasts. Teams can produce biased estimates and can be influenced by particular members of the team (i.e., the CEO).
Delphi A panel of outside experts would be asked to estimate sales for a particular product or service. The results would be summarized in a report and given to the same panel of experts. They would then be asked to read their forecast. This might go through several iterations. Best used for entirely new product service categories. One has to be able to identify and recruit “experts” from outside the organization.
Historical analogy With this technique, one finds a similar product’s or service’s past sales (life cycle) and extrapolates to your product or service. A new start-up has developed an innovative home entertainment product, but nothing like it has been seen in the market. You might examine past sales of CD players to get a sense of what future sales of the new product might be like. One can acquire a sense of what factors might affect future sales. It is relatively easy and quick to develop. One can select the wrong past industry to compare, and the future may not unfold in a similar manner.
Market research The use of questionnaires and surveys to evaluate customer attitudes toward a product or a service. One gains very useful insights into the stated desires and interests of consumers. Can be highly accurate in the short term. Experienced individuals should do these. They can take time to conduct and are relatively expensive.
Quantitative Sales Forecasting Methods
Trend analysis This forecasting technique assumes that sales will follow some form of pattern. For example, sales are projected to increase at 15 percent a year for the next five years. Extremely simple to calculate. Sales seldom follow the same growth rate over any length of time.
Moving average This technique takes recent class data for N number of periods, adds them together, and divides by the number N to produce a forecast. Easy to calculate. The basic use of this type of model fails to consider the existence of trends or seasonality in the data.
Seasonality analysis Many products and services do not have uniform sales throughout the year. They exhibit seasonality. This technique attempts to identify the proportion of annual sales sold for any given time. The sales of swimming pool supplies in the Northeast, for example, would be much higher in the spring and summer than in the fall and winter. Many products and services have seasonal demand patterns. By considering such patterns, forecasts can be improved. Requires several years of past data and careful analysis. Useful for quarterly or monthly forecasts.
Exponential smoothing This analytical technique attempts to correct forecasts by some proportion of the past forecast error. Incorporates and weighs most recent data. Attempts to factor in recent fluctuations. Several types of this model exist, and users must be familiar with their strengths and weaknesses. Requires extensive data, computer software, and a degree of expertise to use and interpret results.
Causal models—regression analysis Causal models, of which there are many, attempt to identify why sales are increasing or decreasing. Regression is a specific statistical technique that relates the value of the dependent variable to one or more independent variables. The dependent variable sales might be affected by price and advertising expenditures, which are independent variables. Can be used to forecast and examine the possible validity of relationships, such as the impact on sales by advertising or price. Requires extensive data, computer software, and a high degree of expertise to use and interpret results.
Forecasting key items such as sales is crucial in developing a good business plan. However, forecasting is a very challenging activity. The further out the forecast, the less likely it will be accurate. Everyone recognizes this fact. Therefore, it is useful to draw on a variety of forecasting techniques to develop your final forecast for the business plan. To do that, you should have a fairly solid understanding of the strengths and weaknesses of the various approaches. There are many books, websites, and articles that could assist you in understanding these techniques and when they should or should not be used. In addition, one should be open to gathering additional information to assist in building a forecast. Some possible sources of such information would be associations, trade publications, and business groups. Regardless of what technique is used or the data source employed in building a forecast for business plan, one should be prepared to justify why you are employing these forecasting models.
Video Clip \(4\):
Ask Tim Berry—How Do I Start a Sales Forecast?
Provides useful insights on how to start forecasting in the small business environment.
Video Clip \(5\):
Sales Forecast, Part 1: Structure
Tim Berry starts a discussion about using spreadsheets for forecasting.
Video Clip \(6\):
Sales Forecast, Part 2: Logic
This module discusses how to explain the logic behind a forecast.
Video Clip \(7\):
Sales Forecast, Part 3: Back to the Spreadsheet
This module continues by explaining how to use spreadsheets in forecasting.
Building a Plan
Building your first business plan may seem extremely formidable. This may explain why there are so many software packages available to assist in this task. After building your first business plan, that steep learning curve should make subsequent plans for the business or other businesses significantly easier.
In preparing to build a business plan, there are some problem areas or mistakes that you should be on guard to avoid. Some may be technical in nature, while others relate to content issues. For the technical side, first and foremost, one should make sure that there are no misspellings or punctuation errors. The business plan should follow a logical structure. No ideal business plan clearly specifies the exact sections that need to be included nor is there an ideal length. Literature concerning business plans indicates that the appropriate length of the body of a business plan line should be between twenty and forty pages. This does not include appendixes that might provide critical data for the reader.
In developing a lengthy report, sometimes it is easy to fall into clichés or overused expressions. These should be avoided. Consider the visuals in the report. Data should be placed in either clearly mapped-out tables or well-designed graphs. The report should be as professional-looking as possible. Anticipate the audience that will be reading the report and write in a way that easily reaches them; avoid using too much jargon or technical terms.
The content in any business plan centers on two areas: realism and accuracy.
Components of the Plan
There is no idealized structure for a business plan or a definitive number of sections that it must contain. The following subsections discuss the outline of a plan for a business start-up and identify some of the major sections that should be part of the plan.
Cover Page
The cover page provides the reader with information about either the author of the plan or the person to contact concerning the business plan. It should contain all the pertinent information to enable the reader to contact the author, such as the name of the business, the business logo, and the contact person’s address, telephone number, and e-mail address.
The table of contents enables the reader to find the major sections and components of the plan. It should identify the key sections and subsections and on which pages those sections begin. This enables the reader to turn to sections that might be of particular importance.
Executive Summary
The executive summary is a section of critical importance and is perhaps the single most important section of the entire business plan. Quite often, it is the first section that a reader will turn to, and sometimes it may be the only section of the business plan that he or she will read. Chronologically, it should probably be the last section written.Jeffry Timmons, Andrew Zachary, and Stephen Spinelli, Business Plans That Work—A Guide for Small Business (New York: McGraw-Hill, 2004), 113. The executive summary should provide an accurate overview of the entire document, which cannot be done until the whole document is prepared.
If the executive summary fails to adequately describe the idea behind the business or if it fails to do so in a captivating way, some readers may discard the entire business plan. As one author put it, the purpose of the executive summary is to convince the reader to “read on.”Carolyn Brown, “The Dos and Don’ts of Writing a Winning Business Plan,” Black Enterprise, April 1996, 114–122. The executive summary should contain the following pieces of information:
• What is the company’s business?
• Who are its intended customers?
• What will be its legal structure?
• What has been its history (where one exists)?
• What type of funding will be requested?
• What is the amount of that funding?
• What are the capabilities of the key executives?
All this must be done in an interesting and captivating way. The great challenge is that executive summaries should be relatively short—between one and three pages. For many business people, this is the great challenge—being able to compress the required information in an engaging format that has significant size limitations.
Business Section
Goals. These are broad statements about what you would like to achieve some point in the near future. Your goals might focus on your human resource policies (“We wish to have productive, happy employees”), on what you see as the source of your competitive advantage (“We will be best in service”), or on financial outcomes (“We will produce above-average return to our investors.”) Goals are useful, but they can mean anything to anyone. It is therefore necessary to translate the goals into objectives to bring about real meaning so that they can guide the organization. Ideally, objectives should be SMART—specific, measurable, achievable, realistic, and have a specific timeline for completion. Here is an example: one organizational goal may be a significant rise in sales and profits. When translating that goal into an objective, you might word the objectives as follows: a 15 percent increase in sales for the next three years followed by a 10 percent increase in sales for the following two years and a 12.5 percent increase in profits in each of the next five years. These objectives are quite specific and measurable. It is up to the decision-maker to determine if they are achievable and realistic. These objectives—sales and profits—clearly specify the time horizon. In developing the plan, owners are often very happy to develop goals because they are open to interpretation, but they will avoid objectives. Goals are sufficiently ambiguous, whereas objectives tie you to particular values that you will have to hit in the future. People may be concerned that they will be weighed on a scale and found wanting for failing to achieved their objectives. However, it is critical that your plan contains both goals and objectives. Objectives allow investors and your employees to clearly see where the firm intends to go. They produce targeted values to aim for and, therefore, are critical for the control of the firm’s operations.
Vision and Mission Statements. To many, there is some degree of confusion concerning the difference between a vision statement and a mission statement. Vision statements articulate the long-term purpose and idealized notion of what a business wishes to become. In the earliest days of Microsoft, when it was a small business, its version of a vision statement was as follows: “A computer on every desk and in every home.” In the early 1980s, this was truly a revolutionary concept. Yet it gave Microsoft’s employees a clear idea (vision) that to bring that vision into being, the software being developed would have to be very “user-friendly” in comparison to the software of that day. Mission statements, which are much more common in small business plans, articulate the fundamental nature of the business. This means identifying the type of business, how it will leverage its competencies, and possibly the values that drive the business. Put simply, a mission statement should address the following questions:
• Who are we? What business are we in?
• Who do we see as our customers?
• How do we provide value for those customers?
Sometimes vision and mission statements are singularly written for external audiences, such as investors or shareholders. They are not written for the audience for whom it would have the greatest meaning—the management team and the employees of the business. Unfortunately, many recognize that both statements can become exercises of stringing together a series of essentially meaningless phrases into something that appears to sound right or professional. You can find software on the web to automatically generate such vacuous and meaningless statements.
Sometimes a firm will write a mission statement that provides customers, investors, and employees with a clear sense of purpose of that company. Zappos has the following as its mission statement: “Our goal is to position Zappos as an online service leader. If we can get customers to associate Zappos as the absolute best in service, then we can expand beyond shoes.” “Inc. 500 Mission Statements,” MissionStatements.com, accessed October 10, 2011, www.missionstatements.com/inc_500_mission_statements.html. The mission statement of Ben & Jerry’s Ice Cream focuses both on defining their product and their values: “To make, distribute and sell the finest quality all-natural ice cream and euphoric concoctions with a continued commitment to incorporating wholesome, natural ingredients and promoting business practices that respect the Earth and the Environment.”“Mission Statement,” Ben & Jerry’s, accessed October 10, 2011, www.benjerry.com/activism/mission-statement.
Keys to Success. This section identifies those specific elements of your firm that you believe will ensure success. It is important for you to be able to define the competencies that you intend to leverage to ensure success. What makes your product or service unique? What specific set of capabilities do you bring to the competitive scene? These might include the makeup of and the experience of your management team; your operational capabilities (e.g., unique skills in design, manufacturing, or delivery); your marketing skillsets: your financial capabilities (e.g., the ability to control costs); or the personnel that make up the company.
Industry Review
In this section, you want to provide a fairly comprehensive overview of the industry. A thorough understanding of the industry that you will be operating in is essential to understand the possible returns that your company will earn within that industry. Investors want to know if they will recover their initial investment. When will they see a profit? Remember, investors often carefully track industries and are well aware of the strengths and limitations within a particular industry. Investors are looking for industries that can demonstrate growth. They also want to see if the industry is structurally attractive. This might entail conducting Porter’s five forces analysis; however, this is not required in all cases. If there appear to be some issues or problems with industry level growth, then you might want to be able to identify some segments of the industry where growth is viable.
Products or Services
This section should be an in-depth discussion of what you are offering to customers. It should provide a complete and clear statement of the products or the services that you are offering. It should also discuss the core competencies of your business. You should highlight what is unique, such as a novel product or service concept or the possession of patents. You need to show how your product or service specifically meets particular market needs. You must identify how the product or the service will satisfy specific customers’ needs. If you are dealing with a new product or service, you need to demonstrate what previously unidentified needs it will meet and how it will do so. At its birth, Amazon had to demonstrate that an online bookstore would be preferable to the standard bookstore by offering the customer a much wider selection of books than would be available at an on-site location.
This section could include a discussion of technical issues. If the business is based on a technological innovation—such as a new type of software or an invention—then it is necessary to provide an adequate discussion of the specific nature of the technology. One should take care to always remember the audience for whom you are writing the plan. Do not make this portion too technical in nature. This section also might discuss the future direction of the product or service—namely, where will you be taking (changing) the product or the service after the end of the current planning horizon? This may require a discussion of future investment requirements or the required time to develop new products and services. This section may also include a discussion of pricing the product or the service, although a more detailed discussion of the issue of pricing might be found in the marketing plan section. If you plan to include the issue of pricing here, you should discuss how the pricing of the product or the service was determined. The more detailed you are in this description, the more realistic it will appear to the readers of the business plan. You may wish to discuss relationships that you have with vendors that might have an impact on reducing cost and therefore an impact on price. It is important to discuss how your pricing scheme will compare with competitors. Will it be higher than average or below the average price? How does the pricing fit in with the overall strategy of the firm?
This section must have a high degree of honesty. Investors will know much about the industry and its limitations. You need to identify any areas that might be possible sources of problems, such as government regulations, issues with new product development, securing distribution channels, and informing the market of your existence. Further, it is important to identify the current competitors in the industry and possible future competitors.
Marketing Plan
An introductory marketing course always introduces the four Ps: product, price, place, and promotion. The marketing section of the business plan might provide more in-depth coverage of how the product or the service better meets customer value than that of competitors. It should identify your target customers and include coverage of who your competitors are and what they provide. The comparison between your firm and its competitors should highlight differences and point to why you are providing superior value. Pricing issues, if not covered in the previous section, could be discussed or discussed in more detail.
The issue of location, particularly in retail, should be covered in detail. Perhaps one of the most important elements of the marketing plan section is to specify how you intend to attract customers, inform them of the benefits of using your product or service, and retain customers. Initially, customers are attracted through advertising. This section should delineate the advertising plan. What media will be used—flyers, newspapers, magazines, radio, television, web presence, direct marketing, and/or social media campaigns? This section should cover any promotional campaigns that might be used.
The Management Team
Physical resources are not the only determinant of business success. The human resources available to a firm will play a critical role in determining its success. Readers of your business plan and potential investors should have a clear sense of the management team that will be running a business. They should know the team with respect to the team’s knowledge of the business, their experience and capabilities, and their drive to succeed. Arthur Rock, a venture capitalist, was once quoted as saying, “I invest in people, not the idea.”“Invest in People, Not Ideas,” Michael Karnjanaprakorn, January 15, 2009, accessed October 10, 2011, www.mikekarnj.com/blog/2009/01/15/invest-in-people-not-ideas.
This section of the business plan has several elements. It should contain an organizational chart that will delineate the responsibilities and the chain of command for the business. It should specify who will occupy each major position of the business. You might want to explain who is doing what job and why. For every member of the management team, you should have a complete résumé. This should include educational background (both formal and informal) and past work experience, including the jobs they have held, responsibilities, and accomplishments. You might want to include some other biographical data such as age, although that is not required.
If you plan to use specific advisers or consultants, you should mention the names and backgrounds of these people in this section of the plan. You should also specify why these people are being used.
An additional element of your discussion of the management team will be the intended compensation schemes. You should specify the intended salaries for the management team while also including issues of their benefits and bonuses or any stock position that they may take in the company. This section should also identify any gaps in the management team and how you intend to fill these positions.
Depending on the nature of the business, you might wish to include in this section the personnel (employees) that will be required. You should identify the number of people that are currently working for the firm or that will have to be hired; you should also identify the skills that they need to possess. Further discussion should include the pay that will be provided: whether they will be paid a flat salary or paid hourly, if and when you intend to use overtime, and what benefits you intend to provide. In addition, you should discuss any training requirements or training programs that you will have to implement.
Financial Statements
The financial statements section of the business plan should be broken down into three key subsections: the income statement, the balance sheet, and the cash-flow statement. Before proceeding with these sections, we discuss the assumptions used to build these sections. The opening section of the financial statements section should also include, in summary format, projections of sales, the sales growth rate, key expenses and their growth rates, net income across the forecasting horizon, and assets and liabilities.Amir M Hormozi, Gail S. Sutton, Robert D. McMinn, Wendy Lucio, “Business Plans for New or Small Businesses: Paving the Path to Success,” Management Decision 40, no. 8 (2002): 755.
As previously discussed, bankers—and to lesser extent venture capitalists—will be primarily concerned with this section of the business plan. It is vital that this section—whether you are an existing business seeking more funding or a start-up—have realistic financial projections. The business plan should contain clear statements of the underlying assumptions that were used to make these financial projections. The clearer the statements and the more realistic the assumptions behind these statements, then the greater the confidence the reader will have in these projections. Few businesspeople have a thorough understanding of these financial statements; therefore, it is advisable that someone with an accounting or a financial background review these statements before they are included in the report. We will have a much more in-depth discussion of these statements in Accounting and Cash Flow".
The future planning horizon for financial projections is normally between three and five years. The duration that you will use will depend on the amount of capital that the business is seeking to raise, the type of industry the business is in, and the forecasting issues associated with making projections. Also, the detail required in these financial statements will be directly tied to the type and size of the business.
Income Statement
The income statement examines the overall profitability of a firm over a particular period of time. As such, it is also known as a profit-and-loss statement. It identifies all sources of revenues generated and expenses incurred by the business. For the business plan, one should generate annual plans for the first three to five years. Some suggest that the planner develop more “granulated” income statements for the first two years. By granulated, we mean that the first year income statement should be broken down on a monthly basis, while the second year should be broken down on a quarterly basis.
Some of the key terms (they will be reviewed in much greater detail in "Financial Management" found in the income statement are as follows:
• Income. All revenues and additional incomes produced by the business during the designated period.
• Cost of goods sold. Costs associated with producing products, such as raw materials and costs associated directly with production.
• Gross profit margin. Income minus the cost of goods sold.
• Operating expenses. Costs in doing business, such as expenses associated with selling the product or the service, plus general administration expenses.
• Depreciation. This is a special form of expense that may be included in operating expenses. Long-term assets—those whose useful life is longer than one year—decline in value over time. Depreciation takes this fact into consideration. There are several ways in which this declining value can be determined. It is a noncash expenditure expense.
• Total expenses. The cost of goods sold plus operating expenses and depreciation.
• Net profit before interest and taxes. This is the gross profit minus operating expenses; another way of stating net profit is income minus total expenses.
• Interest. The required payment on all debt for the period.
• Taxes. Federal, state, and local tax payments for the firm.
• Net profit. This is the net profit after interest and taxes. This is the term that many will look at to determine the potential success of business operations.
Balance Sheet
The balance sheet examines the assets and liabilities and owner’s equity of the business at some particular point in time. It is divided into two sections—the credit component (the assets of the business) and the debit component (liabilities and equity). These two components must equal each other. The business plan should have annual balance sheet for the three- or five-year planning horizon. The elements of the credit component are as follows:
• Current assets. These are the assets that will be held for less than one year, including cash, marketable securities, accounts receivable, notes receivable, inventory, and prepaid expenses.
• Fixed assets. These assets are not going to be turned into cash within the next year; these include plants, equipment, and land. It may also include intangible assets, such as patents, franchises, copyrights, and goodwill.
• Total assets. This is the sum of current assets and fixed assets.
Liabilities consist of the following:
• Current liabilities. These are debts that are to be paid within the year, such as lines of credit, accounts payable, other items payable (including taxes, wages, and rents), short-term loans, dividends payable, and current portion of long-term debt.
• Long-term liabilities. These are debts payable over a period greater than one year, such as notes payable, long-term debt, pension fund liability, and long-term lease obligations.
• Total liabilities. This is the sum of current liabilities and long-term liabilities.
• Owner’s equity. This represents the value of the shareholders’ ownership in the business. It is sometimes referred to as net worth. It may be composed of items such as preferred stock, common stock, and retained earnings.
Cash-Flow Statement
From a practical and survival standpoint, the cash-flow statement may be the most important component of the financial statements. The cash-flow statement maps out where cash is flowing into the firm and where it flows out. It recognizes that there may be a significant difference between profits and cash flow. It will indicate if a business can generate enough cash to continue operations, whether it has sufficient cash for new investments, and whether it can pay its obligations. Businesspeople soon realize that profits are nice, but cash is king.
Cash flows can be divided into three areas of analysis: cash flow from operations, cash flow from investing, and cash flow from financing. Cash flow from operations examines the cash inflows from revenues and interest and dividends from investments held by the business. It then identifies the cash outflows for paying suppliers, employees, taxes, and other expenses. Cash flow from investing examines the impact of selling or acquiring current and fixed assets. Cash flow from financing examines the impact on the cash position from the changes in the number of shares and changes in the short- and long-term debt position of the firm. Given the critical importance of cash flow to the survival of the small business, it will be covered in much more detail in "Financial Management".
Additional Information
Depending on the nature of the business and the amount of funding that is being sought, the plan might include more materials. For an existing business, you may wish to include past tax statements and/or personal financial statements. If the business is a franchise, you should include all legal contracts and documents. The same should be done for any leasing, licensing, or rent agreements. This section should be seen as a catchall incorporating any materials that would support the plan. One does not want to be in the position of being asked by readers of the plan—“Where are these documents?”
Appendixes
The financial section of the business plan should include summaries of the three key financial elements. The details behind the financial statements should be included as an appendix along with clear statements concerning the assumptions that were used to build them. The appendixes may also include different scenarios that were considered in building the plan, such as alternative market growth assumptions or alternative competitive environments. Demonstrating that the author(s) considered “what-if” situations tells potential investors that the business is prepared to handle changing conditions. It should include items such as logos, diagrams, ads, and organizational charts.
Developing Scenarios
Change is constant.
Benjamin Disraeli
Business plans are analyses of the future; they can err on the side of either optimistic projections or conservative projections. From the standpoint of the potential investor, it is always better to err on the side of conservatism. Regardless of either bias, business plans are generally built on the basis of expected futures and past experience. Unfortunately, the future does not always emerge in a clearly predicated manner. One can have a dramatic change that can have significant impact on the business. Often such changes occur in the external environment and are beyond the control of the business management team. These external changes can occur within the technical environment; it can be based on changes in customer needs, changes with respect to the suppliers, changes in the economic environment—at the local, national, or global level. Dramatic change can also occur within the organization itself—the death of the owner or members of the management team.“Workshops and Events,” SCORE, accessed October 10, 2011, www.score.org/events/workshops.
One way for an organization to deal with significant changes is a process known as scenario planning. The real origins of scenario planning can be traced back to the early nineteenth century activity known as Kreigsspiel—war gaming—a system for training officers developed by the Prussian command. This process of looking at future wars was adopted by many militaries in the later nineteenth century. In the 1950s, a more formal format was used at the RAND Institute for examining possible future changes in the military and geopolitical environments. The early 1980s saw it applied to industrial settings. Royal Dutch Shell examined the question of what would happen if there were a significant drop in the price of oil. This was after two oil crises that pushed the price of oil up significantly. The notion that oil prices would drop was considered to be an extremely unlikely event, but it did occur. Royal Dutch Shell was one of the few oil companies that did not suffer because its scenario analyses enabled them to be ready to deal with that situation.P. McNamee, Tools and Techniques for Strategic Management (New York: Pergamon Press, 1985), 187.
What could be the possible use of scenario planning for small businesses? There are several areas in which small businesses should apply scenario planning to be better prepared for future disruptions.
Identify Significant Changes That Might Impact the Business
Consider major shifts in the customer’s notion of value. As mentioned in "Your Business Idea: The Quest for Value", the firm should always be examining what constitutes value in the eyes of the consumer and how that might shift. Henry Ford’s model T car was a global success because customers initially valued a reliable vehicle at a low price. Ford Motor Company continued to meet the customer’s notion of value by constantly driving down the unit cost. However, by the mid-1920s, customers’ notion of value included not only price but also issues such as styling and improved technologies. General Motors was able to recognize that there were changes in the customer’s value notion and provided them with a range of vehicles. Ford failed to recognize that change and suffered a significant drop in sales.
Shifts in the economic environment. The recent recession clearly indicates that economies can suffer significant shifts in a short period of time. These shifts can have dramatic impact on all business operations. Small-business owners have seen significant tightening of bank credit and changes with respect to the requirements for using credit cards. One could easily imagine the critical importance for small businesses to consider the impacts that would follow significant changes in interest rates. Southwest Airlines, in anticipation of possible fluctuations in oil prices, used futures contracts to deal with dramatic shifts in the price of oil. When oil prices rose significantly, they were in a much better position than their competitors.
The entrance of new competitors. Small businesses should always be ready to consider the impact of facing new competitors and new types of competition. Consider the case of small local retail outlets when a Walmart superstore opens in the area.
Consideration of Disasters
The best way to deal with any potential disaster is not while it is occurring or after it has happened but before it occurs. Small businesses should anticipate what they will do in the case of physical disasters, such as fire, earthquakes, or floods. Other disasters might involve the bankruptcy or loss of a major supplier or a major customer. A restaurant or a food market should have a contingency plan in the case of a power failure that might lead to food spoilage. Such a business might also want to conduct a scenario planning exercise to see what its responses would be in the case of a customer complaining of food poisoning. Other disaster scenarios that should be considered by small businesses include the impact and ramifications of having the computer system crash; having the service for the website crash; or having the website hacked, with the possible loss of customer information.
New Opportunities
Almost all businesses, large and small, must be prepared to seize new opportunities. This may mean that they have to consider the impact of technological change on the business or how technology can offer them new business opportunities. The technology of stereo lithography, a process by which three-dimensional objects are built layer by layer, has been available for more than a decade. Bespoke Innovations saw the potential for using this technology. Bespoke Innovations can develop, in a short period of time, custom artificial legs for a price of \$5,000–\$6,000 and with features that are not found in \$60,000 prostheses.Ashlee Vance, “A Technology Sets Inventors Free to Dream,” New York Times, September 14, 2010.
Scenario planning should be a periodic exercise, but it should be conducted no more than once a year. The actual frequency might be dependent on the perceived rate of change for the industry or the presence of storm clouds on the horizon. Scenario planning has several distinct activities, which may be as follows:
• Pick one area that might occur in the future that would have significant impact on the business. What if the national joblessness rate remains at over 9 percent for the next three to five years? What if a major customer decides to buy from a competitor or that customer is in financial trouble? What if there are changes in the national defense budget? A luncheonette in New London, Connecticut, where Electric Boat builds nuclear submarines, wants to consider the impact of changes in the defense budget. A decrease in the budget for building nuclear submarines would reduce the number of subs made in New London, which might lead to layoffs at Electric Boat and fewer customers for the luncheonette.
• Identify factors that might impact that issue. This sometimes is referred to as a PEST analysis, where the P stands for political issues, E stands for economic issues, S stands for sociocultural issues, and T stands for technology issues. Each factor would be analyzed to see how it might impact the scenario. In our previous luncheonette example, the restaurant might want to consider an upcoming election to see how each party would support defense appropriations, and it might look at the overall economy to determine whether a downturn in the economy might lead to a cut in defense appropriations. It is unlikely that sociocultural issues would impact defense appropriations. Technology issues, whether a breakthrough in some design by the United States or by some other country, might determine the number and location of submarines built in the United States.
• Rank the relative importance of the previous factors. Not all factors under consideration can be considered equally important. It is critical in a scenario planning exercise to see which factors are most important so that decision makers can focus on the ramifications of those factors in the analysis.
• Develop scenarios. Having identified the relative importance of the factors, the next stage would be to develop a limited number of possible scenarios (no more than two or three). Each scenario would map out possible outcomes for each key factor. Based on these values, the group conducting the scenario planning exercise would develop insights into this possible future world.
• How do the scenarios impact your business? For each future scenario, the team should examine how that possible future state would impact the operation of the business. Continuing with the luncheonette example, the owner might see that a particular political party would be elected in the next election and the economy will still be in the doldrums. Together, this might indicate a cut in the naval building budget. This will translate into a reduced number of submarines built in New London and a reduction in employment at Electric Boat. The luncheonette’s sales will obviously drop off. Now the owner must consider what it might do in that situation.
Scenario planning offers the opportunity for small business owners to examine the future on a long-term basis. It should force them to look at external environments and conditions that can have a dramatic impact on the survival of their firm. It broadens their thinking and creates an environment of increased flexibility. It enables a business to respond to those sudden shocks that might destroy other firms.
Computer Aids
Business plans can be built using a combination of word-processing and spreadsheet programs by those who are adept at using them. However, the entire process of constructing a comprehensive business plan can be greatly simplified by using a dedicated business plan software package. These packages are designed to produce reports that have all the required sections for a business plan, they greatly facilitate the creation of the financial statements with charts, and they often allow for the inclusion of materials from other programs. Most of them are fairly reasonably priced from \$50 to \$150.
There are many such packages on the market, and they range from those designed for novices to those that can generate annual plans by easily incorporating data from external sources, such as the accounting programs of a business. When evaluating competing programs, there are some primary and secondary factors that should be considered.“2012 Business Plan Software Product Comparisons,” TopTenReviews.com, accessed October 10, 2011, business-plan-software-review.toptenreviews.com. The primary factors are as follows:
• Ease of building the report. The various sections of the report should be clearly identified, and the authors should be able to work on each section independent of their sequence within the report. Text and data entry should be simple and allow for easy corrections or revisions.
• Financial statements. The software should facilitate building the income statement, the balance sheet, and the cash-flow statement. For multiyear projections, the software should support the forecasting process.
• Import from other programs. The software should be able to incorporate data from a variety of programs, such as Word and Excel. Ideally, it should be able to import data from a variety of accounting programs.
• Support services. The software company should bundle a variety of support services, including clear instructions, tutorials, and access to Internet or call-number support. Many packages provide sample business plans for different industries.
The secondary factors are as follows:
• Access to research support. Some software packages include access to business publications and databases to aid with market research.
• Export options. These packages allow for the report or parts of the report to be exported to different formats—Word, Excel, PowerPoint, HTML, or PDF.
• Ancillary analysis tools. Some packages either directly include or offer additional programs for market planning, budgeting, or valuation.
The following is a partial listing of companies that have business planning software:
• Small Business Point. This company offers business planning software and the opportunity for them to build your plan for you.
• Business Plan Pro. This company provides business planning software with sample plans for a wide number of industries plus options for acquiring industry data at national, state, or local levels. The company also has programs for marketing planning and legal issues advice.
• Business Plan Software. This company offers a number of products, including business planning software, a strategic planning program, financial projection and cash-flow forecasting programs, and marketing planning software.
• JIAN Biz Plan. This company’s products include business planning programs, software for human resources, marketing planning programs, and contract development software.
• PlanWrite. In addition to offering programs for business, strategic, and marketing planning, this company has products that provide advice in the area of sales strategy and pricing.
• Plan Magic. This company offers a suite of planning products ranging from particular industries to financial and marketing planning software.
KEY TAKEAWAYS
• The business planning for a start-up business should consider if the owner(s) is/are ready to accept the challenges of operating a business.
• Comprehensive business plans will require information about the industry, competitors, and customers. Owners or the writers of the business plan should be aware of where they can obtain this information.
• Forecasting is critical to the success of any business. There are many different approaches to forecasting: some are simple extrapolations of trends, while others can be computationally complex. The business should use a forecasting system that is not only accurate but also makes the users feel comfortable.
• Although business plans come in different “sizes and shapes,” they should have some key sections: executive summary, mission statement, industry analysis, marketing plan, description of the management team, and financial projections.
• Some businesses should make it a practice of conducting scenario analyses. This is a process of examining possible future events and what should be the response of the business.
• The complexity and difficulty of building a comprehensive business plan can be significantly reduced by using one of the available business-planning software packages.
EXERCISES
1. In Exercise 2 of "Developing our Strategy", you were asked to interview five local business owners. In addition to asking them questions about strategy, please ask them the following questions: (a) How do they forecast their sales? (b) Inventory? (c) Economic conditions? (d) Have they ever conducted anything like a scenario analysis or formally considered what they would do if an emergency struck—fire, flood, death of a business partner, and so forth?
2. Go to the Appendix ("Appendix: A Sample Business Plan"), which contains Robert Rainsford’s business plan. (You will be asked to examine portions of this report throughout the text to evaluate different sections.)
1. Read his executive summary and critique it. How would you improve it?
2. Evaluate the document’s vision and mission statements. Are there any major problems? How would you improve them?
3. Evaluate the industry analysis section of the report. What additional data could be used in this section of the report? Where would you suggest that Robert go to get the data?
3. Imagine that you are going to start a business and that you want a great looking plan. Evaluate three of the business plan software packages. Based on your evaluation, write a report that describes their strengths and weaknesses. Which would you select and why? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/05%3A_The_Business_Plan/5.04%3A_Building_a_Plan.txt |
Learning Objectives
1. Learn that the planning process can add significantly to the delivery of customer value.
2. Understand that the proper management of the cash flow of a business can occur only in an environment of comprehensive planning.
3. Understand that although not all businesses will rely on e-business or e-commerce, they should carefully plan their inclusion into a firm’s operations.
The business plan is the backbone of both start-up and existing businesses. The initial business plan forces one to consider the core issues in detail. These issues directly relate to the themes that are stressed throughout this text: customer value; cash flow; and digital technologies, e-commerce, and e-business. Building a good initial business plan requires the author(s) to seriously consider these three themes. It must be pointed out that these themes must be reviewed regularly as part of a continuous planning process. A great mistake of many small businesses is that they may begin with a formal plan, but they abandon the concept after receiving initial funding. Regardless of the industry or the business size, formally thinking about these themes in the context of planning is essential.
Customer Value
Businesses survive because they provide value to customers. To begin a business, one should have a clear vision as to what constitutes value to the targeted customers. The initial business plan must be able to articulate this vision. However, that notion of value can change over time. Customers’ perceptions of value can evolve or change radically. Competitors can change what they offer customers, and the firm itself can acquire or lose capabilities that were used to provide value. This shifting value landscape does not allow any business to adhere to its initial plan as though it were dogma. Evaluations of customer value must be conducted regularly as part of an annual planning process.
Cash-Flow Implications
It cannot be repeated too often nor overemphasized: the survival of a small business often hinges on its ability to successfully manage its cash flow. Balancing cash inflows with outflows is not something that can be done in an ad hoc fashion. It requires a plan. Because one cannot count on accuracy in long-range forecasts, or even short-range forecasts, examining your cash flow must become part of an ongoing planning process. The text has promoted the idea of small businesses having annually updated plans. In the case of cash-flow calculations, it might be advisable for small firms to update their cash-flow analyses monthly.
The Influence of E-Commerce and E-Business
Not all firms will have the same commitment to e-commerce or e-business options. The level of commitment will be determined not so much by size, but by the nature of the business, the knowledge and experience of the owner(s) and the management team, and the firm’s growth objectives. However, given the declining costs for website development and hosting, and the increasing ease of using tools such as social media, web store sales management, and customer relationship management,Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson/Prentice Hall, 2008), 759. it would be odd if these options were not considered in the planning process. This is not to say that all small businesses must include them in their initial business plan, but the integration of e-commerce or e-business can be an evolutionary process that can be made much easier by thoughtful planning.
KEY TAKEAWAYS
• The planning process for a small business must always incorporate the notion of customer value and recognize that this notion can change over time.
• The proper management of a firm’s cash flow requires a commitment to planning the management of one’s cash flow.
• Although e-business and e-commerce options may not be considered in the original plan for a business, if they are eventually considered, their successful implementation will require a detailed plan.
EXERCISES
1. In Question 2 of Exercise 5.1, you were asked to interview five local business owners. Ask them how they manage to identify how customer needs might change over time and how they would plan on responding to such changes.
2. While interviewing them, ask how they go about managing their cash flow. Ask how far ahead they plan their cash-flow management.
3. If they have a website, ask how they planned for its creation and use.
Disaster Watch
The man who is prepared has his battle half won.
Miguel de Cervantes
When failure is not an option, then planning is a necessity. A well-built plan enables the management team of a business to fully anticipate what problems they may encounter and what will be required of them to make the firm successful. There are an almost innumerable number of factors that can become a disaster for a business, but solid planning can significantly reduce that number. A good plan should also force the owner and the management team to anticipate major areas of concern that can become disasters, such as the following:
• Are the participants ready? For the prospective first-time business owner, the task of building a business plan should provide valuable insights into what will be required to make the business function. The plan should indicate the necessary initial funding and the work commitment necessary for success.
• Unrealistic expectations. A thoughtful plan should eliminate assumptions or outcomes that cannot be supported after careful consideration or analysis. It may be sound that your sales will grow by 100 percent every year for five years or that you will recoup your investment in six months, but some simple running of numbers might show that those are impossible outcomes. Simply “forcing” someone to articulate such assumptions can help return him or her to a more realistic vision of the world. Better yet, have some outside sets of “eyes”—friends, other businesspeople, your lawyer, or your accountant—review the plan.
• Determining whether the business will be profitable. The financial analysis section of your plan should indicate when a start-up will become profitable or how much profit a business will make. This is of great importance to potential investors and to the owner.
• Not truly understanding the market by failing to know how customers determine value. The business plan requires that one clearly identifies who the targeted customers are and how the business will provide greater value than its competitors. Plans force owners and managers to specifically articulate how they will serve their customer base. Without clearly stating these key points, any business is headed for disaster because having some sort of “hunch” or “idea” about your customers and their needs is not enough.
• Failure to adequately capitalize the business. The overwhelming consensus is that small businesses “fail” for two main reasons: inadequate management (often attributed to a failure to plan) and insufficient capitalization. Start-ups often underestimate the required capital to begin operations and continue operations for the foreseeable horizon. A structured plan requires them to consider what will be needed during the next few years.
• Not determining the cash flow. The lifeblood of any business is its cash flow. This is particularly true for small businesses. Anticipating a firm’s cash inflows and outflows is not something that can be handled in an intuitive fashion. It requires analysis. Misjudging these two flows is, perhaps, the surest recipe for disaster.
• Failure to create the appropriate management structure. Small-business owners are often accused of wanting complete control of all aspects of their firm’s operations. For microsized small businesses, this may be feasible, but as the firm’s size increases, it is critical that lines of responsibility be clearly drawn. Managers and employees must know what is expected of them and their responsibilities. A failure to do so produces confusion and conflict—another good recipe for disaster. If the formal delineation of the management structure is not part of a plan, then it is highly unlikely that necessary clarity will arise spontaneously.
Managers in businesses both small and large often complain of “firefighting” problems; unfortunately, many of these problems are a result of inadequate or nonexistent planning. In the case of the smaller enterprise, a small blaze can rapidly become an inferno that can lead to disaster. According to a report released by the Epicurus Institute, “when a business starts or operates without a plan, the principles are not prepared to deal with the slightest problem that can affect their business.” | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/05%3A_The_Business_Plan/5.05%3A_The_Three_Threads.txt |
Max and Mina’s Homemade Ice Cream and Ices
Growing up in the 1970s, Bruce and Mark Becker loved ice cream. Their Grandpa Max used to create all different kinds of ice cream for Grandma Mina and the boys to try. Grandpa was an organic chemist and loved to create some interesting flavors. Years later, after Grandpa Max passed away, Bruce was cleaning out his grandpa’s house and discovered his secret book of recipes.
And so it began.
In the 1980s, Bruce started on his journey and traveled throughout Europe and the United States doing gourmet ice cream research. With all the new information gathered and the treasure trove of Grandpa Max’s secret recipes, Bruce and Mark opened Max and Mina’s Ice Cream in 1997 in a shopping center next to Shimon’s Pizza Falafel Dairy Restaurant in Flushing, Queens, New York. They test marketed their recipes directly to the public. The public loved it—and so did the local restaurants and party planners.
Max and Mina’s Ice Cream revolutionized America’s favorite dessert with daring ingredients and bold innovation. Their unique ability to intrigue and challenge old notions of mundane flavors draws unbelievable attention at home in New York and around the globe. The most distant customer of note was from Australia, someone who insisted on going to Max and Mina’s right off the plane at Kennedy Airport.
The Beckers make their ice cream products with at least 16 percent butterfat, putting them into the gourmet category. All their ice creams are kosher, but some products adhere to even stricter dairy guidelines. The shop itself features an array of posters, a display of Wacky Packages bubblegum stickers, candy wrappers, a Jerry Garcia etching, and old-fashioned signs.
A visit to Max and Mina’s will be an unusual ice cream experience. If you dare to take the plunge, why not try unforgettable flavors like beer, lox, babka, corn-on-the-cob, ketchup, garlic, or merlot—just to mention a few? There are also many of the more traditional flavors that you know and love. There is a rotating menu of one thousand flavors, but only about forty ice cream flavors and eight to ten sorbets are available at any one time. Bruce and Mark constantly encourage their patrons to be vocal in brainstorming new flavors, especially flavors that compliment events. Turkey ice cream, anyone? Have an idea? Stop by and give Max and Mina’s a try.“About Us,” Max and Mina’s Ice Cream, accessed December 2, 2011, www.maxandminasicecream.com/about.html; Miriam Hill, “1000 Flavors and a Little Romance,” Philadelphia Inquirer, accessed December 2, 2011, www.maxandminasicecream.com/images/articles/4.jpg; John Hyland, “Lox in a Cone: Sliced Thin It’s Not,” New York Times, August 16, 2000, accessed December 2, 2011, www.maxandminasicecream.com/images/articles/1.jpg.
Video Clip \(1\)
Max and Mina’s Ice Cream
An ice cream revolution.
6.02: What Marketing Is All About
Learning Objectives
1. Define marketing.
2. Explain why marketing is so important to small business.
3. Explain the marketing concept, the societal marketing concept, and the holistic marketing concept.
4. Define customer value and discuss the role of marketing and delivering it.
5. Explain market segmentation, target market, marketing mix, differentiation, positioning, marketing environment, marketing management, and marketing strategy.
Because the purpose of business is to create a customer, the business enterprise has two—and only two—basic functions: marketing and innovation. Marketing and innovation produce results; all the rest are costs. Marketing is the distinguishing, unique function of the business.Jack Trout, “Peter Drucker on Marketing,” Forbes, July 3, 2006, accessed January 19, 2012, www.forbes.com/2006/06/30/jack-trout-on-marketing-cx_jt_0703drucker .html.
Peter Drucker
Marketing is defined by the American Marketing Association as “the activity, set of institutions, and processes for creating, communicating, and exchanging offerings that have value for customers, clients, partners, and society at large.”“AMA Definition of Marketing,” American Marketing Association, December 17, 2007, accessed December 1, 2011, www.marketingpower.com/Community/ARC/Pages/Additional/Definition/default.aspx. Putting this formality aside, marketing is about delivering value and benefits: creating products and services that will meet the needs and wants of customers (perhaps even delighting them) at a price they are willing to pay and in places where they are willing to buy them. Marketing is also about promotional activities such as advertising and sales that let customers know about the goods and services that are available for purchase. Successful marketing generates revenue that pays for all other company operations. Without marketing, no business can last very long. It is that important and that simple—and it applies to small business.
Marketing is applicable to goods, services, events, experiences, people, places, properties, organizations, businesses, ideas, and information.Adapted from Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 6–7.
There are several concepts that are basic to an understanding of marketing: the marketing concept, customer value, the marketing mix, segmentation, target market, the marketing environment, marketing management, and marketing strategy.
The Marketing Concept…and Beyond
The marketing concept has guided marketing practice since the mid-1950s.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 19. The concept holds that the focus of all company operations should be meeting the customer’s needs and wants in ways that distinguish a company from its competition. However, company efforts should be integrated and coordinated in such a way to meet organizational objectives and achieve profitability. Perhaps not surprisingly, successful implementation of the marketing concept has been shown to lead to superior company performance.Rohit Deshpande and John U. Farley, “Measuring Market Orientation: Generalization and Synthesis,” Journal of Market-Focused Management 2 (1998): 213–32; Ajay K. Kohli and Bernard J. Jaworski, “Market Orientation: The Construct, Research Propositions, and Managerial Implications,” Journal of Marketing 54 (1990): 1–18; and John C. Narver and Stanley F. Slater, “The Effect of a Market Orientation on Business Profitability,” Journal of Marketing 54 (1990): 20–35—all as cited in Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 19. “The marketing concept recognizes that there is no reason why customers should buy one organization’s offerings unless it is in some way better at serving the customers’ wants and needs than those offered by competing organizations. Customers have higher expectations and more choices than ever before. This means that marketers have to listen more closely than ever before.”Charles W. Lamb, Joseph F. Hair, and Carl McDaniel, Essentials of Marketing (Mason, OH: South-Western, 2004), 8.
Sam Walton, the founder of Walmart, put it best when he said, “There is only one boss: the customer. And he can fire everybody in the company, from the chairman on down, simply by spending his money somewhere else.”“You Don’t Say?,” Sales and Marketing Management, October 1994, 111–12. Small businesses are particularly suited to abiding by the marketing concept because they are more nimble and closer to the customer than are large companies. Changes can be made more quickly in response to customer wants and needs.
The societal marketing concept emerged in the 1980s and 1990s, adding to the traditional marketing concept. It assumes that a “company will have an advantage over competitors if it applies the marketing concept in a manner that maximizes society’s well-being”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 12. and requires companies to balance customer satisfaction, company profits, and the long-term welfare of society. Although the expectation of ethical and responsible behavior is implicit in the marketing concept, the societal marketing concept makes these expectations explicit.
Small business is in a very strong position in keeping with the societal marketing concept. Although small businesses do not have the financial resources to create or support large philanthropic causes, they do have the ability to help protect the environment through green business practices such as reducing consumption and waste, reusing what they have, and recycling everything they can. Small businesses also have a strong record of supporting local causes. They sponsor local sports teams, donate to fund-raising events with food and goods or services, and post flyers for promoting local events. The ways of contributing are virtually limitless.
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Do Well While Doing Good
Small business sustainability practices.
The holistic marketing concept is a further iteration of the marketing concept and is thought to be more in keeping with the trends and forces that are defining the twenty-first century. Today’s marketers recognize that they must have a complete, comprehensive, and cohesive approach that goes beyond the traditional applications of the marketing concept.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 19. A company’s “sales and revenues are inextricably tied to the quality of each of its products, services, and modes of delivery and to its image and reputation among its constituencies. [The company] markets itself through everything it does, its substance as well as its style. It is that all-encompassing package that the organization then sells.”Charles S. Mack, “Holistic Marketing,” Association Management, February 1, 1999, accessed January 19, 2012, www.asaecenter.org/Resources/AMMagArticleDetail.cfm?ItemNumber=880. What we see in the holistic marketing concept is the traditional marketing concept on steroids. Small businesses are natural for the holistic marketing concept because the bureaucracy of large corporations does not burden them. The size of small businesses makes it possible, perhaps imperative, to have fluid and well-integrated operations.
Customer Value
The definition of marketing specifically includes the notion that offerings must have value to customers, clients, partners, and society at large. This necessarily implies an understanding of what customer value is. Customer value is discussed at length in Chapter 2 "Your Business Idea: The Quest for Value", but we can define it simply as the difference between perceived benefits and perceived costs. Such a simple definition can be misleading, however, because the creation of customer value will always be a challenge—most notably because a company must know its customers extremely well to offer them what they need and want. This is complicated because customers could be seeking functional value (a product or a service performs a utilitarian purpose), social value (a sense of relationship with other groups through images or symbols), emotional value (the ability to evoke an emotional or an affective response), epistemic value (offering novelty or fun), or conditional value (derived from a particular context or a sociocultural setting, such as shared holidays)—or some combination of these types of value. (See Chapter 2 "Your Business Idea: The Quest for Value" for a detailed discussion of the types of value.)
Marketing plays a key role in creating and delivering value to a customer. Customer value can be offered in a myriad of ways. In addition to superlative ice cream, for example, the local ice cream shop can offer a frequent purchase card that allows for a free ice cream cone after the purchase of fifteen ice cream products at the regular price. Your favorite website can offer free shipping for Christmas purchases and/or pay for returns. Zappos.com offers free shipping both ways for its shoes. The key is for a company to know its consumers so well that it can provide the value that will be of interest to them.
Market Segmentation
The purpose of segmenting a market is to focus the marketing and sales efforts of a business on those prospects who are most likely to purchase the company’s product(s) or service(s), thereby helping the company (if done properly) earn the greatest return on those marketing and sales expenditures.Center for Business Planning, “Market Segmentation,” Business Resource Software, Inc., accessed December 1, 2011, www.businessplans.org/segment.html. Market segmentation maintains two very important things: (1) there are relatively homogeneous subgroups (no subgroup will ever be exactly alike) of the total population that will behave the same way in the marketplace, and (2) these subgroups will behave differently from each other. Market segmentation is particularly important for small businesses because they do not have the resources to serve large aggregate markets or maintain a wide range of different products for varied markets.
The marketplace can be segmented along a multitude of dimensions, and there are distinct differences between consumer and business markets. Some examples of those dimensions are presented in Table \(1\):
LifeLock, a small business that offers identity theft protection services, practices customer type segmentation by separating its market into business and individual consumer segments.
Table \(1\): Market Segmentation
Consumer Segmentation Examples Business Segmentation Examples
Geographic Segmentation
• Region (e.g., Northeast or Southwest)
• City or metro size (small, medium, or large)
• Density (urban, suburban, or rural)
• Climate (northern or southern)
Demographic Segmentation
• The industry or industries to be served
• The company sizes to be served (revenue, number of employees, and number of locations)
Demographic Segmentation
• Age
• Family size
• Family life cycle (e.g., single or married without kids)
• Gender
• Income
• Occupation
• Education
• Religion
• Race/ethnicity
• Generation
• Nationality
• Social class
Operating Variables
• The customer technologies to be focused on
• The users that should be served (heavy, light, medium, or nonusers)
• Whether customers needing many or few services should be served
Psychographic Segmentation
• Personality
• Lifestyle
• Behavioral occasions (regular or special occasion)
• Values
Purchasing Approaches: Which to Choose?
• Highly centralized versus decentralized purchasing
• Engineering dominated, financially dominated, and so forth
• Companies with whom a strong relationship exists or the most desirable companies
• Companies that prefer leasing, service contracts, systems purchases, or sealed bidding
• Companies seeking quality, service, and price
Behavioral Segmentation
• Benefits of the product (e.g., toothpaste with tartar control)
• User status (nonuser, regular user, or first-time user)
• Usage rate (light user, medium user, or heavy user)
• Loyalty status (none, medium, or absolute)
• Attitude toward the product (e.g., enthusiastic or hostile)
Situational Factors: Which to Choose?
• Companies that need quick and sudden delivery or service
• Certain application of the product instead of all applications
• Large or small orders or something in-between
Personal Characteristics: Which to Choose?
• Companies with similar people and values
• Risk-taking or risk-aversive customers
• Companies that show high loyalty to their suppliers
Other Characteristics
• Status in industry (technology or revenue leader)
• Need for customization (specialized computer systems)
Source: Adapted from “Market Segmentation,” Business Resource Software, Inc., accessed December 2, 2011, www.businessplans.org/segment.html; adapted from Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 214, 227.
Market segmentation requires some marketing research. The marketing research process is discussed in Section 6.3 "Marketing Research".
Target Market
Market segmentation should always precede the selection of a target market. A target market is one or more segments (e.g., income or income + gender + occupation) that have been chosen as the focus for business operations. The selection of a target market is important to any small business because it enables the business to be more precise with its marketing efforts, thereby being more cost-effective. This will increase the chances for success. The idea behind a target market is that it will be the best match for a company’s products and services. This, in turn, will help maximize the efficiency and effectiveness of a company’s marketing efforts:
It is not feasible to go after all customers, because customers have different wants, needs and tastes. Some customers want to be style leaders. They will always buy certain styles and usually pay a high price for them. Other customers are bargain hunters. They try to find the lowest price. Obviously, a company would have difficulty targeting both of these market segments simultaneously with one type of product. For example, a company with premium products would not appeal to bargain shoppers…
Hypothetically, a certain new radio station may discover that their music appeals more to 34–54-year-old women who earn over \$50,000 per year. The station would then target these women in their marketing efforts.Rick Suttle, “Define Market Segmentation & Targeting,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/define-market-segmentation-targeting-3253 .html.
Target markets can be further divided into niche markets. A niche market is a small, more narrowly defined market that is not being served well or at all by mainstream product or service marketers. People are looking for something specific, so target markets can present special opportunities for small businesses. They fill needs and wants that would not be of interest to larger companies. Niche products would include such things as wigs for dogs, clubs for left-handed golfers, losing weight with apple cider vinegar, paint that transforms any smooth surface into a high performance dry-erase writing surface, and 3D printers. These niche products are provided by small businesses. Niche ideas can come from anywhere.
Marketing Mix
Marketing mix is easily one of the most well-known marketing terms. More commonly known as “the four Ps,” the traditional marketing mix refers to the combination of product, price, promotion, and place (distribution). Each component is controlled by the company, but they are all affected by factors both internal and external to the company. Additionally, each element of the marketing mix is impacted by decisions made for the other elements. What this means is that an alteration of one element in the marketing mix will likely alter the other elements as well. They are inextricably interrelated. No matter the size of the business or organization, there will always be a marketing mix. The marketing mix is discussed in more detail in "Marketing Strategy". A brief overview is presented here.
Product
Product refers to tangible, physical products as well as to intangible services. Examples of product decisions include design and styling, sizes, variety, packaging, warranties and guarantees, ingredients, quality, safety, brand name and image, brand logo, and support services. In the case of a services business, product decisions also include the design and delivery of the service, with delivery including such things as congeniality, promptness, and efficiency. Without the product, nothing else happens. Product also includes a company’s website.
Price
Price is what it will cost for someone to buy the product. Although the exchange of money is what we traditionally consider as price, time and convenience should also be considered. Examples of pricing decisions include pricing strategy selection (e.g., channel pricing and customer segment pricing), retail versus wholesale pricing, credit terms, discounts, and the means of making online payments. Channel pricing occurs when different prices are charged depending on where the customer purchases the product. A paper manufacturer may charge different prices for paper purchased by businesses, school bookstores, and local stationery stores. Customer segment pricing refers to charging different prices for different groups. A local museum may charge students and senior citizens less for admission.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 401.
Promotion
Having the best product in the world is not worth much if people do not know about it. This is the role of promotion—getting the word out. Examples of promotional activities include advertising (including on the Internet), sales promotion (e.g., coupons, sweepstakes, and 2-for-1 sales), personal sales, public relations, trade shows, webinars, videos on company websites and YouTube, publicity, social media such as Facebook and Twitter, and the company website itself. Word-of-mouth communication, where people talk to each other about their experiences with goods and services, is the most powerful promotion of all because the people who talk about products and services do not have any commercial interest.
Place
Place is another word for distribution. The objective is to have products and services available where customers want them when they want them. Examples of decisions made for place include inventory, transportation arrangements, channel decisions (e.g., making the product available to customers in retail stores only), order processing, warehousing, and whether the product will be available on a very limited (few retailers or wholesalers) or extensive (many retailers or wholesalers) basis. A company’s website is also part of the distribution domain.
Two Marketing Mixes
No matter what the business or organization, there will be a marketing mix. The business owner may not think about it in these specific terms, but it is there nonetheless. Here is an example of how the marketing mix can be configured for a local Italian restaurant (consumer market).
• Product. Extensive selection of pizza, hot and cold sub sandwiches, pasta and meat dinners, salads, soft drinks and wine, homemade ice cream and bakery products; the best service in town; and free delivery.
• Price. Moderate; the same price is charged to all customer segments.
• Promotion. Ads on local radio stations, websites, and local newspaper; flyers posted around town; coupons in ValPak booklets that are mailed to the local area; a sponsor of the local little league teams; ads and coupons in the high school newspaper; and a Facebook presence.
• Place. One restaurant is located conveniently near the center of town with plenty of off-street parking. It is open until 10:00 p.m. on weekdays and 11:30 p.m. on Fridays and Saturdays. There is a drive-through for takeout orders, and they have a special arrangement with a local parochial school to provide pizza for lunch one day per week.
Here is an example of how the marketing mix could be configured for a green cleaning services business (business market).
• Product. Wide range of cleaning services for businesses and organizations. Services can be weekly or biweekly, and they can be scheduled during the day, evening, weekends, or some combination thereof. Only green cleaning products and processes are used.
• Price. Moderate to high depending on the services requested. Some price discounting is offered for long-term contracts.
• Promotion. Ads on local radio stations, website with video presentation, business cards that are left in the offices of local businesses and medical offices, local newspaper advertising, Facebook and Twitter presence, trade show attendance (under consideration but very expensive), and direct mail marketing (when an offer, announcement, reminder, or other item is sent to an existing or prospective customer).
• Place. Services are provided at the client’s business site. The cleaning staff is radio dispatched.
The Marketing Environment
The marketing environment includes all the factors that affect a small business. The internal marketing environment refers to the company: its existing products and strategies; culture; strengths and weaknesses; internal resources; capabilities with respect to marketing, manufacturing, and distribution; and relationships with stakeholders (e.g., owners, employees, intermediaries, and suppliers). This environment is controllable by management, and it will present both threats and opportunities.
The external marketing environment must be understood by the business if it hopes to plan intelligently for the future. This environment, not controllable by management, consists of the following components:
• Social factors. For example, cultural and subcultural values, attitudes, beliefs, norms, customs, and lifestyles.
• Demographics. For example, population growth, age, gender, ethnicity, race, education, and marital status.
• Economic environment. For example, income distribution, buying power and willingness to spend, economic conditions, trading blocs, and the availability of natural resources.
• Political and legal factors. For example, regulatory environment, regulatory agencies, and self-regulation.
• Technology. For example, the nature and rate of technological change.
• Competition. For example, existing firms, potential competitors, bargaining power of buyers and suppliers, and substitutes.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 294–95.
• Ethics. For example, appropriate corporate and employee behavior.
Small businesses are particularly vulnerable to changes in the external marketing environment because they do not have multiple product and service offerings and/or financial resources to insulate them. However, this vulnerability is offset to some degree by small businesses being in a strong position to make quick adjustments to their strategies if the need arises. Small businesses are also ideally suited to take advantage of opportunities in a changing external environment because they are more nimble than large corporations that can get bogged down in the lethargy and inertia of their bureaucracies.
Marketing Strategy versus Marketing Management
The difference between marketing strategy and marketing management is an important one. Marketing strategy involves selecting one or more target markets, deciding how to differentiate and position the product or the service, and creating and maintaining a marketing mix that will hopefully prove successful with the selected target market(s)—all within the context of marketing objectives. Differentiation involves a company’s efforts to set its product or service apart from the competition. Positioning “entails placing the brand [whether store, product, or service] in the consumer’s mind in relation to other competing products, based on product traits and benefits that are relevant to the consumer.”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 170. Segmentation, target market, differentiation, and positioning are discussed in greater detail in Chapter 7 "Marketing Strategy".
Video Link \(2\):
Small business makeover successes
Marketing management, by contrast, involves the day-to-day tactical decisions, resource allocations (funds and people), and carrying out of tasks that implement the marketing strategy. It is the responsibility of marketing management to focus on quality and develop the marketing plan, which is discussed in Chapter 8 "The Marketing Plan".
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Marketing Concepts in Two Minutes
A humorous definition of key marketing concepts.
KEY TAKEAWAYS
• Marketing is a distinguishing, unique function of a business.
• Marketing is about delivering value and benefits, creating products and services that will meet the needs and wants of customers (perhaps even delighting them) at a price they are willing to pay and in places where they are willing to buy them. It is also about promotion, getting the word out that the product or the service exists.
• The marketing concept has guided business practice since the 1950s.
• Customer value is the difference between perceived benefits and perceived costs. There are different types of customer value: functional, social, epistemic, emotional, and conditional.
• Marketing plays a key role is delivering value to the customer.
• Market segmentation, target market, niche market, marketing mix, marketing environment, marketing management, and marketing strategy are key marketing concepts.
• The marketing mix, also known as the four Ps, consists of product, price, promotion, and place.
EXERCISE
1. Select two different kinds of local small businesses. Ask the owners how they segment the market, who they target, and how they define their marketing mix. Compare the answers that you get. Do you notice any similarities? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/06%3A_Marketing_Basics/6.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Explain the difference between a customer and a consumer.
2. Understand the relationship between the customer/consumer and the marketing mix.
3. Define the two types of customer markets.
4. Understand the factors that contribute to consumer behavior.
5. Describe the B2C and B2B buying processes.
6. Understand the differences between B2C and B2B buying behavior.
7. Define customer experience and explain its role in small business marketing.
8. Explain the importance of customer loyalty to small business.
It is very important in marketing to distinguish between the customer and the consumer. The customer, the person or the business that actually buys a product or a service, will determine whether a business succeeds or fails. It is that simple. It does not matter one iota if a business thinks its product or service is the greatest thing since sliced bread if no one wants to buy it. This is why customers play such a central role in marketing, with everything revolving around their needs, wants, and desires. We see the customer focus in the marketing concept, and we see it in the marketing mix.
The marketing mix should follow the determination of customer needs, wants, and desires. However, there are instances in which a product is created before the target market is selected and before the rest of the marketing mix is designed. One well-known example is Ivory Soap. This product was created by accident. Air was allowed to work its way into the white soap mixture that was being cooked. The result was Ivory Soap, a new and extraordinarily successful product for Procter & Gamble.“History of Ivory Soap,” Essortment.com, accessed December 1, 2011, www.essortment.com/history-ivory-soap-21051.html. Most companies do not have this kind of luck, though, so a more deliberate approach to understanding the customer is critical to designing the right marketing mix.
The consumer is the person or the company that uses or consumes a product. For example, the customer of a dry cleaning service is the person who drops off clothes, picks them up, and pays for the service. The consumer is the person who wears the clothes. Another example is a food service that caters business events. The person who orders lunch on behalf of the company is the customer. The people who eat the lunch are the consumers. The person who selects the catering service could be either or both. It is common for the customer and the consumer to be the same person, but this should not be assumed for all instances. The challenge is deciding whether to market to the customer or the consumer—or perhaps both.
Customer Markets
There are two major types of customer markets: business-to-business (B2B) customers and individual consumers or end users (business-to-consumer [B2C]). B2B customers are organizations such as corporations; small businesses; government agencies; wholesalers; retailers; and nonprofit organizations, such as hospitals, universities, and museums. In terms of dollar volume, the B2B market is where the action is. More dollars and products change hands in sales to business buyers than to individual consumers or end users.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 182. The B2B market offers many opportunities for the small business. Examples of B2B products include office supplies and furniture, machinery, ingredients for food preparation, telephone and cell phone service, and delivery services such as FedEx or UPS.
The B2C market consists of people who buy for themselves, their households, friends, coworkers, or other non-business-related purposes. Examples of B2C products include cars, houses, clothing, food, telephone and cell phone service, cable television service, and medical services. Opportunities in this market are plentiful for small businesses. A walk down Main Street and a visit to the Internet are testaments to this fact.
Understanding the Customer
The better a small business understands its customers, the better off it will be. It is not easy, and it takes time, but knowing who the customers are, where they come from, what they like and dislike, and what makes them tick will be of immeasurable value in designing a successful marketing mix. Being intuitive can and does work…but not for everyone and not all the time. A more systematic and thorough approach to understanding the customer makes much more sense. The problem is that many if not most small businesses probably do not take the time to do what it takes to understand their customers. This is an important part of the reason why so many small businesses fail.
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Consumer Behavior Matters
Understanding a customer’s behavior will increase sales.
Consumer Behavior
Consumer behavior—“how individuals, groups, and organizations select, buy, use, and dispose of goods, services, ideas, or experiences to satisfy their needs and wants”Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 182.—is the result of a complex interplay of factors, none of which a small business can control. These factors can be grouped into four categories: personal factors, social factors, psychological or individual factors, and situational factors. It is important that small-business owners and managers learn what these factors are.
• Personal factors. Age, gender, race, ethnicity, occupation, income, and life-cycle stage (where an individual is with respect to passage through the different phases of life, e.g., single, married without children, empty nester, and widow or widower). For example, a 14-year-old girl will have different purchasing habits compared to a 40-year-old married career woman.
• Social factors. Culture, subculture, social class, family, and reference groups (any and all groups that have a direct [face-to-face] or indirect influence on a person’s attitudes and behavior, e.g., family, friends, neighbors, professional groups [including online groups such as LinkedIn], coworkers, and social media such as Facebook and Twitter).Adapted from Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 155. For example, it is common for us to use the same brands of products that we grew up with, and friends (especially when we are younger) have a strong influence on what and where we buy. This reflects the powerful influence that family has on consumer behavior.
• Psychological or individual factors. Motivation, perception (how each person sees, hears, touches, and smells and then interprets the world around him or her), learning, attitudes, personality, and self-concept (how we see ourselves and how we would like others to see us). When shopping for a car, the “thud” sound of a door is perceived as high quality whereas a “tinny” sound is not.
• Situational factors. The reason for purchase, the time we have available to shop and buy, our mood (a person in a good mood will shop and buy differently compared to a person in a bad mood), and the shopping environment (e.g., loud or soft music, cluttered or neat merchandise displays, lighting quality, and friendly or rude help). A shopper might buy a higher quality box of candy as a gift for her best friend than she would buy for herself. A rude sales clerk might result in a shopper walking away without making a purchase.
These factors all work together to influence a five-stage buying-decision process (Table \(1\)), the specific workings of which are unique to each individual. This is a generalized process. Not all consumers will go through each stage for every purchase, and some stages may take more time and effort than others depending on the type of purchase decision that is involved. Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 112. Knowing and understanding the consumer decision process provides a small business with better tools for designing and implementing its marketing mix.
Table \(1\): Five Stages of the Consumer Buying Process
Stage Description Example
1. Problem recognition Buyer recognizes a problem or need. Joanne’s laptop just crashed, but she thinks it can be fixed. She needs it quickly.
2. Information search Buyer searches for extensive or limited information depending on the requirements of the situation. The sources may be personal (e.g., family or friends), commercial (e.g., advertising or websites), public (e.g., mass media or consumer rating organizations), or experiential (e.g., handling or examining the product). Joanne is very knowledgeable about computers, but she cannot fix them. She needs to find out about the computer repair options in her area. She asks friends for recommendations, checks out the yellow pages, does a Google search, draws on her own experience, and asks her husband.
3. Evaluation of alternatives Buyer compares different brands, services, and retailers. There is no universal process that everyone uses. Joanne knows that computer repair services are available at the nearby Circuit Place and Computer City stores. Unfortunately, she has had bad experiences at both. Her husband, David, recently took his laptop to a small computer repair shop in town that has been in business for less than a year. He was very pleased. Joanne checks out their website and is impressed by the very positive reviews. None of her friends could recommend anyone.
4. Purchase decision Buyer makes a choice. Joanne decides to take her computer to the small repair shop in town.
5. Postpurchase behavior How the buyer feels about the purchase and what he or she does or does not do after the purchase. Joanne’s laptop was fixed quickly, and the cost was very reasonable. She feels very good about the experience, so she posts a glowing review on the company’s website, recommends the shop to everyone she knows, and plans to go back should the need arise. Had she been unhappy with her experience, she would have posted a negative review on the company’s website, told everyone she knows not to go there, and refuse to go there again. It is this latter scenario that should be every small business’s nightmare.
Source: Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 168; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 112–17.
Business Buying Behavior
Understanding how businesses make their purchasing decisions is critical to small businesses that market to the business sector. Purchases by a business are more complicated than purchases by someone making a personal purchase (B2C). B2B purchases vary according to dollar amount, the people involved in the decision process, and the amount of time needed to make the decision, Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 137. and they involve “a much more complex web of interactions between prospects and vendors in which the actual transaction represents only a small part of the entire purchase process.”Bill Furlong, “How the Internet Is Transforming B2B Marketing,” BrandNewBusinesses.com, accessed December 1, 2011, www.brandnewbusinesses.com/NewsletterAugust2008A1.aspx.
The individual or the group that makes the B2B buying decisions is referred to as the buying center. The buying center consists of “all those individuals and groups who participate in the purchasing decision-making process, who share some common goals and the risks arising from the decision.”Frederick E. Webster Jr. and Yoram Wind, Organizational Buying Behavior (Upper Saddle River, NJ: Prentice-Hall, 1972), 2, as cited in Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 188. The buying center in a small business could be as small as one person versus the twenty or more people in the buying center of a large corporation. Regardless of the size of the buying center, however, there are seven distinct roles: initiator, gatekeeper, user, purchaser or buyer, decider, approver, and influencer.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 188; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 139. One person could play multiple roles, there could be multiple people in a single role, and the roles could change over time and across different purchase situations.
1. Initiator. The person who requests that something be purchased.
2. Gatekeeper. The person responsible for the flow of information to the buying center. This could be the secretary or the receptionist that screens calls and prevents salespeople from accessing users or deciders. By having control over information, the gatekeeper has a major impact on the purchasing process.
3. User. The person in a company who uses a product or takes advantage of a service.
4. Purchaser or buyer. The person who makes the actual purchase.
5. Decider. The person who decides on product requirements, suppliers, or both.
6. Approver. The person who authorizes the proposed actions of the decider or the buyer.
7. Influencer. The person who influences the buying decision but does not necessarily use the product or the service. The influencer may assist in the preparation of product or service specifications, provide vendor ideas, and suggest criteria for evaluating vendors.
Identification of Needs, Establishment of Specifications, Identification ofSolutions, Identification of Vendors, Evaluation of Vendors, Vendor selection, Negotiation of Terms
The B2B purchasing process for any small business will be some variation of the process described in \(2\). The specifics of the process will depend on the nature of product, the simplicity of the decision to be made, and the number of people involved. Clearly the purchasing process for a single-person business will be much simpler than for a multiproduct business of 400 employee
The Customer Experience
Customer experience is one of the great frontiers for innovation.Jeneanne Rae, “The Importance of Great Customer Experiences…And the Best Ways to Deliver Them,” Bloomberg BusinessWeek, November 27, 2006, accessed December 1, 2011, www.BusinessWeek.com/magazine/content/06_48/b4011429.htm?chan =search.
Jeneanne Rae
Customer experience refers to a customer’s entire interaction with a company or an organization. The experience will range from positive to negative, and it begins when any potential customer has contact with any aspect of a business’s persona—the company’s marketing, all representations of the total brand, and what others say about the experience of working with the business.Fran ONeal, “‘Customer Experience’ for Small Business: When Does It Start?,” Small Business Growing, August 23, 2010, accessed December 1, 2011, smallbusinessgrowing.com/2010/08/23/what-is-the-customer-experience-for-small -business.
Customer Experience in the B2C Market
Customers will experience multiple touch points (i.e., all the communication, human, and physical interactions that customers experience during their relationship life cycle with a small business)Eric Brown, “Engage Emotion and Shape the Customer Experience,” Small Business Answers, December 14, 2010, accessed December 1, 2011, www.smallbusinessanswers.com/eric-brown/engage-emotion-and-shape-the -customer-ex.php. during their visit. In a retail situation, a customer will experience the store design and layout; the merchandise that is carried and how it is displayed; the colors, sounds, and scents in the store; the cleanliness of the store; the lighting; the music; the helpfulness of the staff; and the prices. In a business situation, a customer will experience the design and layout of the reception and office areas, the colors chosen for carpeting and furniture, the friendliness and helpfulness of the reception staff, and the demeanor of the person or people to be seen. The experience also occurs when a customer communicates with a company via telephone; e-mail; the company website; and Facebook, Twitter, or other social media.
The Role of Store Design in Customer Experience
Store design plays a very important role in a customer’s experience. Check out the following three examples of small business store redesigns that have contributed to increased profitability:
1. Fine Wine & Good Spirits, Philadelphia
www.retailcustomerexperience.com/slideshow.php?ssn=273
2. The Diamond Cellar, Dublin, Ohio
www.retailcustomerexperience.com/slideshow.php?ssn=145
3. Roche Bros. Supermarkets
www.retailcustomerexperience.com/slideshow.php?ssn=261
Good customer experiences “from the perspective of the customer…are useful (deliver value), usable (make it easy to find and engage with the value), and enjoyable (emotionally engaging so that people want to use them).”Harley Manning, “Customer Experience Defined,” Forrester’s Blogs, November 23, 2010, accessed December 1, 2011, blogs.forrester.com/harley_manning ?page=1&10-11-23-customer_experience_defined=. A customer experience can be a one-time occurrence with a particular company, but experiences are more likely to happen across many time frames.Harley Manning, “Customer Experience Defined,” Forrester’s Blogs, November 23, 2010, accessed December 1, 2011, blogs.forrester.com/harley_manning ?page=1&10-11-23-customer_experience_defined=. The experience begins at the point of need awareness and ends at need extinction. Lynn Hunsaker, Innovating Superior Customer Experience (Sunnyvale, CA: ClearAction, 2009), e-book, accessed December 1, 2011, www.clearaction.biz/innovation.
Exploring Consumer Behavior Online and Offline
Consumers are willing to pay more for products they can touch. “Touching” is an important part of the customer experience.
What does all this mean in the real world? At the very least, it suggests that your local bookstore—where you can reach out and ruffle a paperback's pages—may have more staying power than e-commerce experts might think.
https://web.archive.org/web/20100912...releases/13380
B2C customer experiences also involve emotional connections. When small businesses make emotional connections with customers and prospects, there is a much greater chance to forge bonds that will lead to repeat and referral business. When a business does not make those emotional connections, a customer may go elsewhere or may work with the business for the moment—but never come back and not refer other customers or clients to the business.“Grow Customers and Referrals!” Small Business Growing, accessed December 1, 2011, smallbusinessgrowing.com/grow-customers-and-referrals.
Many businesses may not appreciate that 50 percent of a customer’s experience is about how a customer feels. Emotions can drive or destroy value.Colin Shaw, “Engage Your Customers Emotionally to Create Advocates,” CustomerThink, September 17, 2007, accessed December 1, 2011, www.customerthink.com/article/engage_your_customers_emotionally. “Customers will gladly pay more for an experience that is not only functional but emotionally rewarding. Companies skilled at unlocking emotional issues and building products and services around them can widen their profit margins…Great customer experiences are full of surprising ‘wow’ moments.”Jeneanne Rae, “The Importance of Great Customer Experiences…And the Best Ways to Deliver Them,” Bloomberg BusinessWeek, November 27, 2006, accessed December 1, 2011, www.BusinessWeek.com/magazine/content/06_48/b4011429.htm?chan =search.
Small businesses should learn and think about how to market a great B2C customer experience, not just a product or a service.Shaun Smith, “When Is a Store Not a Store—The Next Stage of the Retail Customer Experience,” shaunsmith+co Ltd, March 29, 2010, accessed December 1, 2011, www.smithcoconsultancy.com/2010/03/when-is-a-store-not-a-store-%E2%80%93 -the-next-stage-of-the-retail-customer-experience. Design an experience that is emotionally engaging by mapping the customer’s journeyColin Shaw, “Engage Your Customers Emotionally to Create Advocates,” CustomerThink, September 17, 2007, accessed December 1, 2011, www.customerthink.com/article/engage_your_customers_emotionally.—and then think of ways to please, perhaps even delight, the customer along that journey. A history of sustained positive customer experiences will increase the chances that a business will be chosen over its competition.Jeneanne Rae, “The Importance of Great Customer Experiences…And the Best Ways to Deliver Them,” Bloomberg BusinessWeek, November 27, 2006, accessed December 1, 2011, www.BusinessWeek.com/magazine/content/06_48/b4011429.htm?chan =search.
Meaningful, memorable, fun, unusual and unexpected experiences influence the way customers perceive you in general and feel about you in particular. These little details are so easy to overlook, so tempting to brush off as unimportant. But add a number of seemingly minor details together, and you end up with something of far more value than you would without them.
It’s the little details that keep a customer coming back over and over, it’s the little details that cause a customer to rationalize paying more because she feels she is getting more, it’s the little details that keep people talking about you and recommending everyone they know to you.
Anyone can do the big things right; it’s the little things that differentiate one business from another and that influence customers to choose one over the other. Often, small-business owners cut out the little details when times get tough, and this is a big mistake.Sydney Barrows, “6 Ways to Create a Memorable Customer Experience,” Entrepreneur, May 19, 2010, accessed December 1, 2011, www.entrepreneur.com/article/206760.
There is, however, no one-size-fits-all design for customer experience in the B2C market. Small businesses vary in terms of the size, industry, and nature of the business, so customer experience planning and design will necessarily differ in accordance with these factors. The customer experience for a 1-person business will be very different from an experience with a 400-employee company.
Video Clip \(2\):
How to Hire the Right Customer Service Person For Your Small Business
Customer Experience in the B2B Market
Talk to customer experience executives in a B2B environment about emotional engagement and you will see their eyes roll. Ask them if they would consider designing retail stores with customized smell and music to reinforce the customer experience and you will most likely be ushered out of their offices. Mention the iPod or MySpace experience and you will likely face a torrent of sighs and frowns.Lior Arussy, “Creating Customer Experience in B2B Relationships: Managing ‘Multiple Customers’ Is the Key,” G-CEM, accessed December 28, 2011, www.g-cem.org/eng/content_details.jsp?contentid=2203&subjectid=107.
Lior Arussy
Creating customer relationships in the B2B environment is radically different from the B2C environment because customers face different challenges, resources, and suppliers.Lior Arussy, “Creating Customer Experience in B2B Relationships: Managing ‘Multiple Customers’ Is the Key,” G-CEM, accessed December 28, 2011, www.g-cem.org/eng/content_details.jsp?contentid=2203&subjectid=107. In the B2B world, there will almost always be “multiple people across multiple functions who play major roles in evaluating, selecting, managing, paying for and using the products and services their company buys…So, unlike the B2C company, if you are a B2B supplier there will be a host of individual ‘customers’ in engineering, purchasing, quality, manufacturing, etc. with different needs and expectations whose individual experiences you must address to make any given sale.”Richard Tait, “What’s Different about the B2B Customer Experience,” Winning Customer Experiences, August 16, 2010, accessed December 1, 2011, winningcustomerexperiences.wordpress.com/2010/08/16/whats-different-about -the-b2b-customer-experience. This is offset, however, by the fact that a B2B company probably has a substantially smaller number of potential customers in a given target market, so it is often possible to actually get to know them personally. Smart B2B firms can tailor their products or services specifically to deliver the experiences wanted by people they know directly.Richard Tait, “What’s Different about the B2B Customer Experience,” Winning Customer Experiences, August 16, 2010, accessed December 1, 2011, winningcustomerexperiences.wordpress.com/2010/08/16/whats-different-about -the-b2b-customer-experience.
Video Clip \(3\):
How Customer Experience Applies in the B2B Sector
Customer experience concerns are relevant in the B2B environment.
Despite the challenges, customer experience is relevant in the B2B environment. However, because “the buy decision-making processes in most companies are typically fully structured and quantitative criteria-based…the explicitly emotional experience laden sales pitch that drives consumer buying is not a fit in the B2B world.”Richard Tait, “What’s Different about the B2B Customer Experience,” Winning Customer Experiences, August 16, 2010, accessed December 1, 2011, winningcustomerexperiences.wordpress.com/2010/08/16/whats-different-about -the-b2b-customer-experience. The products that often represent B2B business’s sole value proposition are rarely emotionally engaging or visually appealing. Think bolts, wires, copy paper, shredding machines, bread for a restaurant, and machinery. How engaging can these items be?
There are touch points in B2B processesAdapted from Pawan Singh, “The 9 Drivers of B2B Customer Centricity,” Destination CRM.com, December 11, 2010, accessed December 1, 2011, www.destinationcrm.com/Articles/Web-Exclusives/Viewpoints/The-9-Drivers-of -B2B-Customer-Centricity-72672.aspx. before and after the sale (e.g., information gathering, website visits and inquiries, delivery of spare parts, service calls on machinery and office equipment, and telephone interactions) that can be identified and improved. However, the inherent differences between B2B and B2C environments must be clearly understood so that the B2C customer experience models do not become the paradigm for B2B customer experience designs. As is the case in the B2C market, there is no universal approach to customer experience in the B2B market. Small B2B companies also vary in terms of the products and the services offered and the size, industry, and nature of the business, so customer experience planning and design will necessarily differ in accordance with these factors.
The greatest challenge in delighting B2B customers is adding unique and differentiating value that solves customer problems. When defining the customer experience, recognize that this value should extend to the entire customer and business life cycle—presale engagement, the sales process, and postsale interactions. Experiences at every stage of the customer life cycle should be customized to each individual customer.Lior Arussy, “Creating Customer Experience in B2B Relationships: Managing ‘Multiple Customers’ Is the Key,” G-CEM, accessed December 28, 2011, www.g-cem.org/eng/content_details.jsp?contentid=2203&subjectid=107.
Video Link\(4\):
Customer Experience Differentiation
Customer experience in the B2C and B2B environments.
Customer Loyalty
Customer loyalty is “all about attracting the right customers, getting them to buy, buy often, buy in higher quantities and bring [the business] even more customers.”“What Is Customer Loyalty?,” Customer Loyalty Institute, accessed December 1, 2011, www.customerloyalty.org/what-is-customer-loyalty. It involves an emotional commitment to a brand or a business (“We love doing business with your company.”), an attitude component (“I feel better about this brand or this business.”), and a behavior component (“I’ll keep buying this brand or patronizing that business, regardless.”). Attitudes are important because repeat purchases alone do not always mean that a customer is emotionally invested.Adapted from “Why Measure—What Is Loyalty?,” Mindshare Technologies, accessed December 1, 2011, www.mshare.net/why/what-is-loyalty.html. Think about the thrill of buying car insurance. We may keep buying from the same company, but we rarely have an emotional commitment to that company. Emotional commitment is key in customer loyalty.
The benefits of loyal customers are numerous: Adapted from Rama Ramaswami, “Eight Reasons to Keep Your Customers Loyal,” Multichannel Merchant, January 12, 2005, accessed December 1, 2011, multichannelmerchant.com/opsandfulfillment/advisor/Brandi-custloyal/.
• They buy more and are often willing to pay more. This creates a steadier cash flow for a business.
• Loyal customers will refer other customers to a company, saving the marketing and advertising costs of acquiring customers.
• They are more forgiving when you make mistakes—even serious ones—especially if you have a system in place that empowers employees to correct errors on the spot. Then loyal customers become even more loyal.
• A loyal customer’s endorsement can outstrip the most extravagant marketing efforts. The word on the street is usually more powerful.
• Thriving companies with high customer loyalty usually have loyal employees who are genuinely engaged.
• Thriving companies with high customer and employee loyalty are generally known to outpace their competition in innovation.
• Loyal customers understand a company’s processes and can offer suggestions for improvement.
• An increase in customer retention can boost a company’s bottom-line profit by 25–100 percent, depending on fixed costs—costs that remain the same regardless of the amount of sales (e.g., rent).
Customer loyalty begins with the customer experience and is built over time through the collection of positive experiences.Jeffrey Gangemi, “Customer Loyalty: Dos and Don’ts,” BusinessWeek, June 29, 2010, accessed December 1, 2011, www.BusinessWeek.com/smallbiz/tipsheet/06/29.htm. This will be true no matter the size, industry, and nature of the small business. Customers’ experiences will influence how much they will buy, whether they switch to a competitor, and whether they will recommend the brand or the business to someone else.Bruce Temkin, “The Four Customer Experience Core Competencies,” Temkin Group, June 2010, accessed December 1, 2011, experiencematters.files.wordpress.com/2010/06/1006_thefourcustomerexperiencecorecompetencies_v2.pdf. Small businesses cannot rely on the loyalty that comes from convenience (e.g., using the car dealer close to home for repairs instead of the one farther away that provides better service). Loyalty is about making a customer feel special. This is the dream of all small businesses—which is something that small businesses are particularly well suited to create. Because of their size, it is easier for small businesses to have closer relationships with their customers, create a more personal shopping environment, and, in general, create great customer experiences. Think back to Bob Brown of the Cheshire Package Store (Chapter 2 "Your Business Idea: The Quest for Value"). He prides himself on the kind of shopping environment and customer relationships that lead to loyalty.
Grounds for Loyalty
How do people make choices about which pharmacy to go to? Paul Gauvreau decided to find out by asking customers why they were shopping in one particular store.
• “I shop here because it’s close to where I live.” (The convenience shopper.)
• “I like the pharmacist, I trust him/her.” (This customer has a good relationship with their pharmacist.)
• “The staff makes me feel like part of the family.”
• “I feel like they care about my health.”
• “The entire atmosphere in this store reminds me of home, where I felt welcome.”
• “I don’t feel like another number here or just another patient. They really care about me.”
Paul concluded that this pharmacy succeeded in differentiating itself from the competition in a unique way: by how they made their customers feel—and this is what will generate the most intimate loyalty in a customer. Paul Gauvreau, “Making Customers Feel Special Brings Loyalty,” Pharmacy Post 11, no. 10 (2003): 40.
Video Link Video Link\(5\):
Listening to Customers Leads to Loyalty
All customers really want is for the companies they do business with to listen to them.
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Is There a Right Kind of Customer Loyalty?
Behavioral, emotional, and profitable customer loyalty. What they are, and what companies can do to create and improve them.
Small businesses that are operating in the B2B sector might wonder whether there are major differences between B2B and B2C models of customer loyalty. Michael Lowenstein, vice president and senior consultant in customer loyalty management at Harris Interactive says that “except for the specific supplier decision criteria, which varies from situation to situation, there is [sic] more similarities than differences between B2C and B2B in what drives customer loyalty behavior.”Michael Lowenstein, “Customer Loyalty Behavior in B2B vs. B2C Scenarios,” SearchCRM, January 31, 2007, accessed December 1, 2011, searchcrm.techtarget.com/answer/Customer-loyalty-behavior-in-B2B-vs-B2C -scenarios. What can be concluded in either case is that achieving and retaining loyal customers should be an important goal for any company—small or large.
KEY TAKEAWAYS
• The customer and the consumer are not necessarily the same person…but they can be.
• The customer and the consumer should be the focus of the marketing mix.
• B2C and B2B are the two types of customer markets. The B2B market dwarfs the B2C market in terms of sales.
• It is critical for a small business to understand its customers.
• Customer experience is a person’s entire interaction with a small business. It involves emotional connections to the business.
• There is no one-size-fits-all customer experience for a B2C or a B2B small business. The customer’s journey should be mapped and changes made to improve the experience.
• There are big differences between the customer experiences for B2C and B2B businesses.
• There are multiple benefits to customer loyalty. It is important to small business success. A positive customer experience drives loyalty.
EXERCISES
1. Visit a small business that you patronize often. Plan to make a purchase. Describe your experience from the time you enter the store to the time you leave (the touch points) as specifically as possible. What surprised you the most? Were you disappointed at all? Please explain. What recommendations would you make to the owner? Do you plan on going back to this store?
2. Identify a small business to which you are loyal. Why are you loyal to that business? What in particular does the business do that you like? Have you told them? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/06%3A_Marketing_Basics/6.03%3A_The_Customer.txt |
Learning Objectives
1. Understand and be able to explain what marketing research is all about.
2. Explain why a small business should conduct marketing research and why many small businesses do not do it.
3. Define and give examples of the two types of marketing research.
4. Understand the marketing research process.
5. Understand the costs of marketing research.
Not everyone can be like Steve Jobs of Apple. Jobs was famous for saying that he did not pay too much attention to customer research, particularly with respect to what customers say they want. Instead, he was very “adept at seeing under the surface of what customers want now; they just don’t realize it until they see it. This ability is best expressed by the German word ‘zeitgeist’—the emerging spirit of the age or mood of the moment. It probably best translates as market readiness or customer readiness. People like Jobs can see what the market is ready for before the market knows itself.”Shaun Smith, “Why Steve Jobs Doesn’t Listen to Customers,” Customer Think, February 8, 2010, accessed December 1, 2011, www.customerthink.com/blog/why_steve_jobs_doesnt_listen_to_customers. Most small businesses will not find themselves in this enviable position. However, this does not mean that all small businesses take a methodical approach to studying the marketplace and their prospective as well as current consumers. Marketing research among small businesses ranges along a continuum from no research at all to the hiring of a professional research firm. Along the way, there will be both formal and informal approaches, the differences again being attributable to the size, industry, and nature of the business along with the personal predispositions of the small-business owners or managers. Nonetheless, it is important for small-business owners and managers to understand what marketing research is all about and how it can be helpful to their businesses. It is also important to understand that marketing research must take the cultures of different communities into consideration because the target market might not be the same—even in relatively close localities.
What Is Marketing Research?
Marketing research is about gathering the information that is needed to make decisions about a business. As an important precursor to the development of a marketing strategy, marketing research “involves the systematic design, collection, recording, analysis, interpretation, and reporting of information pertinent to a particular marketing decision facing a company.”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, Ohio: Atomic Dog Publishing, 2007), 191. Marketing research is not a perfect science because much of it deals with people and their constantly changing feelings and behaviors—which are all influenced by countless subjective factors. What this means is that facts and opinions must be gathered in an orderly and objective way to find out what people want to buy, not just what the business wants to sell them.“Market Research Basics,” SmallBusiness.com, October 26, 2009, accessed December 1, 2011, smallbusiness.com/wiki/Market_research_basics. It also means that information relevant to the market, the competition, and the marketing environment should be gathered and analyzed in an orderly and objective way.
Why Do It?
The simple truth is that a small business cannot sell products or services—at least not for long—if customers do not want to buy them. Consider the following true scenario:Susan Ward, “Do-It-Yourself Market Research—Part 1: You Need Market Research,” About.com, accessed December 1, 2011, sbinfocanada.about.com/cs/marketing/a/marketresearch.htm. A local small business that specialized in underground sprinkling systems and hot tubs for years decided to start selling go-carts. Not long after they introduced them, they had a fleet of go-carts lined up outside their business with a huge “Must go; prices slashed” banner over them. This was not a surprise to anyone else. Go-carts had nothing to do with their usual products, so why would their regular customers be interested in them? Also, a quick look at the demographics of the area would have revealed that the majority of the consumers in the retirement town were elderly. There would likely be little interest in go-carts. It is clear that the business owner would have benefitted from some marketing research.
Marketing research for small business offers many benefits. For example, companies can find hidden niches, design customer experiences, build customer loyalty, identify new business opportunities, design promotional materials, select channels of distribution, find out which customers are profitable and which are not, determine what areas of the company’s website are generating the most revenue, and identify market trends that are likely to have the greatest impact on the business. Answers can be found for the important questions that all small businesses face, such as the following:Jesse Hopps, “Market Research Best Practices,” EvanCarmichael.com, accessed December 1, 2011, www.evancarmichael.com/Marketing/5604/Market-Research -Best-Practices.html; adapted from Joy Levin, “How Marketing Research Can Benefit a Small Business,” Small Business Trends, January 26, 2006, accessed December 1, 2011, smallbiztrends.com/2006/01/how-marketing-research-can-benefit-a-small -business.html.
• How are market trends impacting my business?
• How does our target market make buying decisions?
• What is our market share and how can we increase it?
• How does customer satisfaction with our products or services measure up to that of the competition?
• How will our existing customers respond to a new product or service?
In many ways, small businesses have a marketing research advantage over large businesses. The small business is close to its customers and is able to learn much more quickly about their buying habits, what they like, and what they do not like. However, even though “small business owners have a sense [of] their customers’ needs from years of experience…this informal information may not be timely or relevant to the current market.”“Market Research Basics,” SmallBusiness.com, October 26, 2009, accessed December 1, 2011, smallbusiness.com/wiki/Market_research_basics.
It therefore behooves a small business to think seriously in terms of a marketing research effort—even a very small one—that is more focused and structured. This will increase the chances that the results will be timely and will enable the small-business owner or manager “to reduce business risks, spot current and upcoming problems in the current market, identify sales opportunities, and develop plans of actions.”“Market Research Basics,” SmallBusiness.com, October 26, 2009, accessed December 1, 2011, smallbusiness.com/wiki/Market_research_basics. The specific nature and extent of any marketing research effort will, however, be a function of the product, the size and nature of the business, the industry, and the small-business owner or manager. There is no approach that is right for all situations and all small businesses.
Types of Marketing Research
Small businesses can conduct primary or secondary marketing research or a combination of the two. Primary marketing research involves the collection of data for a specific purpose or project. Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 91. For example, asking existing customers why they purchase from the business and how they heard about it would be considered primary research. Another example would be conducting a study of specific competitors with respect to products and services offered and their price levels. These would be simple marketing research projects for a small business, either business-to-consumer (B2C) or business-to-business (B2B), and would not require the services of a professional research company. Such companies would be able to provide more sophisticated marketing research, but the cost might be too high for the many small businesses that are operating on a shoestring budget.
Data gathering techniques in primary marketing research can include observation, surveys, interviews, questionnaires, and focus groups. A focus group is six to ten people carefully selected by a researcher and brought together to discuss various aspects of interest at length. Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson, Prentice Hall, 2009), 93. Focus groups are not likely to be chosen by small businesses because they are costly. However, the other techniques would be well within the means of most small businesses—and each can be conducted online (except for observation), by mail, in person, or by telephone. SurveyMonkey is a popular and very inexpensive online survey provider. Its available plans run from free to less than \$20 per month for unlimited questions and unlimited responses. They also provide excellent tutorials. SurveyMonkey, used by many large companies, would be an excellent choice for any small business.
Secondary marketing research is based on information that has already been gathered and published. Some of the information may be free—as in the case of the US Census, public library databases and collections, certain websites, company information, and some trade associations to which the company belongs—or it can be bought. Purchased sources of information (not an exhaustive list) include newspapers,Patricia Faulhaber, “Today’s Headlines Provide Market Research,” Marketing and PR @ Suite101, May 14, 2009, accessed December 1, 2011, patricia-faulhaber.suite101.com/todays-healines-provide-market-research-a117653. magazines, trade association reports, and proprietary research reports (i.e., reports from organizations that conduct original research and then sell it). eMarketer is a company that provides excellent marketing articles for free but also sells its more comprehensive reports. The reports are excellent, providing analysis and in-depth data that cannot be found elsewhere, but they are pricey.
If a small business was looking to introduce a new product to an entirely different market, secondary research could be conducted to find out where customer prospects live and whether the potential market is big enough to make the investment in the new product worthwhile.Joy Levin, “How Marketing Research Can Benefit a Small Business,” Small Business Trends, January 26, 2006, accessed December 1, 2011, smallbiztrends.com/2006/01/how-marketing-research-can-benefit-a-small-business.html. Secondary research would also be appropriate when looking for things such as economic trends, online consumer purchasing habits, and competitor identification.
Table \(1\): Types of Marketing Research
Primary Marketing Research Secondary Marketing Research
Data for a specific purpose or for a specific project Information that has already been gathered and published
Tends to be more expensive Tends to be lower cost
Customized to meet a company’s needs May not meet a company’s needs
Fresh, new data Data are frequently outdated (e.g., using US 2000 census data in 2011)
Proprietary—no one else has it Available to competitors
Examples: in-person surveys, customer comments, observation, and SurveyMonkey online survey Examples: Wall Street Journal, Bloomberg BusinessWeek, US Census 2010, Bureau of Labor Statistics, FedStats, MarketingSherpa, ResearchInfo, and eMarketer
Source: Adapted from Marcella Kelly and Jim McGowen, BUSN (Mason, OH: South-Western, 2008), 147.
The Marketing Research Process
Most small-business owners do marketing research every day—without being aware of it. They analyze returned items, ask former customers why they switched to another company, and look at a competitor’s prices. Formal marketing research simply makes this familiar process orderly by providing the appropriate framework.“Market Research Basics,” SmallBusiness.com, October 26, 2009, accessed December 1, 2011, smallbusiness.com/wiki/Market_research_basics. Effective marketing research follows the following six steps: Adapted from Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 91–103.
1. Define the problem and the research objectives. Care must be taken not to define the problem too broadly or too narrowly—and not to identify a symptom as the problem. The research objectives should flow from the problem definition.
2. Develop the research plan. This is a plan for gathering the needed information, part of which will include cost. Also to be determined is the following: whether primary research, secondary research, or some combination of the two will be used. The specific techniques will be identified, and a timetable will be established.
3. Collect the information. This phase is typically the most expensive and the most error prone.
4. Analyze the information. Analysis involves extracting meaning from the raw data. It can involve simple tabulations or very sophisticated statistical techniques. The objective is to convert the raw data into actionable information.
5. Present the findings. The findings are presented to the decision maker(s). In many small businesses, the owner or the manager may conduct the research, so the findings are presented in a format that will make sense for the owner and other members of the decision-making team.
6. Make the decision. The owner or manager must consider the information and decide how to act on it. One possible result is that the information gathered is not sufficient for making a decision. The problem may be a flawed marketing research process or problems obtaining access to appropriate data. The question becomes whether the situation is important enough to warrant additional research.
What Does It Cost?
A popular approach with small-business owners is to allocate a small percentage of gross sales for the most recent year for marketing research. This usually amounts to about 2 percent for an existing business. It has been suggested, however, that as much as 10 percent of gross sales should be allocated to marketing research if the business is planning to launch a new product.“Market Research Basics,” SmallBusiness.com, October 26, 2009, accessed December 1, 2011, smallbusiness.com/wiki/Market_research_basics.
There are several things that small businesses can do to keep the costs down. They can do the research on their own; work with local colleges and universities to engage business students in research projects; conduct online surveys using companies such as SurveyMonkey and Zoomerang; and create an online community with forums, blogs, and chat sessions that reveal customers’ experiences with a company’s product or the perception of a company’s brand.John Tozzi, “Market Research on the Cheap,” Bloomberg BusinessWeek, January 9, 2008, accessed December 1, 2011, www.BusinessWeek.com/smallbiz/content/jan2008/sb2008019_352779.htm. The latter two options, of course, presume the existence of an e-commerce operation. Even given the inexpensive options that are available, however, hiring a professional research firm can be worth the price. The specific marketing research choice(s) made will depend, as always, on the size and the nature of the business, the industry, and the individual B2C or B2B small-business owner or manager.
When Should Marketing Research Be Done?
There is no precise answer to this question. As a general rule, marketing research should be done when important marketing decisions must be made. It should be done at times when customers may be easily accessible (e.g., a gift shop may want to conduct research before the holiday season when customers are more likely to be thinking about buying gifts for friends and loved ones), when you are thinking about adding a new product or service to the business, or when a competitor seems to be taking away market share. The trick, though, “is not to wait very long, because your competitors can start getting the answers before you do.”Joy Levin, “How Marketing Research Can Benefit a Small Business,” Small Business Trends, January 26, 2006, accessed December 1, 2011, smallbiztrends.com/2006/01/how-marketing-research-can-benefit-a-small-business.html.
Common Marketing Research Mistakes
Before deciding on a marketing research path, it is important for a small-business owner or manager to be aware of the following common pitfalls that small businesses encounter:Darrell Zahorsky, “6 Common Market Research Mistakes of Small Business,” About.com, accessed December 1, 2011, sbinformation.about.com/od/marketresearch/a/marketresearch.htm; Lesley Spencer Pyle, “How to Do Market Research—The Basics,” Entrepreneur, September 23, 2010, accessed December 1, 2011, www.entrepreneur.com/article/217345.
• Thinking the research will cost too much. Small businesses definitely face a challenge to afford the costs of marketing research. However, marketing research costs range from free to several thousands of dollars.
• Using only secondary research. The published work of others is a great place to start, but it is often outdated and provides only broad knowledge. More specific knowledge can be obtained from purchasing proprietary reports, but this can be pricey, and the focus may not be quite right. Primary research should also be considered.
• Using only web resources. Data available on the Internet are available to everyone who can find it. It may not be fully accurate, and its accuracy may be difficult to evaluate. Deeper searches can be conducted at the local library, college campus, or small business center.
• Surveying only the people you know. This will not get you the most useful, accurate, and objective information. You must talk to actual customers to find out about their needs, wants, and expectations.
• Hitting a wall. Any research project has its ups and downs. It is easy to lose motivation and shorten the project. Persistence must be maintained because it will all come together in the end. It is important to talk to actual or potential customers early.
KEY TAKEAWAYS
• Many small businesses do not conduct any marketing research.
• Marketing research is about gathering the information that is needed to make decisions about the business.
• Marketing research is important because businesses cannot sell products or services that people do not want to buy.
• Small businesses can conduct primary or secondary research or a combination of the two. They can also buy proprietary reports that have been prepared by other companies.
• It is common for small businesses to allocate 2 percent of their gross sales to marketing research. Several things can be done to keep marketing research costs down.
• Marketing research should be done when key decisions must be made.
• Small-business owners should be aware of several common marketing research pitfalls that small businesses encounter.
EXERCISE
1. A small-business owner has an idea for a new product that may be a big hit with current customers and bring in new customers as well. The owner has not done much marketing research in the past, but with the lagging economy, the owner wants to be sure that the right steps are being taken. What would you advise the owner concerning the importance of marketing research and how to proceed? Be specific.
FRANK’S BARBEQUE: A MARKETING QUESTION
One night after the restaurant had closed, Frank Rainsford sat down with his son, Robert. Frank had finished reading his son’s business plan for a third time. Robert sensed that his father had some sort of reservations. “What’s the matter, Dad? Didn’t you like the plan?” Frank paused and said, “Bobby, from a technical standpoint I think you have done a very, very credible job, but you are right. I do have some concerns.” Disappointed, Robert asked his father to lay out his concerns.
Frank told him that opening another restaurant was a huge and expensive undertaking. He knew that Robert understood the financial risks, but he was not sure that his son understood the problems associated with getting people to come to a new restaurant. Frank was straightforward and told his son, “I have been at this for thirty-plus years. It took me years to build up my client base. I really know my customers and what they like. Up until this year the only marketing I did was flyers and a few ads in the local paper and the church bulletin. How are we going to understand our customers at the new location? We are going to have to fill it up quickly if we are to pay the bills. I know I’ve had some good success with selling the sauces during the last few years, but remember that I’m selling them from Harry’s grocery store. His customers already know me and my product. Your plans for ramping up sauce sales are great, but again, how are we going to get people to know who we are and interested enough to by a six dollar bottle of barbecue sauce?” Frank went on to tell his son that he knew that Robert was extremely knowledgeable about marketing and the use of the Internet. He reminded Robert that he had given him a greatly enlarged marketing budget in 2010.
If you were Robert, how would you go about alleviating your father’s concerns? (You may want to consult Chapter 16 "Appendix: A Sample Business Plan" and review Robert’s business plan for a new restaurant.) Answer the question from a marketing perspective. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/06%3A_Marketing_Basics/6.04%3A_Marketing_Research.txt |
Learning Objectives
1. Understand how marketing contributes to customer value.
2. Explain how marketing can positively and negatively impact cash flow.
3. Explain how digital technology and the e-environment impact marketing.
Customer Value Implications
It is the customer who decides whether to buy a small business’s products or services. The customer decides whether the appropriate value is present, and that value will always be as he or she perceives it. “The decision to buy and the price that customers are willing to pay is dependent on their assessment of the value they will receive from one product relative to the known alternatives.”Robert R. Harmon and Greg Laird, “Linking Marketing Strategy to Customer Value: Implications for Technology Marketers,” IEEEXplore Digital Library, July 31, 1997, accessed December 1, 2011, ieeexplore.ieee.org/xpl/freeabs_all.jsp?arnumber=653700. Marketing plays a key role in creating and delivering value to the customer, but it is the establishment of a strong link between customer value requirements and the major value-producing activities of the firm that is the foundation on which the delivery of superior customer value is based. Robert R. Harmon and Greg Laird, “Linking Marketing Strategy to Customer Value: Implications for Technology Marketers,” IEEEXplore Digital Library, July 31, 1997, accessed December 1, 2011, ieeexplore.ieee.org/xpl/freeabs_all.jsp?arnumber=653700.
The creation of customer value begins with a company commitment to the customer. Marketing has the responsibility for researching the current or prospective customer base, selecting a target market, and then developing a marketing mix that will hopefully meet the value expectations of customers. Product comes first, followed by price, promotion, and place. Delivering customer value should be the key consideration in all marketing mix decisions, with all four Ps working together. A small business needs to be aware, however, that customer value can and does change. What is considered as providing appropriate value one day may change the next day. It is marketing’s responsibility to keep on top of such value migrations so that the marketing mix can be changed accordingly. Fortunately, small businesses are in a stronger position to make marketing mix changes because they are generally more nimble and are closer to the customer.
Cash-Flow Implications
Because sales are the only generator of revenue in most small businesses, marketing decisions play a major role in the health of a company’s cash flow. A product or a service that does not sell will have a negative impact on cash flow, whereas a winner can result in a cash-flow bonanza. However, a product or a service that generates major cash can actually send the business into failure if the appropriate cash-flow mechanisms are not in place. The timely collection of money owed and being able to pay for the products and the services needed to run the business are critical to a positive cash flow. Providing extended terms for vendor accounts to be paid, delayed payments from credit cards used by customers for their purchases (something that is expected by most customers as part of the value they receive), the costs associated with an over ambitious expansion, money-losing customer promotions, a product or a service that is priced too low (unable to cover costs), and a distribution approach that does not work well will all have a negative impact on cash flow.
Video Clip \(1\):
Cash Flow and the Marketing Budget
Why cash flow is relevant to marketing.
Digital Technology and E-Environment Implications
The integration, acceptance, and popularity of technology in the current marketplace and workplace are widespread, particularly with respect to marketing. Marketing opportunities have exploded with the rise of digital technology and the Internet, and with those opportunities have come new ways to make marketing decisions and interact with customers.
As do all businesses, small businesses should be concerned about the customer experience. Emerging mobile technologies make it possible “to elevate the classic brick-and-mortar shopper experience.”Nathan Pettyjohn, “Evolving the Customer Experience with Mobile Technology,” MarketingProfs, December 28, 2010, accessed December 1, 2011, www.marketingprofs.com/articles/2010/4134/evolving-the-customer-experience -with-mobile-technology. But there is a cautionary note. A mobile shopping solution (i.e., a way for shoppers to engage with their favorite retail brand or store using their mobile phones) can be cost-prohibitive for many retailers or B2B businesses, especially small ones. Nonetheless, it is a technology that small retail businesses should keep their eye on. One retail shopping solution is being developed by ARS Interactive and CellPoint Mobile. It will be “the only fully integrated mobile retail shopping solution in the United States that combines product information, coupons, customer loyalty and mobile payment into one experience. This will give customers complete shopping control directly from their mobile phones, while providing retailers with a constant customer touch-point inside and outside the store.”“Mobile Retail Shopping Solution Featuring Near Field Communication Technology,” PRWeb, January 6, 2011, accessed December 1, 2011, www.prweb.com/releases/2011/ARSMOBILE/prweb4946004.htm.
Video Clip \(2\):
Mobile Marketing Solutions for Retail
An example of a mobile-assisted shopping solution offered by 2ergo.
Technology is also available to help in customer value analysis. New in 2010, the Value-Strategy Tool Kit helps a companyBradley T. Gale, “Webinar on Customer Value Mapping,” Customer Value, Inc., accessed December 1, 2011, www.cval.com.
• understand the true strengths and weaknesses of a product offer and identify opportunities that can make a product more competitive,
• look at a product head-to-head against each competitor to think through the selling strategy,
• set prices based on what a product is truly worth,
• hone the marketing message, and
• align the management team around a plan to serve customers better.
The target for this software is the larger business, but the principles remain the same. Because the price is based on the number of users, a small business with only one or two users may find it affordable.
Social media also needs to be seriously considered in small business marketing efforts. Social media “generally refers to websites featuring user-generated content or material created by visitors rather than the website publishers. In turn, these sites encourage visitors to read and respond to that material.”Robbin Block, Social Persuasion: Making Sense of Social Media for Small Business (Breinigsville, PA: Block Media, 2010), 2. Popular social media sites include Facebook and Twitter. These channels are being used by a wide range of small businesses to market their businesses via interaction with their customers.
As has been said in the past, small businesses will have different technology needs and desires. However, given the pervasiveness of technology in marketing, it is in the best interests of any small business to consider how technology could improve marketing effectiveness.
KEY TAKEAWAYS
• Marketing plays a key role in delivering customer value.
• Marketing decisions play a major role in the health of a company’s cash flow.
• Small businesses of any size should consider how technology could improve marketing effectiveness.
EXERCISE
1. Assume that you have a friend who owns a small office-supply business. Your friend is doing fairly well, but you are convinced that integrating more technology into his marketing efforts would increase sales. What would you recommend to your friend? How might technology add to customer value and a positive cash flow?
Disaster Watch
Customer Experience
You are the owner of the local BMW dealer. A customer has just taken delivery of a new BMW 1 Series. Within a couple of weeks, the customer was in an accident with the car. Another driver had driven into her shiny new car—her pride and joy. It was a disaster for the customer. Her dream of owning a BMW had been shattered by the accident happening when the car was only a few days old.The Customer’s Shoes, “How to Turn a Disaster into a Great Customer Experience,” The Customer’s Shoes Ltd., December 6, 2010, accessed December 1, 2011, www.thecustomersshoes.com/2010/12/how-to-turn-a-disaster-into-a-great -customer-experience. It is now your responsibility to manage the repairs and deal with a customer whose car ownership experience is now in disaster territory. The customer knows that when she gets the car back, it will no longer be new. What could you do to turn this disaster into a great customer experience? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/06%3A_Marketing_Basics/6.05%3A_The_Three_Threads.txt |
Elegant Touch
Anita Bruscino, the sole proprietor of Elegant Touch, began her career as a mechanical engineer. She worked in her family’s manufacturing business until she and her father left because of too many factions in the company. This provided her with the opportunity to start her own business, something she had always known in her heart that she wanted to do.
Anita was inspired to open a gift shop by a family friend who had owned her own gift shop. She gave Anita advice on starting her own business, and Elegant Touch opened in 1994. Anita has since expanded the business and is celebrating the shop’s eighteenth anniversary, with the last six years in its larger location. The shop is warm, lovely, and comfortable, featuring unique gifts for all occasions and specializing in American handcrafted gift items and gift baskets. Shoppers will also find maternity gifts, items for the sweet tooth, specialty foods, special seasonal sectionsLeslie Hutchison, “Elegant Touch Fine Gifts,” CheshirePatch, accessed March 24, 2012, cheshire.patch.com/listings/elegant-touch-fine-gifts.—and a friendly smile from Anita. One thing that you will not find at Elegant Touch is what you find in other gift shops in her market area. When selecting products for her shop, Anita asks vendors whether other stores in the area carry the gift line she is considering. She will not carry duplicates. She likes to see new things and follows the trade magazines to help her do that. When asked how she chooses the products to carry, she described the process as instinctive—“from the gut.”
Anita describes her customer demographics as mostly women, between thirty and seventy years old, married, and established with a home. Because many of her customers are repeat customers, the reason for fresh products is clear. A stale product line is not something that she can afford. Her pricing strategy is consistent with common practice in the industry, but many of her customers have commented that she delivers very high value for the prices she charges. She is not interested in selling online because she does not want to expand any further. She is at a nice comfort level and does not want to deal with additional inventory implications or the need to hire additional employees. As a result, the Elegant Touch website is for basic information only. In promoting Elegant Touch, Anita says that word of mouth works the best. She advertises in the local paper occasionally, supports local events, and is preparing for her first e-mail blast. She is exploring a Facebook presence but is not yet convinced that it will be of much value to her business.
Like all small businesses, Elegant Touch has been impacted by the ups and downs in the economy, with some times being tougher than others. Because Anita has only two part-time employees, however, she has not been faced with the employee layoffs that have hit other small companies. When asked what keeps her going in the rough times, she answered, “You have to love it.” Just walk into her gift shop, and you will see clearly that she does. Except for the content from CheshirePatch.com, all information herein is based on an interview with Anita Bruscino, owner of Elegant Touch, March 2, 2012. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Understand how marketing for small businesses differs from marketing for big businesses.
2. Understand the most significant risk factor facing small businesses.
3. Explain marketing strategy and why it is so important for small businesses.
Small-business marketing and big business marketing are not the same. The basic marketing principles that guide both are the same, but there are important differences with respect to scope, budget, risk factors, and areas of opportunity. Lynne Saarte, “Small Business Marketing Is Different from Big Business Marketing,” Articlecity, accessed December 1, 2011, www.articlecity.com/articles/marketing/article_4959.shtml; Lyndon David, “Small Business Marketing Strategy: How Different Is It from Larger Businesses?,” Slideshare, accessed December 1, 2011, www.slideshare.net/lyndondavid/small-business-marketing-strategy-how-different -is-it-from-larger-businesses. (See Chapter 6 "Marketing Basics" for a discussion of marketing principles.) Small businesses cannot compete with the marketing budgets of big companies. As a result, small businesses do not have the luxury of large staffs and the staying power that comes with high profits. There is little room for error. Failed strategies can lead to ruin.
The scope of small business marketing does not extend across the same level of multiple products and services that characterize most big businesses. Combined with having few if any products in the pipeline, this significantly reduces the insulation that small businesses have against ups and downs in the marketplace or strategic failures. “Small business marketing strategies have to be more targeted, cost-effective and more elaborately planned [s]o as to minimize the losses in case the strategy fails.”Lyndon David, “Small Business Marketing Strategy: How Different Is It from Larger Businesses?,” Slideshare, accessed December 1, 2011, www.slideshare.net/lyndondavid/small-business-marketing-strategy-how-different-is-it-from-larger -businesses.
Competition is the most significant risk factor facing small businesses. Trying to eliminate an established brand takes a lot of work, but it is an overnight job to wipe out a small business. Competition is a huge threat for small businesses. Lyndon David, “Small Business Marketing Strategy: How Different Is It from Larger Businesses?,” Slideshare, accessed December 1, 2011, www.slideshare.net/lyndondavid/small-business-marketing-strategy-how-different-is-it-from-larger -businesses. This means that small businesses should be very knowledgeable about their competition to deal effectively with them.
Opportunity areas for small businesses are also very different from those of big businesses. The small business can take advantage of niche markets and local needs and wants. They are much better able to emphasize personal, one-to-one interactions and can market real time in ways that cannot be matched by big businesses. Smaller can actually end up being more powerful.Ann Handley, “Act Your Shoe Size, Not Your Age: 3 Ways to Market Smaller in 2011,” MarketingProfs, January 3, 2011, accessed December 1, 2011, www.mpdailyfix.com/3-ways-to-market-smaller-in-2011.
Given the special marketing vulnerabilities of small businesses, the importance of understanding the components of a marketing strategy should be clear. A marketing strategy involves selecting one or more target markets, deciding how to differentiate and position the product or the service, and creating and maintaining a marketing mix that will hopefully prove successful with the selected target market(s)—all within the context of marketing objectives. Marketing objectives are what a company wants to accomplish with its marketing strategy: “Strategy is not a wish list, set of goals, mission statement, or litany of objectives…A marketing strategy is a clear explanation of how you’re going to get there, not where or what there is. An effective marketing strategy is a concise explanation of your stated plan of execution to reach your objectives…Marketing without strategy is the noise before failure.”John Jantsch, “Marketing without Strategy Is the Noise before Failure,” Duct Tape Marketing, November 29, 2010, accessed December 1, 2011, www.ducttapemarketing.com/blog/2010/11/29/marketing-without-strategy-is-the -noise-before-failure.
Key Takeaways
• Small-business marketing and big business marketing are not the same.
• The most significant risk factor facing small businesses is competition.
• It is important for a small business to have a marketing strategy so that it is better positioned to choose among options.
• An effective marketing strategy is a concise explanation of a business’s stated plan of execution to reach its objectives.
• Marketing without strategy is the noise before the failure.
EXERCISE
1. You just started a new job with a twenty-five-employee small business. By accident, you found out that the company does not have a clear marketing strategy. So far, the company has been lucky with its product sales, but you have a feeling that things will not continue at the same pace for much longer because a competitor has entered the marketplace. Assuming that you had the opportunity, how would you go about convincing the owner that the smart thing to do right now is to create a marketing strategy? Make the case to the owner. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.02%3A_The_Importance_of_a_Marketing_Strategy.txt |
Learning Objectives
1. Describe the marketing strategy process.
2. Explain why segmentation, target market, differentiation, positioning, and website decisions are so important for the small business.
3. Describe the marketing strategy decision areas for each element of the marketing mix.
The focus of this text is on the management of the small business that is up and running as opposed to a start-up operation. As a result, the considerations of marketing strategy are twofold: (1) to modify or tweak marketing efforts already in place and (2) to add products or services as the business evolves. In some instances, it may be appropriate and desirable for a small business to backfit its marketing activities into a complete marketing strategy framework.
The marketing strategy process consists of several components (Figure 7.1 "Marketing Strategy Process"). Each component should be considered and designed carefully: company vision, company mission, marketing objectives, and the marketing strategy itself.
Vision and Mission
It is awfully important to know what is and what is not your business.Jay Ebben, “Developing Effective Vision and Mission Statements,” Inc., February 1, 2005, accessed December 1, 2011, www.inc.com/resources/startup/articles/20050201/missionstatement.html.
Gertrude Stein
The vision statement tries to articulate the long-term purpose and idealized notion of what a business hopes to become. (Where do we see the business going?) It should coincide with the founder’s goals for the business, stating what the founder ultimately envisions the business to be.Jay Ebben, “Developing Effective Vision and Mission Statements,” Inc., February 1, 2005, accessed December 1, 2011, www.inc.com/resources/startup/articles/20050201/missionstatement.html. The mission statement looks to articulate the more fundamental nature of a business (i.e., why the business exists). It should be developed from the customer’s perspective, be consistent with the vision, and answer three questions: What do we do? How do we do it? And for whom do we do it?
Both the vision statement and the mission statement must be developed carefully because they “provide direction for a new or small firm, without which it is difficult to develop a cohesive plan. In turn, this allows the firm to pursue activities that lead the organization forward and avoid devoting resources to activities that do not.”Jay Ebben, “Developing Effective Vision and Mission Statements,” Inc., February 1, 2005, accessed December 1, 2011, www.inc.com/resources/startup/articles/20050201/missionstatement.html. Although input may be sought from others, the ultimate responsibility for the company vision and mission statements rests with the small business owner. The following are examples of both statements:
• Vision statement. “Within the next five years, Metromanage.com will become a leading provider of management software to North American small businesses by providing customizable, user-friendly software scaled to small business needs.”Susan Ward, “Sample Vision Statements,” About.com, accessed December 1, 2011, sbinfocanada.about.com/od/businessplanning/a/samplevisions.htm.
• Mission statement. “Studio67 is a great place to eat, combining an intriguing atmosphere with excellent, interesting food that is also very good for the people who eat there. We want fair profit for the owners and a rewarding place to work for the employees.”“Organic Restaurant Business Plan: Studio67,” Bplans, accessed December 1, 2011, www.bplans.com/organic_restaurant_business_plan/executive_summary_fc.cfm.
Marketing Objectives
Marketing objectives are what a company wants to accomplish with its marketing. They lay the groundwork for formulating the marketing strategy. Although formulated in a variety of ways, their achievement should lead to sales. The creation of marketing objectives is one of the most critical steps a business will take. The company needs to know, as precisely as possible, what it wants to achieve before allocating any resources to the marketing effort.
Marketing objectives should be SMART: specific, measurable, achievable, realistic, and time-based (i.e., have a stated time frame for achievement). It has been recommended that small businesses limit the number of objectives to a maximum of three or four. If you have fewer than two objectives, you aren’t growing your business like you should be in order to keep up with the market. Having more than four objectives will divide your attention, and this may result in a lackluster showing on each objective and no big successes.“How to Choose Marketing Plan Objectives,” accessed January 24, 2012, www.hellomarketing.biz/planning-strategy/marketing-plan-objectives.php. If a small business has multiple marketing objectives, they will have to be evaluated to ensure that they do not conflict with each other. The company should also determine if it has the resources necessary to accomplish all its objectives. Adapted from “Marketing Plan: Marketing Objectives and Strategies,” Small Business Notes, accessed December 1, 2011, www.smallbusinessnotes.com/starting -a-business/marketing-plan-marketing-objectives-and-strategies.html.
For small businesses that already have, or are looking to have, a web presence and sell their products or services online, e-marketing objectives must be included with all other marketing objectives. E-marketing is defined as “the result of information technology applied to traditional marketing.”Judy Strauss and Raymond Frost, E-Marketing (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 6. The issues of concern and focus will be the same as for traditional marketing objectives. The difference is in the venue (i.e., online versus on ground). Examples of e-marketing objectives are as follows: to establish a direct source of revenue from orders or advertising space; improve sales by building an image for the company’s product, brand, and/or company; lower operating costs; Bobette Kyle, “Marketing Objectives for Your Website,” WebSiteMarketingPlan.com, December 10, 2010, accessed December 1, 2011, www.websitemarketingplan.com/marketing_management/marketingobjectivesarticle.htm. provide a strong positive customer experience; and contribute to brand loyalty. The ultimate objective, however, will be “the comprehensive integration of e-marketing and traditional marketing to create seamless strategies and tactics.”Judy Strauss and Raymond Frost, E-Marketing (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 5.
The Marketing Strategy
With its focus being on achieving the marketing objectives, marketing strategy involves segmenting the market and selecting a target or targets, making differentiation and positioning decisions, and designing the marketing mix. The design of the product (one of the four Ps) will include design of the company website. Differentiation refers to a company’s efforts to set its product or service apart from the competition, and positioning is placing the brand (whether store, product, or service) in the consumer’s mind in relation to other competing products based on product traits and benefits that are relevant to the consumer.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 179. These steps are discussed in Section 7.3 "Segmentation and the Target Market" through Section 7.8 "Marketing Strategy and Promotion". It has been said that “in some cases strategy just happens because a market and a product find each other and grow organically. However, small businesses that understand the power of an overarching marketing strategy, filtered and infused in every tactical process, will usually enjoy greater success.”John Jantsch, “The Cycle of Strategy,” Duct Tape Marketing, March 29, 2010, accessed December 1, 2011, www.ducttapemarketing.com/blog/2010/03/29/the-cycle-of -strategy.
KEY TAKEAWAYS
• The marketing strategy process consists of company vision, company mission, marketing objectives, and the marketing strategy itself.
• The company vision: Where do we see the business going?
• The company mission: Why does our business exist?
• Marketing objectives: What do we want to accomplish with our marketing strategy?
• Marketing strategy: How will we accomplish our marketing objectives?
• Marketing objectives should be SMART: specific, measurable, achievable, realistic, and time-based (i.e., have a specific time frame for accomplishment).
• Small businesses should limit the number of objectives to three or four to increase the chances that they will be achieved.
• E-marketing objectives must be included with traditional marketing objectives.
• E-marketing and traditional marketing should be integrated to create seamless marketing strategies and tactics.
• Marketing strategy involves segmenting the market, selecting a target or targets, making differentiation and positioning decisions, and designing the marketing mix. The design of the product will include design of the company website.
EXERCISES
1. Develop the marketing objectives for Frank’s All-American BarBeQue restaurant in Darien, Connecticut.
2. Explain the differences between an onground marketing strategy and an online marketing strategy. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.03%3A_The_Marketing_Strategy_Process.txt |
Learning Objectives
1. Explain segmentation and the target market.
2. Explain why segmentation, the target market, differentiation, positioning, and website decisions are so important for a small business.
3. Describe the marketing strategy decision areas for each element of the marketing mix.
Whether market segments and target markets are selected on the basis of intuition, marketing research, or a combination of the two, they are the basis for creating an effective marketing mix for any small business. Segmentation and target market decisions must be made for both onground and online customers.
Segmentation
Market segmentation, dividing a market into relatively homogeneous subgroups that behave much the same way in the marketplace, is the necessary precursor to selecting a target market or target markets. The extensive bases on which a company is able to segment a market are presented in Table 6.1 "Market Segmentation". The challenge is knowing which group(s) to select. Many small business owners have a good intuitive sense of the segments that make sense for the business, and they choose to go with that intuition in devising their marketing strategy. However, that intuition may not be precise or current enough to be of the most help in planning a marketing strategy. Marketing research can be of help here, even to the smallest of businesses.
Marketing research can help the small business identify and refine the segments that offer the greatest opportunities. Part of that process will be to identify segments that meet the requirements of measurability, substantiality, stability, accessibility, actionability, and differential response.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 175–76. Meeting these requirements will increase the chances for successful segmentation.
• Measurability. Is it easy to identify and estimate the size of a segment? A small business that moves forward without a clear definition of its market segments is working blind. Intuition can only go so far. Are there people who are interested in freshly baked cookies for dogs (it would seem so), and how many of these people are there? (Check out Happy Hearts Dog Cookies.)
• Substantiality. Is the segment large and profitable enough to justify an investment? A small business may not require a huge number of customers to be profitable, but there should be enough people interested in the product or the service being offered to make operating the business worthwhile. Fancy designer clothes for dogs, for example, is a business that can survive—but not everywhere (see www.ralphlauren.com/search/index.jsp?kw=pup&f=Home).
• Stability. Stability has to do with consumer preferences. Are they stable over time? Although segments will change over time, a small business needs to be aware of preferences that are continuously changing. Small businesses can be more nimble at adapting their businesses to change, but too much volatility can be damaging to a business’s operations.
• Accessibility. Can a business communicate with and reach the segment? A small business interested in women who work outside the home will present greater communication challenges than will stay-at-home wives and mothers.
• Actionability. Is a small business capable of designing an effective marketing program that can serve the chosen market segment? There was a small manufacturer of low-priced cigarettes in Virginia that found it difficult to compete with the big brands and other established lower-priced brands such as Bailey’s. The manufacturer’s solution was to sell to Russia where “Made in Virginia, USA” worked very well with customers and retailers. Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 176.
• Differential response. The extent to which market segments are easily distinguishable from each other and respond differently to company marketing strategies.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 176. For the small business that chooses only one segment, this is not an issue. However, the small manufacturer of ramen noodles in New York City needs to know whether there are different segments for the product and whether the marketing strategy will appeal to those segments in the same positive way.
Once multiple segments have been identified, it is necessary to select a target market or target markets. If only a single segment has been identified, it becomes the target market.
Target Market
The selection of a target market or target markets will be based on the segments that have been identified as having the greatest potential for the business. (In "Marketing Basics", a target market refers to one or more segments that have been chosen as the focus for business operations.) Only some of the people in the marketplace will be interested in buying and/or using a company’s product or service, and no company has the resources to be all things to all people. Resources are always finite, but this will especially be the case for the small business, so all marketing efforts should be directed as precisely as possible.
Selecting the target market should be guided by several considerations:Susan MaGee, “How to Identify a Target Market and Prepare a Customer Profile,” accessed January 24, 2012, http://edwardlowe.org/erc/?ercID=6378; Adapted from “3 Reasons to Choose a Target Market,” Morningstar Marketing Coach, December 16, 2008, accessed December 1, 2011, www.morningstarmultimedia.com/3-reasons-to-choose-a-target-market.
• Financial condition of the firm. Limited resources may dictate the selection of only one target market.
• Whether the competition is ignoring smaller segments. If yes, this may be a ready-made target market.
• Is the market new to the firm? If yes, concentrating on one target market may make the most sense.
• Specific need or want. Does the proposed target market have a specific need or want for the product or the service?
• Ability to buy. Does the proposed target market have the resources to buy the product or the service?
• Willingness to buy. Is the proposed target market willing to buy the product or the service?
• Will this target market be profitable? There needs to be enough demand to make money.
Choosing the right target market is a critical part of the marketing strategy of a small business. The target market should be the best match for a company’s products and services, thus helping to maximize the efficiency and effectiveness of its marketing efforts.
If a small business wants to go with a niche market, the same considerations apply. A niche market is a small, more narrowly defined market that is not being served well or at all by mainstream product or service marketers. The great advantage of pursuing a niche market is that you are likely to be alone there: “other small businesses may not be aware of your particular niche market, and large businesses won’t want to bother with it.”Susan Ward, “Niche Market,” About.com, accessed December 1, 2011, sbinfocanada.about.com/cs/marketing/g/nichemarket.htm. Ideally, a small business marketing to a niche market will be the only one doing so. Niches are very important to small businesses that want to sell pricey chocolates (see, for example, www.cocoadolce.com/about.php). They focus on niches such as weddings, seasonal offerings, and specialty items. They also sell online in order to reach a broader market.
KEY TAKEAWAYS
• Market segments and target markets are the basis for creating an effective marketing mix.
• Segmentation and target market decisions must be made for both onground and online customers.
• Market segmentation precedes the selection of a target market.
• There are many ways to segment a market.
• Segments must be measurable, substantial, stable, accessible, actionable, and easily distinguishable from other segments.
• The target market should be the segment or segments that show the greatest profit potential for a small business.
• A niche market is a small, more narrowly defined target market that is not being served well or at all by other businesses.
EXERCISES
1. How should the market for Frank’s All-American BarBeQue be segmented for his new restaurant in Darien, Connecticut? How should Frank decide on a target market or target market(s)? Be specific. Do not assume that the Darien market is the same as the Fairfield market.
2. Assume that you work for a small manufacturer of children’s hair-care products. What criteria would you use for effective segmentation? How would you then decide on a target market or target markets? Be specific. Adapted from Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 185. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.04%3A_Segmentation_and_the_Target_Market.txt |
Learning Objectives
1. Explain differentiation and positioning.
2. Explain why differentiation and positioning are so important for an online marketing strategy and an onground marketing strategy.
3. Understand that a successful differentiation strategy cannot be copied by competitors.
4. Understand that there are many ways to differentiate a product or a service.
5. Understand that successful positioning of a small business or its brand is built on a well-defined target market combined with solid points of differentiation.
Differentiation and positioning considerations are relevant to each element of the marketing mix as well as to onground and online marketplaces. The small business should be working toward a competitive advantage—“the ability to perform in one or more ways that competitors cannot or will not match.”Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 276.
Differentiation
Differentiation, setting yourself apart from the competition, is one of the most important and effective marketing tools available to small business owners.Bonny Albo, “Making a Business Stand Out from Its Competitors,” Entrepreneurs @ Suite 101, August 9, 2009, accessed December 1, 2011, bonny-albo.suite101.com/marketing-strategy-differentiation-a136498. Effective differentiation can put a business (or a brand) in the top position among the competition, but an ineffective differentiation strategy can leave a business buried in the middle or at the bottom of the pack.Kim T. Gordon, “Dare to Be Different,” April 1, 2005, accessed December 1, 2011, www.entrepreneur.com/article/76736. A successful differentiation strategy cannot be imitated by competitors—but it can bring you great success with consumers.Dan Herman, “The Surprising Secret of Successful Differentiation,” Fast Company, June 7, 2008, accessed December 1, 2011, www.fastcompany.com/blog/dan -herman/outsmart-mba-clones/surprising-secret-successful-differentiation?.
Video Clip \(1\):
Differentiation is everyone’s goal, but few are able to achieve it.
Small businesses, whether business-to-consumer (B2C) or business-to-business (B2B), can differentiate their companies or brands in many different ways: quality, service, price, distribution, perceived customer value, durability, convenience, warranty, financing, range of products/services offered, accessibility, production method(s), reliability, familiarity, product ingredients, and company image are all differentiation possibilities.Bonny Albo, “Making a Business Stand Out from Its Competitors,” Entrepreneurs @ Suite 101, August 9, 2009, accessed December 1, 2011, bonny-albo.suite101.com/marketing-strategy-differentiation-a136498. There are others as well, limited only by the imagination. One way to uncover differentiation possibilities is to examine customer experience with a product or a service by asking the following questions:Ian C. MacMillan and Rita Gunther McGrath, “Discovering New Points of Differentiation,” Harvard Business Review, July–August 1997, 133–145, as cited in Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 277.
• How do people become aware of their needs for a product or a service?
• How do customers find a company’s offering?
• How do customers make their final selection?
• How do consumers order and purchase the product or the service?
• What happens when the product or the service is delivered?
• How is the product installed?
• How is the product or the service paid for?
• How is the product stored?
• How is the product moved around?
• What is the consumer really using the product for?
• What do consumers need help with when they use the product?
• What about returns or exchanges?
• How is the product repaired or serviced?
• What happens when the product is disposed of or no longer used?
No matter what the bases are for differentiating a company or a product, the decision should be made carefully with the expectation that the difference cannot be imitated. When customers are asked whether they can tell the difference between a particular small business and its closest competitors, the answer will hopefully be yes.
Video Clip \(2\):
The “Murals Your Way” Advantage
How Murals Your Way sets itself apart from other wall mural companies.
Video Link \(3\):
Bedbug Dog Sniffs Up Profits
An unusual means of differentiation.
Positioning
Positioning is about the mind of the consumer: placing a company or a brand (sometimes they are the same, e.g., Carbonite, CakeLove, and Sugar Bakery & Sweet Shop) in the consumer’s mind in relation to the competition.Al Ries and Jack Trout, Positioning: The Battle for Your Mind (New York: McGraw-Hill, 2001), 3.
The positioning decision is often the critical strategic decision for a company or a brand because the position can be central to customers’ perception and choice decisions. Further, because all elements of the marketing program can potentially affect the position, it is usually necessary to use a positioning strategy as a focus for developing the marketing program. A clear positioning strategy can ensure that the elements of the marketing program are consistent and supportive.David A. Aaker and Gary Shansby, “Positioning Your Product,” Business Horizons, May–June 1982, 56–62.
Both big and small businesses practice positioning, but small businesses may not know it as positioning. The small business owner thinks about positioning intuitively, does not use the terminology, and does not always know how to promote the position. Additionally, in many if not most small businesses, “the positioning of products is based on the opinions of the business owner, his or her family, and selected friends and family.”“Product Positioning,” Inc., accessed December 1, 2011, www.inc.com/encyclopedia/product-positioning.html. This notwithstanding, an understanding of positioning should be in every small business owner’s tool kit.
Video Clip \(4\):
Small-Business Market Position
Small-business owners must figure out how the company should be positioned.
Video Clip \(5\):
What Is Market Positioning?
A discussion of positioning.
Successful positioning of a small business or its brand is built on a well-defined target market combined with solid points of differentiation. There are six approaches to positioning that the small business owner should consider:David A. Aaker and Gary Shansby, “Positioning Your Product,” Business Horizons, May–June 1982, 56–62.
1. Positioning by attribute. The most frequent positioning strategy. The focus is on a particular attribute, a product feature, or customer benefit. CakeLove in Maryland positions itself as “cakes from scratch” with natural ingredients (not the least of which is butter, lots of it).
Video Link \(6\):
Welcome to CakeLove
An introduction to CakeLove bakery.
1. Positioning by price/quality. A very pervasive approach to positioning. Some small companies and brands offer more in terms of service, features, or performance, and a higher price serves to signal this higher quality to the customer. As an example, Derry Church Artisan Chocolates are very expensive, but they position themselves as having the very high quality that justifies a high price.Jim T. Ryan, “Sweet Strategy: Artisan Chocolatier Eyes Internet, Corporate Giving for Growth,” Central Penn Business Journal, November 26, 2010, 3–6.
2. Positioning by use or application. Focuses on how a product is used or different applications of the product. A solitary custom tailoring shop located in a downtown professional office area could position itself as the only tailor where you can conveniently go “for lunch.”
3. Positioning by product user. The focus shifts from the product to the user. KIND Snacks are cereal bars positioned as a snack bar for those who are interested in a snack that is wholesome, convenient, tasty, healthy, and “economically sustainable and socially impactful.”“Our Story,” KIND Healthy Snacks, accessed December 8, 2011, www.kindsnacks.com/our-story. It is a great snack for hikers and campers.
4. Positioning by product class. Focuses on product-class associations. A cleaning service that uses only green products and processes can position itself as the green choice in cleaning services. Healthy Homes Cleaning is an example of a green cleaning business.
5. Positioning with respect to a competitor. Comparing a small business brand to its competitors. Some comparisons will be very direct; others will be subtle.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 181. A small manufacturer that does not miss delivery times and makes products that are free of flaws can position itself on the basis of timely delivery and manufacturing excellence.Lisa Nielsen, “Product Positioning and Differentiation Strategy,” Chron.com, accessed June 1, 2012, smallbusiness.chron.com/product-positioning -strategy-3350.html.
Joe’s Redhots’ Business Positioning Strategy
Joe’s Redhots will sell premium-quality hot dogs and other ready-to-eat luncheon products to upscale business people in high-traffic urban locations. Joe’s Redhots will be positioned versus other luncheon street vendors as “the best place to have a quick lunch.” The reasons are that Joe’s Redhots have the cleanest carts; the most hygienic servers; the purest, freshest products; and the best value. Prices will be at a slight premium to reflect this superior vending service. Joe’s Redhots will also be known for its fun and promotional personality, offering consumers something special every week for monetary savings and fun.“Positioning Strategy Statement,” Business Owner’s Toolkit, accessed December 1, 2011, www.toolkit.com/small_business_guide/sbg.aspx?nid=P03_7003.
The challenge for a small business is to decide which approach to positioning a company or a brand is the best fit. This decision “often means selecting those associations which are to be built upon and emphasized and those associations which are to be removed or de-emphasized.”David A. Aaker and Gary Shansby, “Positioning Your Product,” Business Horizons, May–June 1982, 56–62. In the process of writing a positioning statement, something that is encouraged as a way to keep the business on track, be aware of the difference between a broad positioning statement and a narrow positioning statement. A broad statement should encompass enough to allow a company to add products without the need to create a new positioning statement on a frequent basis; a narrow positioning statement puts a company in a “specialist” position in its market.Andy LaPointe, “Is Your Positioning Statement Confusing Your Customers?,” Small Business Branding, May 13, 2007, accessed December 1, 2011, www.smallbusinessbranding.com/714/is-your-positioning-statement-confusing -your-customers. The following are some examples:
• Broad position statement. “Professional money management services for discerning investors”
• Narrow position statement. “Equity strategies for low risk investors”
• Broad position statement. “Elegant home furnishings at affordable prices”
• Narrow position statement. “Oak furniture for every room in your house”Andy LaPointe, “Is Your Positioning Statement Confusing Your Customers?,” Small Business Branding, May 13, 2007, accessed December 1, 2011, www.smallbusinessbranding.com/714/is-your-positioning-statement-confusing -your-customers.
KEY TAKEAWAYS
• Differentiation and positioning considerations are relevant to each element of the marketing mix as well as the onground and online marketplaces.
• Differentiation and positioning can contribute to the competitive advantage of a small business.
• Differentiation is one of the most important and effective marketing tools available to a small business owner.
• Small businesses, both B2B and B2C, can differentiate their companies or brands in many different ways.
• Ideally, differentiation should be done in a way that cannot be imitated by the competition.
• Positioning is about placing a company or a brand in the mind of the consumer in relation to the competition. It is always comparative.
• Small businesses practice positioning as much as larger companies do, but they may not use the terminology.
• All small business owners should understand what positioning is and how they can use it to their advantage.
EXERCISES
1. Although Frank’s All-American BarBeQue has a very loyal following in Fairfield, Connecticut, developing a marketing plan and strategy for the Darien store will require specific statements of differentiation and positioning. What should they be? Remember that the Darien market may be similar to the Fairfield market, but the two markets should not be seen as identical.
2. Continuing with the scenario about the small manufacturer of hair-care products for children, how would you differentiate and position the product for competitive advantage? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.05%3A_Differentiation_and_Positioning.txt |
Learning Objectives
1. Understand why product is the key element in the marketing mix.
2. Identify the multiple decisions and considerations that factor into product or service development.
3. Describe the three product layers and explain why small businesses should pay attention to them.
4. Explain the importance of product design to marketing strategy.
5. Understand the role of packaging to product success.
6. Explain what a brand is and why it is probably a company’s most important asset.
7. Explain the implications of the product life cycle for the marketing mix.
8. Understand that a company’s website is part of its product or service, whether or not the company sells anything online.
9. Explain the decision areas for the company website.
The key element in the marketing mix is the product. Without it, price, promotion, and place are moot. The same is true for marketing strategy. Fulfilling a company’s vision and mission and achieving its marketing objectives must be led by the product.
There are multiple decisions and considerations that factor into product or service development: features and benefits, product mix, design, brand, the product life cycle, and the company website. Knowing product development issues can be very helpful for even the smallest business that is looking to keep its current product line responsive to the customers while also looking to expand its product line as the company grows (if growth is desired).
Product Features and Benefits
A product has multiple layers: core, augmented, and symbolic. These three layers can help a small business owner understand the product features and benefits that will best deliver value to current and prospective customers. These layers also provide the bases for differentiating and positioning the product. The product layers refer to both products and services and business-to-consumer (B2C) or business-to-business (B2B) customers.
The core layer is the nuts and bolts of a product, its physical anatomy, and its basic features. It is also the basic benefit or problem solution that B2C or B2B customers are looking for. Someone buying an airline ticket, for example, is buying transportation.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 226. Someone buying an ice cream cone is buying a delicious and fun treat. The core layer is also where considerations of quality begin. Quality “refers to overall product quality, reliability, and the extent to which [the product or the service] meets consumers’ needs,” and the perception of quality has the greatest impact on customer satisfaction.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 117. Decisions about design, manufacturing, preparation, ingredients, service delivery, component parts, and process materials all reflect a business’s philosophy about quality. The augmented layer is where additional value is added via things such as packaging, promotion, warranties, guarantees, brand name, design, financing opportunities where appropriate, prompt and on-time service, and additional services that may enhance a product. The augmented layer for Southwest Airlines is its well-known brand name, its packaging and promotion as a “fun” flying experience, and its “bags fly free” policy. The ice cream cone that is purchased in an old-fashioned ice cream parlor will likely be considered of greater value to many customers than the ice cream cone purchased at a Dairy Queen. It is this layer where many marketing mistakes are made because opportunities are missed. The symbolic layer captures the meaning of a product to a consumer—its emotional and psychological connections. There are many loyal customers of Southwest Airlines because they really enjoy flying with them. It is inexpensive, convenient, and fun. The old-fashioned ice cream parlor will engender nostalgia and create powerful emotional ties. The most serious marketing errors are made when the symbolic product layer is either ignored or not understood. The power of symbolism should never be underestimated.
Every small business should look at its products within the context of the product layers. It is the creativity and imagination of the small business owner with the product layers that can set a business apart. They provide an excellent basis for dissecting an existing product to see where opportunities may have been missed, features could be added or changed, and features or enhancements could be explained more effectively in promotional activities. The product layers should also be used to develop new products that the business plans to introduce.
Product Mix
All small businesses have a product mix, the selection of products or services that is offered to the marketplace. With respect to the product mix for small companies, a company will usually start out with a limited product mix. However, over time, a company may want to differentiate products or acquire new ones to enter new markets. A company can also sell existing products to new markets by coming up with new uses for its products.Rick Suttle, “What Is a Product Mix?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/product-mix-639.html. No matter the approach, the product mix needs to be created so that it is responsive to the needs, wants, and desires of the small business’s target market.
For small businesses engaged in e-marketing, product selection is a key element for online success. Part of the challenge is deciding which products to market online because some products sell better online than others.Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 101. If a business has a brick-and-mortar presence, a decision must be made whether all the inventory or only part of it will be sold online. Items that sell well online change over time, so it is important to keep up to date on the changes.Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 101. A second decision to be made is the number of items in the catalog (i.e., the number of items you will sell). Given intense online competition and shoppers’ desires for good selections, there needs to be a critical mass of products and choices—unless a company is lucky enough to have a very narrow niche with high demand. If a company has only one or two products to sell, the situation should be evaluated to determine whether selling online will be profitable.Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 101–2.
Product Design
In his book, Re-imagine! Business Excellence in a Disruptive Age,Tom Peters, Re-imagine! Business Excellence in a Disruptive Age (London: Dorling Kindersley Limited, 2003), 132–46. Tom Peters devotes two chapters to the importance of design to business success. He says that design is “the principal reason for emotional attachment (or detachment) relative to a product service or experience”—and he quotes Apple’s CEO, Steve Jobs, in saying that design is the “fundamental soul of a man-made creation.”Tom Peters, Re-imagine! Business Excellence in a Disruptive Age (London: Dorling Kindersley Limited, 2003), 132–146, as cited in Bob Lamons, “Strong Image Design Creates Passion for Firm, Its Products,” Marketing News, April 15, 2005, 7. This is true whether the product comes from a big business or a small business.
Product design involves aesthetic properties such as color, shape, texture, and entire form, but it also includes a consideration of function, ergonomics, technology, and usabilityDana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 242; Dominic Donaldson, “The Importance of Good Product Design,” Artipot, December 8, 2008, accessed December 1, 2011, www.artipot.com/articles/246078/the -importance-of-good-product-design.htm. as well as touch, taste, smell, sight, and sound. The pulling together of these things, as appropriate to the specific product or service being designed, should result in a design that matches customer expectations. “Design represents a basic, intrinsic value in all products and services.”Ted Mininni, “Design: The New Corporate Marketing Strategy,” MarketingProfs, November 5, 2005, accessed December 1, 2011, www.marketingprofs.com/articles/2005/1670/design-the-new-corporate-marketing-strategy.
Design offers a powerful way to differentiate and position a company’s products and services, often giving company a competitive edge.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 325. Improved profit margins from increased sales and increased market share are often the result. It is essential to get the visual design of a product right for the market you are appealing to. It can make the difference between selling a product—or not.Dominic Donaldson, “The Importance of Good Product Design,” Artipot, December 8, 2008, accessed December 1, 2011, www.artipot.com/articles/246078/the -importance-of-good-product-design.htm.
Design is particularly important in making and marketing retail services, apparel, packaged goods, and durable equipment. The designer must figure out how much to invest in form, feature development, performance, conformance, durability, reliability, repairability, and style. To the company, a well-designed product is one that is easy to manufacture and distribute. To the customer, a well-designed product is one that is pleasant to look at and easy to open, install, use, repair, and dispose of. The designer must take all these factors into account.
The arguments for good design are particularly compelling for smaller consumer products companies and start-ups that do not have big advertising dollars.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 325.
Quirky.com is a small business that has taken product design to a whole new level: collaboration. First seen as a “bold but ultimately wild-eyed idea,”Cliff Kuang, “Product-Design Startup Quirky Gets \$6 Million in VC Funding,” Fast Company, April 7, 2010, accessed December 1, 2011, www.fastcompany.com/1609737/product-design-startup-quirky-gets-6-million-in-vc-funding. Quirky recently secured \$6 million in venture financing. Check out how they operate in Note 7.42 "Video Clip 7.5". A company like this could be very helpful to a small business that is looking to introduce a new product.
Video Clip \(1\):
Quirky’s Ben Kaufman on Innovation
An innovative approach to product design: collaboration.
Design issues also apply to services. Some of the design issues for services that are delivered in a store (e.g., dry cleaning, repair, and restaurant) are the same as for any retail store: the design of the physical space, the appearance of the personnel, the helpfulness of the personnel, the ease of ordering, and the quality of service delivery. For services that are performed at a customer’s home or at a business site, the design issues include timeliness; the appearance and helpfulness of personnel; the quality of installation, service, and repair; and the ease of ordering the service. The special characteristics of services (i.e., intangibility, perishability, inseparability, and variability, as defined in Figure \(3\) present design challenges that are different from those faced by physical products.
Whether a small business is offering a product, a service, or a combination of the two to either the B2C or B2B marketplace, there is no question that excellent product design is a gateway to business success.
Packaging Design
The design of the product or the service package is another decision component of the product. Packaging can be defined as “all the activities of designing and producing the container for a product.”Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 239. Packages “engage us consciously and unconsciously. They are physical structures but at the same time they are very much about illusion. They appeal to our emotions as well as to our reason.”Randall Frost, “Packaging Your Brand’s Personality,” Brandchannel, October 3, 2005, accessed December 1, 2011, www.brandchannel.com/features_effect.asp?pf_id =283. Thus the package communicates both emotional and functional benefits to the buyer, and it can be a powerful means of product differentiation. A well-designed package can build brand equity and drive sales.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 339. A poorly designed package can turn the customer off and can lead to wrap rage—the anger and frustration that results from not being able to readily access a product, which often leads to injuries (see Note 7.48 "Video Clip 7.6"). Although difficult-to-open packaging may be seen as necessary by the manufacturers and retailers, it does not do much for a positive customer experience.
Video Clip \(2\):
Wrap Rage
Wrap rage: what it is about, with examples.
Video Clip \(3\):
Opening Plastic Clamshells with a Can Opener
Plastic clamshell packages inspire wrap rage. They are easier to open if you start with a can opener.
Brand
A brand is defined by the American Marketing Association as “a name, term, sign, symbol, or design, or a combination of them, intended to identify the goods or services of one seller or group of sellers and to differentiate them from those of competitors…A brand may identify one item, a family of items, or all items of that seller. If used for the firm as a whole, the preferred term is trade name.”“Brand,” American Marketing Association, accessed December 1, 2011, www.marketingpower.com/_layouts/Dictionary.aspx?dLetter=B. A brand is a promise to the consumer that certain expectations will be met, a promise that—if broken—may result in the loss of that customer. A company’s brand is probably its most important asset.
Video Clip \(4\):
A Brand Is More Than a Logo
What a brand is all about.
Building a brand is an ongoing process for a small business because it wants a memorable identity. It is important for the business to constantly monitor its brand to ensure that it represents the core values and needs of its existing and potential customers.Miranda Brookins, “How to Brand a Business,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/brand-business-211.html. The brand needs to reach people on an emotional levelMarc Gobe, Emotional Branding: The New Paradigm for Connecting Brands to People (New York: Allworth Press, 2001), xv. because customers ultimately make decisions on an emotional level, not a logical level. For this reason, a small business should think in terms of tapping into as many senses as possible with its brand. “Almost our entire understanding of the world is experienced through our senses. Our senses are our link to memory and can tap right into emotion.”Martin Lindstrom, Brand Sense: Build Powerful Brands through Touch, Taste, Smell, Sight, and Sound (New York: Free Press, 2005), 10. Scenting the air of a store with a fresh fragrance could be a powerful contributor to the store’s brand.
Whether a small business wants to keep its brand (but may be monitoring it) or is looking to rebrand (changing the brand), there are four fundamental qualities of great brands that should be kept in mind:Adapted from Patrick Barwise and Sean Meehan, “The One Thing You Must Get Right When Building a Brand,” Harvard Business Review, December 2010, 80–84.
1. They offer and communicate a clear, relevant customer promise, such as fun, speedy delivery, or superior taste.
2. They build trust by delivering on that promise. Keeping a customer informed when something goes wrong can help build and retain trust.
3. They drive the market by continually improving the promise. A small business should always be looking to make things better for its customers. Think in terms of the total customer experience.
4. They seek further advantage by innovating beyond the familiar. If a small business focuses on the customer experience, there are undoubtedly ways to improve the brand by adding the unexpected.
The ultimate objective is to have a brand that delivers a clear message, is easy to pronounce, confirms a company’s credibility, makes an emotional connection with the target market, motivates the buyer, and solidifies customer loyalty.Laura Lake, “What Is Branding and How Important Is It to Your Marketing Strategy?,” About.com, accessed December 1, 2011, marketing.about.com/cs/brandmktg/a/whatisbranding.htm; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 230.
Video Clip \(5\):
Good Branding Will Build a Company
A strong branding and marketing strategy is an investment that will pay dividends for years to come.
Video Clip 7. \(6\):
Small Business Branding Tips
A small business owner talks about the importance and mechanisms of creating a strong and memorable company brand.
Product Life Cycle
Every product has a life span. Some are longer than others. The pet rock had a very short life span. The automobile is still going strong. Some products or services experience an early death, not able to make it very far out the door. Take, for example, Colgate Kitchen Entrees (yes, as in the toothpaste); Cosmopolitan Yogurt (off the shelves in eighteen months); and Ben-Gay Aspirin (the idea of swallowing Ben-Gay was not a winner).“Top 25 Biggest Product Flops of All Time,” Daily Finance, accessed December 1, 2011, www.dailyfinance.com/photos/top-25-biggest-product-flops-of-all-time.
Even the big guys make mistakes, so small businesses are not immune from product goofs. The products that do make it, however, go through what is known as the product life cycle (PLC), defined as “the performance of the product in terms of sales and profits over time.”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 244. The traditional PLC is shown in Figure 7.5 "The Traditional Product Life Cycle".
Small-business owners should understand the PLC because there are specific implications for marketing strategy. The product development (incubation) stage is when a product is being prepared for sale. There are costs but no sales. The product introduction stage is when a product is available to buy for the first time. Sales will generally be low but increasing, marketing expenses will be high, and profits will be typically low or nonexistent. The focus of the marketing strategy will be to create awareness, establish a market, and create demand for the product.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 339; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 244; Kristie Lorette, “How Would the Marketing Mix Change at Different Stages of the Product Life Cycle?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/would-marketing-mix-change-different-stages-product-life-cycle-3283.html. The product growth stage is when sales grow rapidly as the target market adopts a product and competition enters the marketplace once it observes the success. Marketing strategy should focus on differentiation and building a brand preference. There is substantial profit improvement. Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 339; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 244; Kristie Lorette, “How Would the Marketing Mix Change at Different Stages of the Product Life Cycle?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/would-marketing-mix-change-different-stages-product-life-cycle-3283.html. Rapid growth must be managed carefully so that the company does not succeed into failure. The product maturity stage is characterized by slow growth because most of the buyers interested in a product have bought it. Sales may increase but slowly due to intense price competition. Profits stabilize or decline. The marketing strategy must focus on getting people to switch brands by using special promotions and incentives.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 339; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 244; Kristie Lorette, “How Would the Marketing Mix Change at Different Stages of the Product Life Cycle?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/would-marketing-mix-change-different-stages-product-life-cycle-3283.html. The product decline stage is when sales decline and profits erode. A product has become obsolete because of an innovation (think VHS to DVD to Blu-Ray) or the tastes of the target market have changed. The marketing strategy works to reinforce the brand image of the product. The product may be dropped from the product line or rejuvenated if possible and practical.
There are many small business owners who may not see the PLC as applying to their products or services. After all, accounting services are accounting services, a luncheonette is a luncheonette, and hardware is hardware. Thinking this way would be a mistake. Accounting practices change, people’s tastes change, hardware solutions change, and government regulation inserts itself. What is successful today may not be successful tomorrow. The PLC provides guidance for watching how a product or a service progresses in the marketplace so that the necessary marketing strategy steps can be taken.
The New Product Development Process
If the development of a new product is being considered, the following steps are suggested as guidance:
• Generate new product ideas. Search for ideas for new products.
• Screen new product ideas. Make sure the product fits the target market and the overall mission of the business.
• Develop and evaluate new product concepts. Develop product concepts and determine how consumers will view and use the product.
• Perform a product business analysis. Calculate projected business costs, return on investment, cash flow, and the long-term fixed and variable costs. Long-term fixed costs are production costs that do not vary with the number of units produced (e.g., annual rent). Long-term variable costs are production costs that vary with the number of units produced (e.g., selling more hot dogs will require more hot dogs, ketchup, mustard, and relish).
• Design and develop the product. Develop a product prototype. A product prototype is an exact match to the product description developed in the concept development and evaluation stages. It is a sample.
• Test market the product. Introduce the product to a market to find out how the product will be received when it is introduced for real. The test market should be as close as possible in terms of characteristics (e.g., demographics) as the target market. For a small business, an appropriate test market might be a few select customers.
• Launch the product or the service. The product is introduced to the full marketplace.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 239–43.
The Company Website
A company’s website is part of its product or service. The conventional wisdom is that all businesses should have a website. The reality is that there are many small businesses that do very well for themselves without a web presence. The small local deli, accounting or insurance services, a legal firm, a liquor store, or a dental office may not see the need for a website. At the same time, customers are increasingly expecting a web presence, so any small business that does not have a website runs the risk of losing sales because of it. The time may also be approaching when not having a website will be perceived as odd, with questions raised as to the seriousness of the business. Every small business without a website should determine whether this matters to them or not.
This section about the company website is targeted to the small business that has a web presence already or is planning to have one. A small business owner should have a basic understanding of website design to contribute to the discussion and communicate effectively when working with professionals Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 751.—as well as to organize the owner’s visceral reaction when it is time to evaluate other websites, plan the company’s website, or revise the company’s current website. Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 67. In addition, any commitment to e-marketing requires a website.
Stanford University’s Persuasive Technology Lab found that people quickly evaluate a website by visual design alone, with the visual design setting the tone for the user’s experience. Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 22–23. “Image is everything online. Good design evokes trust, makes navigation clear, establishes branding, appeals to target customers, and makes them feel good about doing business with the website they are on. Design does not have to be expensive for it to work. It does, however, need to represent an organization and appeal to a visitor. Professional design is not something organizations spend money on; it is something they invest in to support trust, positioning, and long-term marketing” (emphasis added). Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 23.
This section of the chapter discusses website objectives and the fundamental design elements: layout, color, typography, graphics, interactivity, navigation, usability, content, and performance. User experience is also discussed.
Video Clip \(7\):
Web Design Mistakes Small Businesses Make
Mistakes that small businesses should watch for when designing their websites.
Website Objectives
“The goal of any Web site is to deliver quality content to its intended audience and to do so with an elegant design.”Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 751. Website objectives define what a company wants its website to do. For example, a website can build awareness of the business; build awareness of particular brands or services; distribute information to supporters, customers, and stakeholders on products or issues; sell products or services; build relationships with customers; develop a new marketing strategy or reinforce an existing strategy; manage an event (e.g., online registration and payment); build the company image; and gather marketing research by collecting data from users or conducting online surveys.“What Are the Objectives of Your Web Site?,” 3w designs, accessed December 1, 2011, www.3w-designs.co.uk/textonly/new-web-site-aims.html. Whichever objective or combination of objectives is chosen, each objective should meet the criteria discussed in Section 7.2 "The Marketing Strategy Process". Clear-cut objectives will increase the chances that a company’s website design and content will work to achieve those objectives.Ottavio Storace, “How to Build a Web Site That Achieves Objectives,” Webmaster Resources @ Suite 101, July 13, 2009, accessed December 1, 2011.
Website Layout
Layout refers to the positioning of the various elements that comprise a web page: where each text object will be positioned on each page or screen, the width and length of columns, the amount of space that will be placed between the lines of text, the alignment to be used (e.g., left or right), whether the page will be text only or use more advanced designs (e.g., multiple columns),“Glossary of Web Terminology: Website Layout,” April 5, 2010, accessed January 24, 2012, www.azurewebdesign.com/glossary-of-web-terminology; Sue A. Conger and Richard O. Mason, Planning and Designing Effective Web Sites (Cambridge, MA: Course Technology, 1998), 96. and the placement of graphics. Layout is important because it is one of the first things a visitor perceives when landing on a website. Research shows that “web users spend 69% of their time viewing the left half of the page and 30% viewing the right half, [so] a conventional layout is thus more likely to make sites profitable.”Jakob Nielsen, “Horizontal Attention Leans Left,” Useit.com, April 6, 2010, accessed December 1, 2011, www.useit.com/alertbox/horizontal-attention.html.
Color
Color is a powerful component of design. It affects mood and emotion, and it evokes associations with time and place. For example, psychedelic color combinations take us back to the 1960s, and turquoise and yellow combinations remind us of art deco in the 1950s. For websites, color is important in defining a site’s environment because “people see color before they absorb content.”“Welcome to Color Voodoo Publications,” Color Voodoo, accessed December 1, 2011, www.colorvoodoo.com. A lasting color impression occurs within ninety seconds and accounts for 60 percent of acceptance. What are the implications for website design? Decisions regarding color can be highly important to success.
The key to the effective use of color in website design is “to match the expectations of the target audience. Financial services sites tend to use formal colors (e.g., green or blue) with simple charts to illustrate the text but not many pictures. Sites directed at a female audience tend to feature lighter colors, usually pastels, with many pictures and an open design featuring lots of white space. Game sites are one type of site that can get away with in-your-face colors, Flash effects, and highly animated graphics.”Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 751.
Colors should be selected that reflect the purpose of the site and enhance the design. Understanding the meaning of color and the cultural use of color and how colors interact is important in website design to convey the right tone and message and evoke the desired response to the site.Jacci Howard Bear, “The Meaning of Color,” About.com, accessed December 1, 2011, desktoppub.about.com/od/choosingcolors/p/color_meanings.htm?p=1. The wrong choice could adversely affect a visitor’s experience at the site,Joanne Glasspoole, “Choosing a Color Scheme,” Metamorphosis Design, accessed December 1, 2011, www.metamorphozis.com/content_articles/web_design/Choosing_A_Color_Scheme.php. which could adversely affect a company’s sales and image.
Video Clip 7. \(8\):
Color Psychology in Web Design
Insights into color and its importance in website design.
Color Perceptions for Business
“The following list provides the traditional meanings of common colors and suggests compatible business usage:
• Pink. Romance, love, friendship, delicacy, feminine; ideal for relationship coaches, florists, and breast cancer awareness sites.
• Purple. Royalty, spiritual, transformation, creativity, new age; ideal for spirituality-based or new age businesses and businesses in the creative realm.
• Blue. Solid, communication, calm, wisdom, trust, reassuring; ideal for financial businesses, insurance companies, and lawyers.
• Green. Growth, money, abundance, fertility, freshness, health, environment; ideal for grocers, environmental businesses, therapists, healthcare businesses.
• Red. Energy, strength, passion; ideal for bold businesses based on power and for professionals; use in combination with black.
• Black. Power, sophisticated, elegant, formal, style, dramatic, serious; ideal for fine dining establishments; commonly used as an accent color.
• Gold and yellow. Wealth, wisdom, prestige, power, energy, joy, clarity, light, intelligence, optimism; ideal for the construction industry.
• White. Purity, goodness, simplicity, clean; ideal for almost every business.
• Brown. Friendship, earthy, comfort, content, reliable, sturdy; ideal for businesses involved in administrative support.
• Orange. Vibrant, enthusiasm, energy, warmth; ideal for creative businesses and teachers.
• Gray. Security, staid, quality, professional, stable; ideal for the legal industry.”Lena Claxton and Alison Woo, How to Say It: Marketing with New Media (New York: Prentice Hall, 2008), 34.
Typography
Typography is the art of designing a communication by using the printed word.”Colin Wheildon, Type & Layout: How Typography and Design Can Get Your Message Across—or Get in the Way (Berkeley, CA: Strathmoor Press, 1996), 19. More specifically, it is the use of typefaces (or fonts) in a design. Typeface refers to a particular type or font (e.g., Times New Roman and Arial). Typography is an integral part of web design and plays a role in the aesthetics of the website.Shannon Noack, “Basic Look at Typography in Web Design,” Six Revisions, April 7, 2010, accessed December 1, 2011, sixrevisions.com/web_design/a-basic -look-at-typography-in-web-design. About 95 percent of the information on the web is written language, so it is only logical that a web designer should understand the shaping of written information (i.e., typography).Oliver Reichenstein, “Web Design Is 95% Typography,” Information Architects, Inc., October 19, 2006, accessed December 1, 2011, www.informationarchitects.jp/en/the-web-is-all-about-typography-period. It is possible to blow away more than 50 percent of website visitors and readers by choosing the wrong typeface.Colin Wheildon, Type & Layout: How Typography and Design Can Get Your Message Across—or Get in the Way (Berkeley, CA: Strathmoor Press, 1996), 19.
Graphics
Graphics, defined as pictures, artwork, animations, or videos, can be very effective if used correctly. Graphics can provide interest, information, fun, and aesthetics, but they can also take forever to load, be meaningless or useless, not fit on the screen, and use colors that are not browser safe colors (i.e., colors that look the same on PC and Macintosh operating systems). Images enhance a web page, but they should be selected and placed carefully.
Graphics should be used to “convey the appropriate tone of your message. As the old saying goes, a picture is worth a thousand words. Make sure your images correspond to the text and are appropriate to the business you offer. For example, an audiologist shouldn’t use a picture of a woman holding her glasses because the spotlight should be on hearing.”Lena Claxton and Alison Woo, How to Say It: Marketing with New Media (New York: Prentice Hall, 2008), 35. Graphics should also help create a mood, or a sense of place. The use of the graphics has to be thoroughly considered because they slow the loading of a website.“When to Use Graphics on Your Website,” Improve the Web, May 9, 2007, accessed December 1, 2011, www.improvetheweb.com/when-use-graphics-your-site.
It has been shown that quality images boost sales and enhance the visitor experience. “Consumers who browse products on websites want to see the products they’re considering for purchase represented by the highest quality image possible…People do not buy what they cannot see, so the higher the quality and resolution of [the] imagery, the better [the] results will be.”Dave Young, “Quality Images Boost Sales,” Practical eCommerce, March 14, 2007, accessed December 1, 2011, www.practicalecommerce.com/articles/436-Quality -Images-Boost-Sales. The key for any small business that wants graphics on its website is to consider how the graphics will add value to the user experience. The graphics should be for the direct benefit of the user, not the business. Do not get carried away with lots of images and animations because they can make a web page very hard to read. Graphics are a major part of the design, not just afterthoughts.Jennifer Kyrnin, “Basics of Web Layout,” About.com, accessed December 1, 2011, webdesign.about.com/od/layout/a/aa062104.htm.
Site Navigation
People will not use a website if they cannot find their way around it. If web users cannot find what they are looking for or figure out how the site is organized, they are not likely to stay long—or come back.Steve Krug, Don’t Make Me Think: A Common Sense Approach to Web Usability (Berkeley, CA: New Riders Publishing, 2000), 51. “The purpose of site navigation is to help visitors quickly and easily find the information they need on a website. Among the questions considered in site navigation are, How will visitors enter a site? How will visitors use the site? How will they find out what is available at the site? How will they get from one page to another and from one section to another? How will visitors find what they are looking for?”Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 754.
Site navigation must be easy, predictable, consistent, and intuitive enough so that visitors do not have to think about it.Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 754. “Designing effective navigation can also entice your visitors to try out the other things you offer on your site.”“Website Navigation Tips,” Entheos, accessed December 1, 2011, www.entheosweb.com/website_design/website_navigation_tips.asp. The key to understanding navigation is to realize that if it is too hard to use or figure out, web visitors will be gone in a nanosecond, perhaps never to be seen again. What does this mean to a small business? Lost sales and lost opportunities.
Site Usability
A website’s usability, or ease of use, “can make or break an online experience, and it is directly correlated to the success of the site.”Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 38. Website usability measures the quality of a user’s experience when interacting with a website,“Usability Basics,” Usability.gov, accessed December 1, 2011, www.usability.gov/basics/index.html. and it works hand in hand with site navigation. According to usability.gov, usability is a combination of five factors:“Usability Basics,” Usability.gov, accessed December 1, 2011, www.usability.gov/basics/index.html.
1. Ease of learning. How fast can a user who has never seen the user interface before learn it sufficiently well to accomplish basic tasks? The user interface is the way a person interacts with a website.“Definition of User Interface,” accessed December 1, 2011, www.pcmag.com/encyclopedia_term/0,2542,t=user+interface&i=53558,00.asp.
2. Efficiency of use. Once an experienced user has learned to use the website, how fast can he or she accomplish tasks?
3. Memorability. If a user has used the website before, can he or she remember enough to use it effectively the next time or does the user have to start over again learning everything?
4. Error frequency. How often do users make errors while using the website, how serious are these errors, and how do users recover from these errors?
5. Subjective satisfaction. How much does the user like using the website?
Usability is necessary for survival on the Internet. If a website is difficult to use, people will leave,Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 756. and they may be inclined to tell everyone they know on Facebook and Twitter about their negative experiences. It is as simple—and as serious—as that. Small-business owners should consider postlaunch usability testing to help ensure the best user experience. Three free tools are HubSpot’s Website Grader, SiteTuners, and Google Analytics.
Site Interactivity
Site interactivity is about things on a company’s website site that prompt some kind of action from visitors.“Web Development Glossary for Small Businesses,” Lightwave Communications, accessed December 1, 2011, www.lightwavewebdesign.com/web-development -glossary/website-glossary-g-i.html. Visitors become engaged with the site, they stay longer, they look deeper into the site to see what the company is offering, they are less likely to jump to another site, and they feel that they are part of a community and connected. This will keep them coming back to the site. Folusho Orokunie, “Do Not Make Your Website Visitors Yawn! Make Your Site Interactive,” accessed December 1, 2011, folusho.com/do-not-make-your-website-visitors -yawn-make-your-site-interactive.
There are many ways in which a small business can provide interactivity on its site. The following are some examples:“Examples of Possible Interactive Features on Your Website,” Zamba, accessed December 1, 2011, www.zambagrafix.com/interact.htm; “Importance of Web Interactivity: Tips and Examples, Hongkiat.com, accessed December 1, 2011, www.hongkiat.com/blog/importance-of-web-interactivity-tips-and-examples.
• Free calculators for calculating payments when something is being financed
• Surveys, polls, or quizzes
• Blogs, bulletin boards, and discussion forums
• Facebook and Twitter links
• Searchable database of frequently asked questions
• Site search engine
• Interactive games, puzzles, and contests
• Articles that engage visitors, allowing them to add comments or opinions
• Three-dimensional flip-books (e.g., Gorenje Kitchens showcase a range of products, thus engaging the visitor while flipping through the book.)
The sources of interactivity on a website are limited only by a small business owner’s creativity and, of course, budget. However, it should never be a question of saying yes or no to interactivity. It is a matter of how much, what kind, and where. Remember that when customers feel compelled to do something, they are that much closer to buying.“Importance of Interactive Websites,” Thunder Data Systems, accessed December 1, 2011, www.thunderdata.com/thunder_bits/importance_of_interactive_websites .html.
Content
Content refers to all the words, images, products, sound, video, interactive features, and any other material that a business puts on its website.Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 744; Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 67. It is the content that visitors are looking for, and it is what will keep them on the site. High-quality content will also keep people interested so that they come back for more. “A poorly and ineffectively ‘written’ website has an adverse impact on the efficiency of the website. Moreover, it also gives a negative impression of the brand [or company] behind it. Without good ‘content’ a website is an empty box.”JPDC, “The Importance of Visitor-Oriented Online Content on Your Website,” Mycustomer.com, June 12, 2009, accessed December 1, 2011, www.mycustomer.com/blogs/marketingadvisor/marketing-advisor/importance-visitor-oriented-online -content-your-website.
Good content is relevant, customer-centric (i.e., it is written in the language and words of the target audience(s) that visit the website), and complies with what we know about how people read online content. They don’t. They scan it—because it takes 25 percent longer to read the same material online than it does to read it on paper.Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 73. If a company’s content does not fit its target audience(s), the website will not generate good results.JPDC, “The Importance of Visitor-Oriented Online Content on Your Website,” Mycustomer.com, June 12, 2009, accessed December 1, 2011, www.mycustomer.com/blogs/marketingadvisor/marketing-advisor/importance-visitor-oriented-online -content-your-website.
Most small businesses may think that they must generate all website content. However, some of the best and most successful content may be the easiest to create: the content generated by website users. Interestingly, it is not uncommon for user-generated content to get higher search engine rankings than a business’s home page, not an insignificant fact. Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 55. User-generated content includes the following: Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 55.
• Message boards
• Product reviews
• New uses for a company’s products (e.g., using a dishwasher to cook a whole salmon)
• Testimonials or case studies (how users solved problems)
• Social media pages
• Twitter feeds
• Video contest submissions
• Interviews with users
• Online groups or communities such as LinkedIn or Ning
The gold standard of user-generated content is customer reviews. Customer reviews can increase site traffic by as much as 80 percent, overall conversions by 60 percent, and the average order value by 40 percent. With respect to the posting of both positive and negative reviews, it has been shown that “users trust organizations that post both negative and positive reviews of their product if organizations address the feedback constructively.”Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 56.
There are many factors that will contribute to the success of a small business website. However, the website will not do as well as it should, and it will not reach its full potential, without good quality content.“Content Is King—Good Content Holy Grail of Successful Web Publishing,” The Media Pro, August 14, 2010, accessed December 1, 2011, www.themediapro.com/earn-sleeping/content-is-king-holy-grail-of-successful-web-publishing.
Video Link \(9\):
The Value of the About Page
Why the “About” page is so important to a business website.
Product Display
How a website displays products will impact the success of the website. As a result, product display should be seen as a website design issue. Key decisions that should be made for each category of product that is available on the website include the choice of which products to feature, how to provide product detail pages (an individual page for each product is preferable because there is more room for product details), the sort options that will be available to the shopper (e.g., price), and where items on special will be placed on the page (the upper right corner is recommended).Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 103.
Performance
No matter how well designed a website is, and no matter how high the quality of content, a website that takes too long to load will lose visitors. A website’s loading speed determines how fast the pages respond to a user request. Faster site speed is preferred by the users who want an optimal browsing experience, and the small business that wants increasing incoming connections and high sales. Users want faster speeds.“Google Finally Sets the Record Straight: Website Speed Is a Legit Search Ranking Factor,” Linkbuilding.net, June 13, 2010, accessed December 1, 2011, linkbuilding.net/2010/06/13/google-finally-sets-the-record-straight-website-speed-is-a-legit -search-ranking-factor.
Visiting a fast-loading site is a pleasant experience. Visiting a slow-loading site is not. Surveys now show that a person will wait less than three seconds (perhaps even less) for a webpage to load before leaving, with a one-second delay possibly meaning a 7 percent reduction in sales.Imad Mouline, “Is Your Website Fast Enough for Your Customers?,” CNN Money, August 27, 2010, accessed June 1, 2012, tech.fortune.cnn.com/2010/04/...rs/#more-24083. Google claims that the amount of site traffic drops by 20 percent for every 0.5 seconds of load time.“Improving Site Speed and Load Times,” Optimum7.com, April 6, 2010, accessed December 1, 2011, www.optimum7.com/internet-marketing/website-speed/improving-site-speed-and-load-time.html.
There are several factors that slow down the loading time for a website, not the least of which is the connection speed of the user’s computer. This is out of the control of the web designer and the site owner (the small business). The biggest culprit, however, is a large graphic or several small graphics on a single page. Efraim Turban et al., Electronic Commerce: A Managerial Perspective (Upper Saddle River, NJ: Pearson Prentice Hall, 2008), 755. There are ways around this, known by any credible website designer. The impact of “slow down” features should be tested before the site launches and monitored afterwards. Imad Mouline, “Is Your Website Fast Enough for Your Customers?,” CNN Money, August 27, 2010, accessed June 1, 2012, tech.fortune.cnn.com/2010/04/...r-website-fast -enough-for-your-customers/#more-24083. The small business owner can take advantage of some of the popular tools that are available, usually for free, to measure a company’s website speed: YSlow (a Firefox extension); Google Page Speed (a Firefox add-on); or Webmaster Tools.“Google Finally Sets the Record Straight: Website Speed Is a Legit Search Ranking Factor,” Linkbuilding.net, June 13, 2010, accessed December 1, 2011, linkbuilding.net/2010/06/13/google-finally-sets-the-record-straight-website-speed-is-a-legit -search-ranking-factor; “Improving Site Speed and Load Times,” Optimum7.com, April 6, 2010, December 7, 2011, www.optimum7.com/internet-marketing/website -speed/improving-site-speed-and-load-time.html. Once the problem areas have been identified, steps can be taken to make improvements. The goal is to have an interesting and speedy site.
KEY TAKEAWAYS
• The key element in the marketing mix is the product. Without it, price, promotion, and place are moot.
• All products and services have three layers: core, augmented, and symbolic.
• All small businesses have a product mix, the selection of products or services that is offered to the marketplace.
• Product selection is a key element for online success because some products will sell better online than others.
• Product design is the principal reason for emotional attachment or detachment relative to a product, a service, or an experience. It presents a powerful way to differentiate and position a company’s products and services.
• The product or service package communicates both emotional and functional benefits to the buyer, and it can be an important means of product differentiation.
• A company’s brand is probably its most important asset.
• The product life cycle refers to a product’s life span.
• A company’s website is part of its product or service. Website objectives must be developed and decisions must be made about the fundamental design elements of layout, color, typography, graphics, interactivity, usability, content, product display, and performance.
EXERCISES
1. Go to “How to Rate a Web Site” at www.newentrepreneur.com/Resources/Articles/Rate_a_Web_Site/rate_a_web_site.html and download the Web Site Scorecard. Select two small business websites or use the websites specified by your professor. Working with the “How to Rate a Web Site” article and the Web Site Scorecard, evaluate the two sites. Be sure to note your impressions about the site’s performance in each area.
2. Frank’s All-American BarBeQue has a very basic website: the store’s location, hours, and some of the menu. Frank’s son, Robert, has extensive experience with website design. How do you think he would advise his father on fully using the website for competitive advantage?
3. For each of the following, describe the core, augmented, and symbolic layers. a. a gift shop
b. a dry cleaner
c. a dance studio
d. highway paving materials
4. Some marketers believe that product performance (functions) makes the most difference when consumers evaluate products. Other marketers maintain that the looks, feel, and other design elements of products (form) are what really make the difference. Make the case: Product functionality is the key to brand success OR product design is the key to product success.Philip Kotler and Kevin Lane Kotler, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 343. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.06%3A_Marketing_Strategy_and_Product.txt |
Learning Objectives
1. Understand the role of price in the marketing mix and to a company.
2. Understand the different pricing strategies that a small business can follow.
3. Understand price-quality signaling and its importance to the pricing decision.
4. Understand that the price of a product or a service lets customers know what to expect from a business.
Marketing, whether online or onground, is the only activity that generates revenue for most small businesses, and the price element in the marketing mix accounts for that. Price can be defined very narrowly as the amount of money charged for a product or a service. However, price is really more than that. It is “the sum of all values (such as money, time, energy, and psychic cost) that buyers exchange for the benefits of having or using a good or service.”Judy Strauss and Raymond Frost, E-Marketing (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 233. Ultimately, the meaning of price will depend on the viewpoints of the buyer and the seller.Judy Strauss and Raymond Frost, E-Marketing (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 233.
Deciding on a price for its products or services is one of the most important decisions that a small business will make. The price of a product or a service must be a price that the company’s target market is willing to pay and a price that generates a profit for the company. If this is not the case, the business will not be around for long.“Pricing a Product or Service,” Small Business Notes, accessed June 1, 2012, http://www.smallbusinessnotes.com/ma...r-service.html.
Choosing the right pricing strategy is not an easy thing to do because there are so many factors involved. For example, competition, suppliers, the availability of substitute products or services, the target market, the image and reputation of a business, cost and profit objectives, operating costs, government regulation, and differentiation and positioning decisions will all impact price. Pricing is a complex activity, often seen as an art rather than a science. For small businesses that are marketing or want to market online, pricing strategies are even more complicated. For example, online buyers have increasing power that leads to control over pricing in some instances (e.g., online bidding on eBay). There is also price transparency where buyers and sellers can easily and quickly view and compare prices for products sold online, and some companies use dynamic pricing by varying prices for individual customers.Judy Strauss and Raymond Frost, E-Marketing (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 233.
There are several pricing strategies available to the small business owner. However, having the lowest price is not typically a strong position for small businesses because larger competitors can easily destroy any small business that is trying to compete on price alone. Darrell Zahorsky, “Pricing Strategies for Small Business,” About.com, accessed December 1, 2011, sbinformation.about.com/cs/bestpractices/a/aa112402a.htm. Think Walmart. The best choice for a small business will be the strategy that helps the business reach its sales and profit objectives, enhances the reputation of the company, satisfies the target market, and sends the correct price-quality signal. Price-quality signaling occurs when the cost of a good or a service reflects the perceived quality of that product or service. Dana Griffin, “Pricing Strategy Theory,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/pricing-strategy-theory-1106.html. However, pricing objectives must be formulated before a pricing strategy can be selected.
Pricing Objectives
Pricing objectives (i.e., what the company wants to accomplish with its pricing strategy) should be related to a company’s objectives and should follow the decision about where a company wants to position its products or services. Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 383. Different small businesses in the same industry may have different pricing objectives based on size of the business; in-house capabilities; and whether the focus is on profit, sales, or government action. Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 358–59.
• Sales-based objectives. Increasing sales volume and market share relative to the competition may involve penetration pricing, where a business prices a new product below that of the competition to quickly penetrate the market at the competitor’s expense, acquire a large market share, and then gradually raise the price. This objective might be appropriate for a small business that is introducing a new product or service to a very competitive marketplace.
• Profit-maximization objectives. Quickly recovering the costs of product development while providing customer value may involve price skimming, where a new product is priced higher than that of the competition to maximize profit. This objective would work for a small business with customers who are more concerned with quality, uniqueness, and status rather than price. However, a product’s image and quality must warrant the high price.
• Status-quo-based objectives. Used to minimize the impact of competitors, government, or channel members and to avoid a sales decline, these objectives are reactive rather than proactive, so they should be adopted for the short term only. Small businesses must be able to meet the needs of their target market.
Pricing Strategy
Once the pricing objectives are set, a small business must determine a pricing strategy. The small business owner can consider a variety of approaches. Discount pricing, cost-based pricing, prestige pricing, even-odd pricing, and geographic pricing are discussed here. In general, traditional pricing strategies can also be applied to the online environment.Judy Strauss and Raymond Frost, E-Marketing (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 247. How goods and services are priced tells consumers a lot about what to expect from a small business.
Discount Pricing
A small business might choose a discount pricing strategyDiane Watkins, “What Is Discount Pricing Strategy?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/discount-pricing-strategy-794.html. if it is looking to drive traffic and sales short term or if it wants to be permanently seen as the value leader in an industry.Rick Suttle, “Industry Pricing Strategy,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/industry-pricing-strategy-4684.html. Discount pricing is used with customers who buy in large quantities, customers who buy during off-peak times (seasonal), promotions used to increase traffic, and loss leaders (products that are discounted to get customers in the door in the hope that they will also buy more profitable products). Discount pricing can be used in the online environment in ways similar to brick-and-mortar stores. If the discounting is short term, inventory can be reduced, and revenues are increased temporarily.Diane Watkins, “What Is Discount Pricing Strategy?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/discount-pricing-strategy-794.html. An important disadvantage, however, is that customers often associate low price with low quality, particularly if a brand name is unfamiliar. A discount pricing strategy could lead to a product or a service being perceived as low quality. Also, price reductions can be easily matched by the competition, eliminating any but the earliest advantage.Diane Watkins, “What Is Discount Pricing Strategy?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/discount-pricing-strategy-794.html.
Cost-Based Pricing
Cost-based pricing is a very simple approach. A company figures out how much it costs to make a product or deliver a service and then sets the price by adding a profit to the cost.[citation redacted per publisher request]. For example, if it costs a small toy manufacturer \$10 to make its signature stuffed animal (taking into account fixed and variable costs) and the company wants a 20 percent profit per unit, the price to the retailer will be \$12.“Cost-Based Pricing,” Small Business Notes, accessed December 1, 2011, www.smallbusinessnotes.com/marketing-your-business/cost-based-pricing.html.
Cost-based pricing is very easy to use. It is flexible (allowing different profit percentages to be added to different product lines), allows for easy price adjustments if costs go up or down, and is simple to calculate. On the downside, cost-based pricing ignores product demand, what the competition is doing with pricing, and positioning, and it provides no incentive for cost efficiencies.“The Highs And Lows of Cost-Based Pricing,” Fiona Mackenzie, August 26, 2009, December 1, 2011, fionamackenzie.com.au/pricing-strategy/the-highs-and-lows-of -cost-based-pricing.html.
Prestige Pricing
Prestige pricing (or premium pricing) taps into the belief that a high price means high quality. Although this relationship exists in many instances, it is not true in all cases. Nonetheless, prestige pricing is “a strategy based on the premise that consumers will feel that products below a particular price will have inferior quality and will not convey a desired status and image.”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing), 358–59. A small children’s clothing store that carries only top-of-the-line merchandise would use a prestige pricing strategy. Clothing from this store would be seen as having a higher perceived value than clothing from Macy’s but perhaps comparable in value to clothing from Bloomingdale’s, Nordstrom, or Neiman-Marcus.
Prestige pricing can be very effective at improving brand identity in a particular market. However, it is not typically used when there is direct competition because such competition tends to have a downward effect on pricing. Unique products usually have the best chance of succeeding with prestige pricing.Lisa Magloff, “What Is Premium Pricing Strategy?,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/premium-pricing-strategy-1107.html.
Even-Odd Pricing
Also known as the “nine and zero effect,”Ivana Taylor, “8 Pricing Strategies You Can Implement Right Now,” August 19, 2008, accessed December 1, 2011, Small Business Trends, smallbiztrends.com/2008/08/8-pricing-strategies-you-can-implement-right-now.html. even-odd pricing can be used to communicate quality or value. It assumes that consumers are not perfectly rational, which is true. Emotion plays a much larger role in consumer behavior than rationality.
Even-numbered pricing, or setting selling prices in whole numbers (e.g., \$20), conveys a higher-quality image. A small, high-end gift shop, for example, would use even pricing for most if not all its products, with odd-numbered prices (e.g., \$18.97) used for products that are on sale. Odd-numbered prices give consumers the impression that they are getting a great value. It is a psychological effect with no basis in logic. But it does work in practice.
Geographic Pricing
Some small companies will use a geographic pricing strategy. This pricing strategy takes the geographic location of a customer into consideration, the rationale being that distribution can increase product delivery costs and thus the cost of the product. Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing), 369. Taxes, the cost of advertising, competitors who benefit from government subsidies, consumer demand, differences in costs of living, and the general cost of doing business are other factors that enter into the decision to use geographic pricing. Small businesses that sell outside the United States would likely encounter the need for geographic pricing. This strategy might also be appropriate when selling in different states.
KEY TAKEAWAYS
• Marketing is the only activity that generates revenue for most small businesses.
• Price accounts for revenue.
• Determining a price for its products or services is one of the most important decisions that a small business will make.
• There are many factors involved in choosing the right pricing strategy.
• Having the lowest price is not typically a strong position for small businesses.
• Pricing objectives should be created before a pricing strategy is selected.
• In general, traditional pricing strategies can be applied to the online environment.
• Discount pricing, cost-based pricing, prestige pricing, even-odd pricing, and geographic pricing are pricing strategies that can be considered by a small business.
• How goods and services are priced tells consumers a lot about what to expect from a small business.
EXERCISES
1. Frank’s All-American BarBeQue is planning to significantly expand its takeout business. Currently, customers come into the restaurant and order from the menu. With the new Darien facility and website, customers will be able to order online or fax an order to the restaurant. Frank and Robert have been arguing over how to structure the takeout portion of their operations. Frank wants to maintain the approach where customers order items from the menu. Robert believes that in today’s world, it would be more convenient for customers to order complete prepackaged meals. Father and son have argued about the nature of these meals. Frank has suggests a limited number of standard meals that could be prepared during the day and sold in the evening when commuters are returning home. However, this might mean that excess inventory would be built up on unwanted items. Robert wants to offer greater variety. These would include a main course, two side dishes, and a dessert. Because there could be a large number of combinations, most would have to be made after the receipt of an order. The “rush” to make these meals would drive up costs. How would you go about pricing these two types of meals?
2. Visit two small businesses—one that you think would use even-numbered pricing and one that you think would use odd-numbered pricing. Were you right? If not, how would you describe their pricing strategies? Be as specific as you can.
3. Visit NapaStyle, and analyze its pricing strategy.
4. Select a product or a service that you purchased recently from an onground small business and an online small business. The two businesses should be different. Evaluate the price that you paid. What appears to be the pricing strategy of each business? Do you think the price was fair? Why or why not? How would you assess the value that you received for the price you paid?Adapted from David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 488. Tip: If you are not sure whether an online business can be considered a small business, type in the name of the business plus “corporate HQ” into Google or your preferred search engine. The search should return results that include the number of employees. As long as the company has fewer than five hundred employees, you are all set. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.07%3A_Marketing_Strategy_and_Price.txt |
Learning Objectives
1. Understand the role of place in the marketing mix and the importance of place to a company.
2. Understand the different distribution strategies that a small business can follow.
3. Explain the importance of logistics to small businesses.
No matter how great a product or a service may be, customers cannot buy it unless it is made available to them onground or online or both. This is the role of the place P in the marketing mix—to get a product or a service to the target market at a reasonable cost and at the right time. Channels of distribution must be selected, and the physical distribution of goods must be managed.
Channels of Distribution
A small business may choose the direct, retail, wholesale, service, or hybrid channels. In general, business-to-business (B2B) distribution channels parallel those of business-to-consumer (B2C) businesses.
Direct Channel
Many small businesses use the direct channel. The direct channel involves selling directly to the final consumer with no intermediaries (retailers and wholesalers, also known as middlemen) in the process. The direct channel provides close contact with the customer and full control of all aspects related to the marketing of a company’s products.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 300. The Sugar Bakery & Sweet Shop in East Haven, Connecticut (winner of the Food Network’s 2010 “Cupcake Wars”), uses the direct channel, as does the local farmer when selling fruits and vegetables to the local population. Michael Dell started out by selling computers from his dorm room, and the founders of Nantucket Nectars began their business by selling their home-brewed fruit drinks to boaters in Nantucket Harbor.[citation redacted per publisher request]. Many B2B sellers also use the direct channel. Consolidated Industries, Inc., for example, sells helicopter parts directly to Sikorsky Aircraft and airline parts directly to Boeing. (See Chapter 5 "The Business Plan" for more information on Consolidated Industries, Inc.)
Video Clip \(1\):
Sugar Bakery & Sweet Shop
The story of the winner of the Food Network’s 2010 “Cupcake Wars.”
Video Link \(2\):
iPhone App Beefs Up Sausage Sales
How an iPhone app has made business easier and better for a mobile sausage vendor.
Service businesses use the direct channel because there is no way to do otherwise. Services are performed and consumed at the same time, so there is no role for intermediaries. Tanning salons, home repair services, legal services, real estate services, and medical services all deliver directly to the consumer. Online services are also delivered directly to the final consumer, such as Carbonite and Legal Zoom.
The Internet has increased the opportunities for small businesses to use the direct channel as the only means of distribution or as an additional sales channel. For example, Vermont Teddy Bear in Shelburne, Vermont, uses the Internet as its primary sales channel. Its only other channel is its onground factory tours that are offered year-round.
Video Clip \(3\):
Vermont Teddy Bear Company
How the company started and how it has grown. It now makes 5,000 bears a day.
Retail Channel
Many small businesses may choose to produce or manufacture products and distribute them to retailers for sale. This is considered an indirect channel because the retailer is an intermediary between the producer or manufacturer and the final consumer. If a small business that makes one-of-a-kind, handcrafted picture frames sells its frames to a picture-framing business that in turn sells the frames to its customers, this would be an example of using the retail channel. An online business that sells products made by several producers or manufacturers would also be using the retail channel—and would be called an e-tailer.
Video Clip \(4\):
Future Vision of Retailing
Microsoft’s vision of future retailing.
Video Clip \(5\):
YOUReality Retail Visualization Product
A new software product that enables customers to interact with products in their own space—really, really cool.
Although selling through retailers may expand the distribution coverage to a small business’s target market, the business must give up some control over pricing and promotion. In addition, the business should expect to get a wholesale price from the retailer that is significantly lower than what it would get if it sold directly to the final consumer.
Wholesale Channel
Wholesalers are also intermediaries. A wholesaler is “a [large or small] business that sells to retailers, contractors, or other types of businesses (excluding farms), but not to the general public (or at least not in any significant amount).”“Monthly & Annual Wholesale Trade Definitions,” US Census Bureau, October 22, 2010, accessed December 1, 2011, www.census.gov/wholesale/definitions.html. A small business that chooses to use wholesalers is also using an indirect channel of distribution. Using a wholesaler makes sense when a business makes a product that it wants to sell in many stores that would not be easily or conveniently reachable through the direct channel or the retail channel. For example, Kathleen King’s small gourmet baked goods company (now known as Tate’s Bake Shop) earns much of its annual revenue from the wholesale distribution of its baked goods to approximately one hundred gourmet shops on Long Island, in New York City, and in other states.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 300. Her products can be viewed online at www.tatesbakeshop.com, and her story—including some valuable business lessons that she learned along the way—can be viewed in Note 7.107 "Video Clip 7.17".
Video Clip \(6\):
Tate’s Bake Shop
The story of Kathleen King’s gourmet baked goods business—and some important business lessons learned.
Although any small business that uses wholesalers will see a reduction in profit, there are several advantages to wholesaling. For example, wholesalers are able to sell and promote to more customers at a reduced cost, they can deliver more quickly to buyers because wholesalers are closer to them, and wholesalers can inventory products, thereby reducing inventory costs and risks to their suppliers and customers.Philip Kotler and Kevin Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 458–59. Small businesses that produce only one or a few products commonly use the wholesale channel of distribution. Retail outlets may not be placing orders from the small business because it is not known. The wholesaler can put the product in front of them.Jeff Madura, Introduction to Business (St. Paul, MN: Paradigm Publishing, 2010), 445.
Multichannel Distribution
A small business may choose a multichannel distribution system (or hybrid channel). This channel option uses two or more channels of distribution to reach one or more customer segments, offering customers multiple purchase and communication options.Philip Kotler and Kevin Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 429; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 303. The multichannel approach offers three important advantages:Philip Kotler and Kevin Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 429.
1. Increased market coverage. More customers are able to shop for a company’s product in more places, and customers who buy in more than one channel are often more profitable than one-channel customers.
2. Lower channel cost. Selling by phone or online is cheaper than selling via personal visits to small customers.
3. More customized selling. A technical sales force could be added to sell more complex equipment.
The hybrid approach works well for small businesses. Tate’s Bake Shop sells directly through its store in Southampton, New York, and online. It sells indirectly to gourmet retailers such as Sugar and Spice in Chappaqua, New York, through its wholesalers. Local restaurants also use the multichannel approach when customers can order online or by phone and then pick up the food at the restaurant.
Physical Distribution (Logistics)
Physical distribution (logistics) involves “all the activities involved in the physical flow and storage of materials, semifinished goods, and finished goods to customers in a manner that is efficient and cost effective.”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 306. Logistics can be performed by the producer or the manufacturer, intermediaries, or the customer. Deciding on the right logistics solution may be the differentiator that puts a company ahead of its competition. Jennifer Nichols, “Guide to Transportation and Logistics Companies for Small Business,” Business.com, accessed December 1, 2011, www.business.com/guides/logistics-management-for-small-business-175. Logistics are relevant to both online and onground companies.
The costs of logistics can account for as much as 10–35 percent of a company’s gross revenues, so any money that can be saved can lead to more affordable products for consumers and increased profitability. The costs will vary by several factors (e.g., industry sector, company location, and company size). Retailers that offer a wide assortment of products will spend more on logistics because transportation and storage costs will increase as the number of carried products increases. Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 307.
Video Clip \(7\):
Logistics
UPS Commercial: We Love Logistics. A fun insight into what logistics are all about.
Logistics involve the following four primary functions: transportation, warehousing, inventory control, and order processing.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 307.
1. Transportation. The transportation choices for a small business will determine whether products will arrive at their destination in good condition and on time. Transportation costs will increase product price. The choices include truck, rail, air, water, and pipeline. Table \(1\): compares these choices. The selection of the best mode or combination of transportation modes depends on a variety of factors, including cost, speed, appropriateness for the type of good, dependability, and accessibility. All these things will affect customer value and customer satisfaction.
Table \(1\): Characteristics of Different Modes of Transportation
Mode Percentage of Total Transportation Cost Speed Product Examples*
Rail 42 Medium Lower Coal, stone, cement, oil, grain, lumber, and cars
Truck 28 Higher Higher Perishables, clothing, furniture, and appliances
Pipeline 16 Lower Low Oil, gas, chemicals, and coal as a semifluid
Water 13 High Low Coal, stone, cement, oil, grain, and cars
Air 0.4 High High Jewelry, perishables, electronics, wine, and spirits
*Small businesses are represented in each of the product examples given.
Source: Adapted from Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 308.
1. Warehousing.Philip Kotler and Kevin Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 464. Producers and manufacturers must store goods before they are sold because production and consumption rarely match. Some inventory may be kept at or near the point of production or manufacture, but the rest is located in warehouses. Some warehouses also provide assembly, packaging, and promotional display construction services…all for a fee, of course.
2. Inventory control. Inventory control is about ensuring that goods are where customers want them when they want them. In other words, it is about avoiding the “out of stock” situation that irritates customers. Small-business owners must understand how much inventory will be needed to address their customers’ needs on a timely basis and at the appropriate cost (think pricing strategy). High inventories are undesirable because they may lead to obsolete products, depressed sales of new models, and liquidation prices that may change customer expectations in the future.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 312. Small businesses should think of inventory as a wasting asset: it does not improve with time and, in fact, becomes less valuable with every day that passes—taking up space and incurring heat, light, power, handling, and interest charges. Every day that shows inventory and no sales will also show no profit. The goal is to keep inventory as low as possible.“How to Run a Small Business: Inventory Management,” StartupNation LLC, accessed December 1, 2011, www.startupnation.com/business-articles/899/1/AT _InventoryMgt.asp.
3. Order processing.Philip Kotler and Kevin Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 464. Every small business should want to shorten the elapsed time between an order’s receipt, delivery, and payment. Although there are typically multiple steps involved, the reality is that the longer the cycle, the lower the customer’s satisfaction, the higher the company’s costs, and the lower the company’s profits. Streamlining the process should be a priority.
There are several things that small businesses can do to increase the efficiency and the effectiveness of their logistics.Jennifer Nichols, “Guide to Transportation and Logistics Companies for Small Business,” Business.com, accessed December 1, 2011, www.business.com/guides/logistics-management-for-small-business-175. For example, a business can select a logistics company that is industry specific (e.g., wine or clothing) because that company will understand the shipping needs of the products or use small business logistics services from UPS or FedEx.
Logistics management also includes supply chain management. This is the focus of "Supply Chain Management: You Better Get It Right".
Place and the Website
For small businesses that sell online or hope to sell online, the company website “places” the product or the service in the hands of the customer. As a result, there are several decisions that must be made to facilitate the process so that customers can have a good online experienceAdapted from Sharad Singh, “Five Retail IT Trends to Watch in 2011,” RetailCustomerExperience.com, December 10, 2010, accessed December 1, 2011, www.retailcustomerexperience.com/article/178220/Five-retail-IT-trends-to-watch-in -2011; Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 111–19. and be less inclined to abandon their shopping carts and leave the site without making a purchase.
• Better sorting and searching. Make it easier for shoppers to find what they are looking for.
• Multibrand combinations in a single cart. If multiple brands are carried, make it possible to combine shopping carts across brands and apply promotions on the entire cart.
• Clarity on price and delivery rate. Prices and delivery rates should be marked clearly, with no ambiguity.
• Multiple payment options. Offer more than credit cards. (See Chapter 4 "E-Business and E-Commerce" for a discussion of payment options.)
• Check-out options. Do not require a customer to register before completing checkout.
• Provide a product search engine. The larger and more complex the product selection, the more a product search engine is needed. Shoppers can search by product name; product type; price; product attributes, such as color, size, or material; or brand either alone or in combination.
• Two clicks to buy. The fewer the number of clicks to buy, the greater the chances that a shopper will do just that.
• Customer support. Offer customer support throughout the buying process. Make it easy to communicate with a real person; spell out the company’s warranty, refund, and return policies; ensure privacy and security; and let shoppers know if you put cookies on their computers.
• Fulfilling orders. Ideally, send each customer an e-mail confirming when the order is completed, remind the shopper to print the order details, and provide a tracking number with a direct link to the carrier’s website so that the shopper can follow the progress of shipment.
Shopping cart abandonment, or leaving a website without buying any of the items in the shopping cart, is something that affects almost every Internet retailer, including small businesses. Cart abandonment estimates range from 20 percent to 60 percent.“Digital Window Shopping: The Long Journey to ‘Buy’” McAfee, Inc., accessed December 1, 2011, www.mcafeesecure.com/us/resources/whitepapers/digital_window _shopping.jsp. An understanding of why shoppers are abandoning their carts should lead to some serious thinking during website design and operation. Table \(1\) gives examples of why shoppers abandon a purchase. Because shipping is the number one reason why shoppers abandon their shopping carts, think very carefully about what the shipping charges will be.Jan Zimmerman, Web Marketing for Dummies, 2nd ed. (Hoboken, NJ: Wiley, 2009), 118.
Table \(2\): Why Online Shoppers Abandon Their Shopping Carts
High shipping charges 46%
Wanted to comparison shop 37%
Lack of money 36%
Wanted to look for a coupon 27%
Wanted to shop offline 26%
Could not find preferred payment option 24%
Item was unavailable at checkout 23%
Could not find customer support 22%
Concerned about security of credit card data
21%
“Digital Window Shopping: The Long Journey to ‘Buy’” McAfee, Inc., accessed December 1, 2011, www.mcafeesecure.com/us/resources/whitepapers/digital_window _shopping.jsp.
KEY TAKEAWAYS
• Understand that place is about getting the product or the service to the target market where customers want it, when they want it, and at a reasonable cost.
• A small business may choose the direct, retail, wholesale, service, or hybrid channels or some combination of these channels.
• In general, B2B distribution channels parallel those of B2C businesses.
• The direct channel involves selling to the final customer with no intermediaries involved.
• Service businesses use the direct channel only because services are performed and consumed at the same time.
• The retail channel is considered indirect because the retailer is an intermediary between the producer or manufacturer and the final customer.
• The wholesale channel is also an indirect channel. The wholesaler is placed between the producer or manufacturer and the retailer.
• The multichannel distribution system (hybrid channel) uses two or more channels to reach one or more customer segments.
• Logistics are about getting materials, semifinished goods, and finished goods to customers efficiently and cost effectively. They can be handled by the producer or the manufacturer, intermediaries, or the customer.
• Logistics include decisions related to warehousing, transportation, inventory control, and order processing. These decisions are relevant to both online and onground companies.
• Websites play an important role in “placing” goods and services into the hands of customers.
• It is important to reduce the number of customers who abandon their shopping carts (i.e., leave the website without purchasing the items in their shopping carts).
• Shopping cart abandonment is common among online retailers. Shoppers abandon their carts for a variety of reasons, the most important one being high shipping charges.
EXERCISES
1. In the Appendix (Chapter 16 "Appendix: A Sample Business Plan"), you will find the business plan for Frank’s All-American BarBeQue. This plan examined several possible locations for a second restaurant. Frank and Robert considered several factors when evaluating alternative towns as possible locations. Some of these included population size, average income, travel times, and percentage of population. Based on the data, they selected Darien, Connecticut. Do you agree with the decision? Why or why not? Do you think other factors should have been considered? If yes, what would you recommend?
2. Assume that you own a small business that specializes in gift baskets for children. You have been satisfied with your success so far but are anxious to spread your wings. You sell online as well as onground and have received several notes from potential online customers expressing their disappointment that you distribute the gift baskets only in the New England area. You have decided to find out what logistics would be involved in shipping to San Francisco, California; Dallas, Texas; Chicago, Illinois; and Anchorage, Alaska. Discuss the transportation mode(s) that would best fit your company for each area.
3. Visit Levenger, Carbonite, and ZipCar. How do these small businesses get their products or services “into the hands” of the customer? Think broadly and creatively. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.08%3A_Marketing_Strategy_and_Place.txt |
Learning Objectives
1. Understand the role of promotion in the marketing mix and its importance to a company.
2. Understand the different ways that a small business can promote its products or services.
3. Explain the differences and similarities in the marketing communications mix of online and onground businesses.
Promotion, the fourth P in the marketing mix, is now more commonly referred to as marketing communications. Marketing communications can be defined as “the means by which firms attempt to inform, persuade, and remind customers—directly or indirectly—about the products and brands they sell. In a sense, marketing communications represent the ‘voice’ of the company and its brands and are a means by which it can establish a dialogue and build relationships with consumers.”Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 470. Marketing communications are all about getting the word out about a company’s products and services because customers cannot buy what they do not know about, and, in the process, creating more of a two-way relationship with customers than was typical of the more traditional notion of promotion. A further conceptual iteration is the term integrated marketing communications (IMC), which is “the coordination and integration of all marketing communication tools, avenues, and sources within a company into a seamless program designed to maximize the communication impact on consumers, businesses, and other constituencies of an organization.”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 380. Small-business owners should be familiar and comfortable with all three terms because at least one of them will be the basis of conversations with vendors, employees, and other businesses. However, from a small business management perspective, IMC should be the guiding philosophy for a company.
Prior to selecting and designing any communications, however, objectives must be established for the marketing communications program.
IMC Objectives
Every small business must decide what it wants to accomplish with its IMC plan. Although many IMC plans may be oriented toward a single objective, it is possible for a program to accomplish more than one objective at a time. The problem is that this may be confusing to potential customers.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 393. IMC objectives can fall into seven major categories: increase demand, differentiate a product (stressing benefits and features not available from competitors), provide more information about the product or the service (more information seen as being correlated with greater likelihood of purchase), build brand equity (the value added to a brand by customer perceptions of quality and customer awareness of the brand), reduce purchase risk (important for new products and gaining new customers of current products), stimulate trial (to build new brands and rejuvenate stagnant brands),Adapted from Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 393–96. and brand recognition. As with all objectives, IMC objectives must meet the SMART (specific, measurable, achievable, realistic, and time-based) criteria that are described in Section 7.2 "The Marketing Strategy Process".
Marketing Communications Mix
The marketing communications mix for a small business, either pure-play or brick-and-click, will consist of some combination of the following major modes of communication: advertising, sales promotion, events and experiences, public relations (PR) and publicity, direct marketing, interactive marketing, word-of-mouth communication, and personal selling. Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 470. Each mode of communication has its own advantages and disadvantages, which should all be considered carefully before any final selections should be made.
Advertising
Advertising is “any paid form of nonpersonal presentation and promotion of ideas, goods, or services by an identified sponsor.”Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 472. Advertising is around us all the time—for example, ads are on television and radio, in newspapers and magazines, in train stations and on trains, on the sides and inside of buses, in public restrooms, in taxis, on websites, and on billboards. Ads can also be found in other places, and the locations are limited only by the creativity of the company placing the ads.
Small businesses must choose advertising media (e.g., radio, television, newspapers, billboards, the Internet, and magazines) based on its product, target audience, and budget. A local travel agency selling spring getaways to college students, for example, might post flyers on campus bulletin boards, run ads in the campus newspaper (for the students) and local newspapers (for the parents), and run ads on the college radio station. Examples of tried and true advertising media for small businesses include the yellow pages, newspaper and magazine advertising, direct mail, business cards, vehicle advertising, radio and cable television advertising, bench/bus stop advertising, local website advertising, e-mail advertising, eBay listings, community involvement, and cross-promotion (joining forces with other businesses).Susan Ward, “17 Advertising Ideas for Small Businesses,” About.com, accessed December 1, 2011, sbinfocanada.about.com/od/advertising/a/17adideas.htm. Lanee Blunt, “Small Business Advertising: Low Cost Flyers,” Advertising @ Suite 101, February 11, 2011, accessed December 1, 2011, lanee-blunt.suite101.com/small-business -advertising-low-cost-flyers-a346278. Even advertising in the big leagues is not out of the question for a small business. Salesgenie.com decided to advertise during Super Bowl XLII in February 2008, choosing to risk major capital to connect with the huge Super Bowl customer base.The Street, “Small Shops Aim for Super Bowl Edge,” MSN Money, February 1, 2011, accessed December 1, 2011, money.msn.com/how-to-invest/small-shops-aim-for-a -super-edge-thestreet.aspx.
Advertising on the Internet is also a consideration for the marketing communications mix of any business with a web presence. According to Lorrie Thomas, author of Online Marketing,Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 157. online advertising “can rocket your web marketing into the stratosphere” if it is done correctly. If not done correctly, however, it will “blast a giant crater in your budget.” Online advertising includes the following entities: banner ads (image ads that range in size and technical capability); e-mail advertising (ads in newsletters, an ad in another company’s e-mail, e-mailing a list with a dedicated message, or a company advertising to its own customers with its own e-mail list); news site advertising (placing ads on news, opinion, entertainment, and other sites that the audience frequents); blog advertising (buying ads directly on popular blogs); social media advertising (advertising on sites such as Twitter, Facebook, and LinkedIn); and affiliate marketing (company A places an ad for its product on the site of company B; company A then pays company B an agreed-on fee when a customer clicks on the ad and buys something.)Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 159–61. Another possibility is Google AdWords. A small business can promote itself alongside relevant Google search results and on Google’s advertising network. This allows a business to reach people who are already looking online for information about the products and services that a business offers.“Google AdWords: Advertise Your Business on Google,” accessed January 24, 2012, accounts.google.com/ServiceLogin?service=adwords&hl=en<mpl=regionalc &passive=true&ifr=false&alwf=true&continue=https://adwords.google.com/um/gaiaau...&sourceid=awo& subid=us-en-et-bizsol.
Video Link \(1\):
Attracting Consumer Attention through Advertising
Relating ads to the target market, making ads appealing, and including the element of surprise.
Advertising offers several advantages to the small business. For example, advertising is able to reach a diverse and geographically dispersed audience; it allows the seller to repeat a message many times; and it provides the opportunity for dramatizing the company and its products through the artful use of print, color, and sound. However, the audience does not feel obligated to pay attention or respond to an ad.Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 487. Whether the advantages of advertising outweigh the costs and disadvantages is something that must be decided by each small business.
Sales Promotion
Given the expense of advertising and the fact that consumers are exposed to so many advertising messages every day, many companies correctly believe that advertising alone is not enough to get people to try a product a product or a service. Enter lower-cost sales promotion techniques. Sales promotion refers to the variety of short-term incentives to encourage trial or purchase of a product or a service. Examples of commonly used sales promotions include contests, sweepstakes, coupons, premiums and gifts, product samples, rebates, low-interest financing, price discounting, point-of-sale displays, and frequent user or loyalty programs.Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 472; “Sales Promotion Strategy,” Small Business Bible, accessed December 1, 2011, www.smallbusinessbible.org/salespromotionstrategy.html. These promotions can be used by and offer several advantages to small businesses:Chris Joseph, “Sales Promotion Advantages,” Chron.com, accessed December 1, 2011, smallbusiness.chron.com/sales-promotion-advantages-1059.html.
• Attracting new customers with price. A reduced price could lure customers away from the competition. For example, a small electronics store that is competing with a large retailer could offer a discounted price on a popular cell phone for a limited time.
• Gain community favor. By offering a promotion that helps a worthy cause, you can create a good name for the business. Donate a portion of sales to the local food bank, buy clothing for the homeless, or donate to the local animal shelter to help pay veterinarian bills.
• Encourage repeat purchases. Rewards and loyalty programs can be very successful for small businesses. Coffee clubs are popular (buy so many coffees at the regular price and you get one cup free), but this approach can work for sandwiches at a deli, bags of bird food or dog food at the local pet store, shoe repairs at the local cobbler, dry cleaning services, and virtually any other kind of business.
• Entice reluctant customers. Giving away a free product or service is usually a good way to get people to try a product or a service for the first time, the hope being that it will lead to a purchase. However, the product or the service has to be good enough to stand on its own so that when the “free” unit is gone, the person will come back to buy.
• Providing information. It can be very effective if you run a promotion that helps provide information to potential customers to help them make a decision. This works especially well for products or services that are complicated or unfamiliar to customers, for example, software or product usage (particularly for business-to-business [B2B] customers), financial services, investment services, or estate planning. Free onground seminars or webinars or webcasts (seminars or presentations that are delivered online and that are typically an hour in length) can be very effective at gaining new customers or clients.
Sales promotions can be delivered to the customer in a variety of ways, such as snail mail (US Postal Service), in person, in local new newspapers and regional editions of national magazines, on television and radio, in e-mail, on websites, and in electronic coupons that are sent to a customer’s mobile device. Groupon (see Note 7.132 "Video Clip 7.19"), which is described as the hottest thing in retail marketing right now, offers customers coupons at local businesses: everything from restaurants to spas to painting lessons to sleigh rides.
Video Clip \(2\):
Learn How Groupon Works!
A hot new source of coupons for local businesses.
Events and Experiences
Events and experiences are “company-sponsored activities and programs designed to create daily or special brand interactions.”Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 472. A small business could choose to sponsor a Halloween costume event for petsJerry Robertson, “Secrets to Low Cost PR for Small Businesses,” Yahoo! Voices, February 14, 2007, accessed December 1, 2011, voices.yahoo.com/secrets-low-cost -pr-small-businesses-193968.html. or an entertainment event, such as a battle of the bands, to raise money for local scholarships. Participation in a local business fair could provide exposure for a product or a service and the opportunity to experience the product if that is possible. A local restaurant could participate in a chili competition. Factory tours and company museums, both of which can also be virtual, can offer great experiences for customers.
There are several advantages to events and experiences:Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 489. (1) A well-chosen event or experience can be very effective because the consumer gets personally involved. (2) Experiences are more actively involving for consumers because they are real time. (3) Events are not hard sell, and most consumers will appreciate the softer sell situation.
Events and experiences also tap into the importance of the customer experience, discussed in Chapter 6 "Marketing Basics". Today, customers “want products, communications, and marketing campaigns to deliver experiences. The degree to which a company is able to deliver a desirable customer experience—and to use information technology, brands, and integrated communications and entertainment to do so—will largely determine its success.”Bernd H. Schmitt, Experiential Marketing (New York: The Free Press, 1999), 22, 24. By having special events, a small business will stand out from the rest,Jerry Robertson, “Secrets to Low Cost PR for Small Businesses,” Yahoo! Voices, February 14, 2007, accessed December 1, 2011, voices.yahoo.com/secrets-low-cost-pr -small-businesses-193968.html. and they will create desirable publicity for the company.
Public Relations and Publicity
Public relations (PR) and publicity are designed to promote a company’s image or its individual products.Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 472. A small business can also use PR to clarify information in response to negative publicity. (Publicity usually being “an outcome of PR that is produced by the news media and is not paid for or sponsored by the business involved.”)Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 382. Traditional PR tools include press releases and press kits that are sent to the media to generate positive press on behalf of the business. A press kit, the most widely used PR tool, pulls together company and product information to make a good, solid first impression.“Developing a Press Kit for Your Small Business,” AllBusiness, accessed December 1, 2011, www.allbusiness.com/print/445-1-22eeq.html. (Be sure to print the company’s website address on everything.) A press kit can be particularly useful for small businesses, although the smallest of businesses may not see the need. Other common platforms include speeches, seminars (online and offline), brochures, newsletters, annual reports, charitable donations, community relations, and company magazines.Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 472. Increasingly, companies are using the Internet: interactive social media, such as blogs, Twitter, and Facebook; home-page announcements for specific occasions (e.g., messages of sympathy for the victims of a disaster); and e-mail.
Social media services such as Google Alerts and TweetBeep can be very helpful for managing a company’s reputation. Reputation management “is the process of tracking other’s opinions and comments about a company’s actions and products, and reacting to those opinions and comments to protect and enhance the company’s reputation.”Erica DeWolf, “Social Media Tools Should Be Used for PR,” eMarketing & New Media, May 4, 2009, accessed December 1, 2011, ericadewolf.wordpress.com/2009/05/04/social-media-tools-should-be-used-for-pr. Both services notify the business when the company name is mentioned. Addressing extremely negative comments immediately is very important for any small business with a web presence.
Most small businesses are not likely to have PR departments. Instead, there will be one person whose job includes—among many other things—PR and publicity. The key is for PR and marketing to work closely together so that “every piece of communication produced by the company speaks with one voice.”Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 444.
Getting publicity for a small business is usually free. Stories about events and experiences might be of interest to the media. One great idea is to have a group of people outside the business with positive picketing, holding signs such as “Low prices” or “Beware of friendly employees.” This was actually done by a small business, and it resulted in the business being on the front page of the local paper.Jerry Robertson, “Secrets to Low Cost PR for Small Businesses,” Yahoo! Voices, February 14, 2007, accessed December 1, 2011, voices.yahoo.com/secrets-low-cost-pr -small-businesses-193968.html.
Video Link \(3\):
Obtaining Publicity for a Business
Information and tips for small businesses.
PR and publicity tend to be underused by all businesses. However, PR and publicity should be particularly appealing to the small business because of the following three distinct qualities:Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 488–489.
• High credibility. News stories and features are more authentic and credible to readers.
• Ability to catch buyers off guard. PR can reach prospects who prefer to avoid salespeople and advertisements.
• Dramatization. PR has the potential for dramatizing a company or a product.
Direct Marketing
Direct marketing is the “promotion of a product from the producer directly to the consumer or business user without the use of any type of channel members.”Erica DeWolf, “Social Media Tools Should Be Used for PR,” eMarketing & New Media, May 4, 2009, accessed December 1, 2011, ericadewolf.wordpress.com/2009/05/04/social-media-tools-should-be-used-for-pr. Common direct marketing platforms include catalogs; direct mailing; telemarketing; television shopping; electronic shopping; fax mail; voice mail; blogs; websites;Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 473. e-mail; direct response radio, television, and Internet;Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 505. social media, such as Facebook and Twitter; and mobile devices. Because channel members are bypassed, direct marketing normally allows for greater profitability; perhaps more importantly, however, it can develop stronger brand loyalty with customers.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 504.
Video Link \(4\):
What Is Direct Marketing?
A brief explanation of direct marketing.
Direct marketing is about using information to educate, establish trust, and build a company (or someone in it) as an authority. This can be accomplished in multiple ways, such as website copy, a one-time piece of direct mail, a series of articles that build on one another,Lisa Barone, “Webcast: Direct Marketing for Small Businesses,” Outspoken Media, April 16, 2009, accessed December 1, 2011, outspokenmedia.com/online-marketing/webcast-direct-marketing-for-small-businesses. a webcast or webinar, or a blog. There is no one more qualified to educate the market about a need than a small business owner: “They’re the ones who will know their audience and what they’ll find unique, irresistible and compelling. They’re the best people to craft the message. Everything else in the organization can be outsourced, but the knowledge that a small business owner has about the people they serve, that can’t be replicated.”Lisa Barone, “Webcast: Direct Marketing for Small Businesses,” Outspoken Media, April 16, 2009, accessed December 1, 2011, outspokenmedia.com/online-marketing/webcast-direct-marketing-for-small-businesses.
Direct marketing offers several advantages to both the business-to-consumer (B2C) and B2B small businesses:Kris Carrie, “Advantages of Direct Marketing,” Article Dashboard, accessed December 1, 2011, www.articledashboard.com/Article/Advantages-of-Direct-Marketing/587894.
• Flexible targeting. A business can identify, isolate, and “talk” with well-defined target markets. This can translate into a higher conversion and success rate than if you tried to communicate with everyone in the mass market.
• Customized messages. Can be prepared to appeal to the addressed individual.
• Up-to-date. Messages can be prepared quickly.
• Multiple uses. Direct marketing can be used to sell, but it can also be used to test new markets, trial new products or customers, reward existing customers to reward loyalty, collect information for future campaigns, or segment a customer base.
• Lower cost per customer acquisition. The cost can be significantly less than other marketing methods.
• Control and accountability. Direct marketing offers great control and accountability than other marketing methods.
• Swift and flexible. Direct marketing is swift and flexible in achieving results.
Interactive Marketing
Interactive marketing refers to “online activities and programs designed to engage customers or prospects and directly or indirectly raise awareness, improve image, or elicit sales of products and services.”Philip Kotler and David Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 472. Everything is personalized and individualized—from the website content to the products being promoted.Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 558. The audience is engaged with the brand, with customers getting the chance to reshape and market it in their own unique way.Mike Yapp, “10 Best Interactive Marketing Practices,” iMedia Connection, January 9, 2006, accessed December 1, 2011, www.imediaconnection.com/content/7764.asp. Forrester Research forecasts that interactive marketing expenditures will reach \$55 billion by 2015, accounting for 21 percent of all expenditures on marketing. The greatest growth is projected to come from social media, with the next biggest growth sector being mobile marketing.Joe Mandese, “Forrester Revises Interactive Outlook, Will Account for 21% of Marketing by 2014,” MediaPost News, July 8, 2009, accessed December 1, 2011, www.mediapost.com/publications/?fa=Articles.showArticle&art_aid=109381.
Common interactive marketing tools include e-mail, websites, online shopping, videos, webinars and webcasts, blogs, and social media such as Facebook and Twitter. Because e-mail, websites, online shopping, webinars and webcasts have been mentioned previously, the focus here will be on videos, blogs, and social media. Using online videos has become an increasingly popular strategy in small business marketing. Consumers are much more likely to visit a company after viewing its video, and they can be up to 40 percent more likely to make some sort of contact.Karen Scharf, “Small Business Marketing with Video,” Business Know-How, accessed December 1, 2011, www.businessknowhow.com/internet/videomarketing.htm. Online video content is becoming increasingly popular with avid Internet users, so a small business should consider creating a video for its website. The content can be created easily, and it can be posted on the company’s website as well as in other locations on the Internet (YouTube or on the company’s blog, for instance) to get more page views.Sean Rasmussen, “Using Online Videos to Increase Popularity,” Aussie Internet Marketing Blog, July 30, 2009, accessed December 1, 2011, seanseo.com/internet-marketing/using-online-videos. According to Ad-ology’s 2011 Small Business Marketing Forecast, 45 percent of US small businesses with fewer than 100 employees plan to use online video. This reflects the fact that small businesses are becoming increasingly savvy about how to use the Internet to market their products and services.Mike Sachoff, “Small Businesses Plan to Focus on Mobile Marketing and Online Video in 2011,” SmallBusinessNewz, January 18, 2011, accessed December 1, 2011, www.smallbusinessnewz.com/topnews/2011/01/18/small-businesses-plan-to -focus-on-mobile-marketing-and-online-video-in-2011. Paul Bond Boots, a small US maker of custom-made cowboy boots that are individually handmade to fit, features five really cool videos on its website. Recently, the company has turned to the Internet for most of its sales.
A blog “is a web page made up of usually short, frequently updated posts that are arranged chronologically—like a what’s new page or a journal.” Business blogs, as opposed to personal blogs, are used as a company communication tool to share a company’s knowledge and expertise, build additional web traffic, connect with potential customers, develop niche markets, give the business a human face, help reputation management, and provide a free avenue for press releases.Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 73–74. For an example, visit Michael Chiarello’s blog at www.michaelchiarello.com. If his name is not familiar, he is the founder of NapaStyle, a high-end small business retailer with both an onground and online presence.
Blogs are fairly simple to set up, and they are a great way to keep website content fresh. However, even though small businesses hear much about blogs these days, creating one must be considered carefully. Blogs today “have evolved into multimedia communities where bloggers (and the blogging community) have grown in size, stature, and impact to eclipse all but the largest media outlets.”Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 72. But this does not mean that it is essential for every small business to have a blog. Maintaining a blog takes a lot of time and energy—and then there need to be people to read it. After careful consideration, it may be better to focus a company’s promotional efforts elsewhere.
Social media “generally refers to websites featuring user-generated content or material created by visitors rather than the website publishers. In turn, these sites encourage visitors to read and respond to that material.”Robbin Block, Social Persuasion: Making Sense of Social Media for Small Business (Breinigsville, PA: Block Media, December 2010), 2. Social media is changing the way that people communicate and behave. Social media outlets such as Facebook, LinkedIn, and Twitter are, among other things, driving purchases—and they should be seen “like a virtual cocktail party where all attendees can discuss [a company’s] products, services, experiences, and new ideas.”Lorrie Thomas, Online Marketing (New York: McGraw-Hill, 2011), 99.
The top four social media networks are Twitter, Facebook, LinkedIn, and YouTube. This is true in general and for small businesses in particular.Lisa Barone, “Which Social Media Sites Are Most Beneficial?,” Small Business Trends, January 26, 2011, accessed December 1, 2011, smallbiztrends.com/2011/01/which-social-media-site-most-beneficial%E2%80%99.html. Overall, small businesses use social media sites for lead generation, monitoring what is being said about their businesses, keeping up with the industry, improving the customer experience, and competitive intelligence.Lisa Barone, “Which Social Media Sites Are Most Beneficial?,” Small Business Trends, January 26, 2011, accessed December 1, 2011, smallbiztrends.com/2011/01/which-social-media-site-most-beneficial%E2%80%99.html. Many small businesses in the B2B sector are already using social media for business as a resource, to engage in initiatives, or both. However, companies with more than one hundred employees are more active than smaller companies.Lisa Barone, “Study: How Are B2Bs Using Social Media,” Small Business Trends, November 25, 2009, accessed December 1, 2011, smallbiztrends.com/2009/11/b2bs-social-media-study.html.
Despite the hype surrounding social media, and the fact that many small businesses are already connected, small businesses must still consider the use of social media just as carefully as the other modes of marketing communications. Social media has not worked out well for some small businesses that have used it, so each business must decide what social media is expected to do for the company, and then it must be used well and strategically. When considering whether or how to factor social media into an IMC strategy, consider these words from Lisa Barone, cofounder and chief branding officer at Outspoken Media, “In 2011, if you’re not using social media to gain attention over your competitors, you can bet they’re using it to gain attention over you.”Lisa Barone, “Which Social Media Sites Are Most Beneficial?,” Small Business Trends, January 26, 2011, accessed December 1, 2011, smallbiztrends.com/2011/01/which-social-media-site-most-beneficial%E2%80%99.html. This will undoubtedly continue to be the case.
Video Clip \(5\):
Social Media
The top five things you should know about social media.
Personal Selling
A small business owner needs to connect with customers before a sale can take place. Sometimes personal selling is the best way to do that. Personal selling, “the process of communicating with a potential buyer (or buyers) face-to-face with the purpose of selling a product or service,”“Personal Selling,” eNotes, accessed December 1, 2011, www.enotes.com/personal-selling-reference/personal-selling-178681. is absolutely essential in the marketing communications mix of a small business. History has shown that the most successful entrepreneurs have been skilled salespeople who were able to represent and promote their companies and products in the marketplace.“Personal Selling,” eNotes, accessed December 1, 2011, enotes.com/personal -selling-reference/personal-selling-178681. It stands to reason that successful small business owners should have the same sales skills.
Although personal selling plays an important role in the sale of consumer products, it is even more important in the sale of industrial and business products. More than four times as many personal selling activities are directed toward industrial and business customers than toward consumers.John M. Ivancevich and Thomas N. Duening, Business Principles, Guidelines, and Practices (Mason, OH: Thomson Learning, 2007), 431. Regardless of the type of customer or consumer, however, the objectives of personal selling are the same:“Objectives of Personal Selling,” KnowThis.com, accessed December 1, 2011, www.knowthis.com/principles-of-marketing-tutorials/personal-selling/objectives-of -personal-selling.
• Building product awareness. A salesperson should educate customers and consumers on new product offerings.
• Creating interest. Because personal selling is a person-to-person, and often a face-to-face, communication, it is a natural way for getting customers and consumers to experience a product for the first time. Creating interest goes hand-in-hand with building product awareness.
• Providing information. A large part of the conversation with the customer focuses on product information.
• Stimulating demand. The most important objective of personal selling by far is persuading customers and consumers to make a purchase.
• Reinforcing the brand. Most personal selling focuses on building long-term relationships with customers and consumers. However, strong relationships can be built only over time, and they require regular communication.
Like all other forms of marketing communications, personal selling offers both advantages and disadvantages. On the plus side, personal selling is flexible and dynamic, providing companies with the best opportunity to tailor a message to satisfy customers’ needs. Personal selling’s interactive nature also makes it the most effective promotional method for building relationships with customers, particularly in the B2B market, and it is the most practical promotional method for reaching customers who are not easily reached through other methods.“Advantages of Personal Selling,” KnowThis.com, accessed December 1, 2011, www.knowthis.com/principles-of-marketing-tutorials/personal-selling/advantages -of-personal-selling. Personal selling can help a small business build strong, loyal relationships with customers and consumers.
On the minus side, the biggest disadvantage may be the negative perceptions that many people have of salespeople: pushy, annoying, slippery, and willing to do anything for the sale—whether legal or not. The reality, of course, is that most salespeople (unfortunately, not all) do not fit this stereotype. The successful salesperson is the person who focuses his or her efforts on satisfying customers over the long term as opposed to his or her own selfish interests. Also on the negative side is the high cost of personal selling. Personal sales contacts are very expensive, with the costs incurred (compensation plus sales support) whether the sale is made or not.“Disadvantages of Personal Selling,” KnowThis.com, accessed December 1, 2011, www.knowthis.com/principles-of-marketing-tutorials/personal-selling/disadvantages-of-personal-selling. Then there are the costs of training the sales staff on product knowledge, industry information, and perhaps selling skills.“Disadvantages of Personal Selling,” KnowThis.com, accessed December 1, 2011, www.knowthis.com/principles-of-marketing-tutorials/personal-selling/disadvantages-of-personal-selling. Depending on the size of the company, small businesses will have varying numbers of salespeople, so some of the costs will vary as well.
The traditional sales process is typically seen as a series of six steps:John M. Ivancevich and Thomas N. Duening, Business Principles, Guidelines, and Practices (Mason, OH: Thomson Learning, 2007), 435; Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 560–561; Dana-Nicoleta Lascu and Kenneth E. Clow, Essentials of Marketing (Mason, OH: Atomic Dog Publishing, 2007), 489–98.
1. Prospecting and qualifying. Locating potential customers who have a need for a product and the ability to pay for it. For example, prospects for a small electric motor company would be all the businesses that use small electric motors. Prospects can be found through a variety of sources, including current customers, trade directories, business associates, and newspaper or magazine articles.
2. Preapproach. It is important to learn as much about a prospect as you can. For example, you want to know about the prospect’s needs, attitudes about available products and brands, critical product attributes and benefits desired, and current vendor(s).
3. Presentation and demonstration. This is where the salesperson tells the product “story” to the buyer: the product’s features, advantages, benefits, and value. It is important not to spend too much time on product features because benefits and value will most directly influence the purchase decision. It is also important to ask questions and listen carefully to a prospect’s answers because they will provide valuable insights into the prospect’s needs.
4. Overcoming objections. You should expect customers to pose objections. The key to overcoming these objections is to maintain a positive approach, ask the prospect to clarify the objections, and respond to the objections by reiterating the major benefits of the product or the service and pointing out additional features, guarantees, service, and anything else that would address the objections.
5. Closing. This is when the salesperson asks the prospect to buy the product. The request can be direct, or the salesperson can encourage the purchase by using a trial closing approach like asking, “Would you like us to finance product A for you?” Closing the sale is understandably the most difficult step for many salespeople because of the fear that the prospect will say no.
6. Follow-up and maintenance. These activities are necessary for customer satisfaction and repeat business. They are key to establishing the strong long-term relationships that every small business desires and needs. The salesperson should schedule a follow-up call to ensure proper installation, instruction, servicing, and troubleshooting and resolution should any problems be detected. Always remember that unhappy customers will defect to competition—and they will spread negative comments about the company. Because it is much cheaper to retain an old customer than to obtain new ones, it is in a company’s best interests to provide good follow-up and maintenance services.
Although these steps are helpful as a way to summarize the kinds of things that are relevant to personal selling, the Internet has revolutionized the selling process.Thomas Young, “A Selling Revolution: How the Internet Changed Personal Selling (Part 1),” Executive Street, accessed December 1, 2011, blog.vistage.com/marketing/a-selling-revolution-how-the-internet-changed-personal-selling. The traditional process just described has become largely obsolete, with roles changing. Web searches and online content help prospective customers or clients do their own prospecting and qualifying. This eliminates the most time-consuming part of the traditional sales process. A company’s website becomes the first sales presentation and, as a result, is critical in moving a prospect toward a sale. In short, all employees must be fully integrated into web marketing because web marketing is the primary driver of the sales process. The more web-savvy you are, the greater the chances that your selling will beat the competition.Thomas Young, “A Selling Revolution: How the Internet Changed Personal Selling (Part 1),” Executive Street, accessed December 1, 2011, blog.vistage.com/marketing/a-selling-revolution-how-the-internet-changed-personal-selling.
Video Link \(6\):
Small Business Selling
An overview of personal selling.
KEY TAKEAWAYS
• Promotion and marketing communications are relatively synonymous terms.
• IMC is about pulling all the marketing communications together to convey a consistent message.
• Small-business owners should be familiar and comfortable with the terms promotion, marketing communications, and integrated marketing communications (IMC).
• There are multiple categories of IMC objectives.
• The marketing communications mix for a small business will consist of some combination of advertising, sales promotion, events and experiences, PR and publicity, direct marketing, interactive marketing, and personal selling. This mix is applicable to both pure-play and brick-and-click businesses.
• There is a lot of hype about blogs and social media. They can be very effective, but they have not worked well for all small businesses that have used them. They should be considered carefully before inclusion in a company’s IMC strategy.
EXERCISES
1. Frank’s All-American BarBeQue has historically taken a very low-key approach to promoting the business, choosing to rely on word-of-mouth communication. Robert believes that Frank needs to increase the sophistication of the marketing communications. Design an IMC plan for Frank’s BarBeQue. Keep the following in mind: (1) Frank’s is a small business with a very limited IMC budget; (2) advertising in prime time and national television are not options; and (3) Frank’s is selling both food and its BBQ sauces.
2. Choose two products or services that you purchased recently from small businesses, one from an online business and one from an onground business. The products should be different from those chosen for price. For each product or service, identify the various media that were used to promote the product or the service and analyze the marketing communications mix. Do you agree with the marketing communications mix that was used? What recommendations would you make for change?Adapted from David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 488. Tip: If you are not sure whether an online business can be considered a small business, type in the name of the business plus “corporate HQ” into Google or your preferred search engine. The search should return results that include the number of employees. As long as the company has fewer than five hundred employees, you are all set. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.09%3A_Marketing_Strategy_and_Promotion.txt |
Learning Objectives
1. derstand the role of marketing strategy in delivering customer value.
2. Explain how marketing strategy can positively and negatively impact cash flow.
3. Explain how digital technology and the e-environment are impacting marketing strategy.
Customer Value Implications
As stated in Chapter 6 "Marketing Basics", marketing plays a key role in creating and delivering value to the customer, but it is the establishment of a strong link between customer value requirements and the major value-producing activities of a firm that is the foundation on which the delivery of superior customer value is based.Robert R. Harmon and Greg Laird, “Linking Marketing Strategy to Customer Value: Implications for Technology Marketers,” PDFCast.org, accessed December 1, 2011, pdfcast.org/pdf/linking-marketing-strategy-to-customer-value-implications-for -technology-marketers. Marketing strategy provides that strong link.
A customer’s decision to buy will always be contingent on the strategic effectiveness of the marketing mix: the ability of the product or the service to meet the needs, wants, and desires of the customer; a price that is attractive when compared with possible alternatives; the availability of the product or the service in an onground or online place that is in sync with the customer’s needs; and an integrated marketing communications (IMC) program that creates awareness, provides information, and persuades. Although the different elements of the marketing mix will be of differing importance depending on the customer and the situation, it all begins with the product. Well-designed and well-made products will usually come out ahead on the customer value scale. Innovative channels of distribution, such as Redbox for DVDs, gourmet and ethnic food carts, kiosks in airports for selling small electronics products, and conducting financial transactions on a smartphone, can all add to customer value. Social media as a part of the IMC mix can be a particularly great way to create customer value because a consumer’s social network can be used as a communication channel to spread the word about a product’s characteristics, quality, benefits, and value.Angela Hausman, “Marketing Strategy: Using Social Media to Create Customer Value,” Hausman Marketing Letter, October 25, 2010, accessed June 1, 2012, www.hausmanmarketingletter.co...ocial-media-to -create-customer-value. Salespeople also create value for customers by helping to identify creative and cost-effective solutions to customer problems, making the customer buying process easier, and creating a positive customer experience. Pricing is always tricky, but there should be a clear and positive link between the price that customers pay and what customers see as the value received in return.
Cash-Flow Implications
An efficient and effective marketing strategy will keep costs down and stimulate sales. A small business owner could not ask for more as a way to realize a positive cash flow. However, the reality is that things will not go as planned most of the time, and this will wreak havoc with cash flow. This means that the marketing strategy should be developed and implemented within the context of a cash-flow strategy so that when things do not go as planned, you can make appropriate adjustments.
One of the biggest temptations for creating cash flow when money is tight is cutting the price as a way to stimulate sales. Think very carefully before doing this. The price reduction may generate more sales, but you may send unintended negative signals to customers about quality and value. You may also trigger a price cut by competitors that eliminates the benefits of your own price cut. A better strategy would be to maintain the price and offer the customer more value—as long as that additional value does not end up costing you more in money in the long run.Mark Hunter, “Discounting to Create Cash Flow? Be Careful,” PowerHomeBiz.com, May 19, 2011, accessed December 1, 2011, www.powerhomebiz.com/blog/2011/05/discounting-to-create-cash-flow-be-careful.
Digital Technology and E-Environment Implications
The opportunities for using digital technology and the e-environment in marketing strategy have exploded as the technologies continue to develop and become more sophisticated. Strategic decisions can be made more quickly, with information that can be compiled and analyzed more completely and faster than ever before. The Internet offers an information bonanza and myriad opportunities for implementing the marketing strategy.
Mobile commerce continues to be one of the biggest trends to affect small business owners. More than 48 percent of Americans who own smartphones use them for shopping, so integrating mobile commerce into the marketing strategy should be strongly considered. Many small businesses that already use mobile commerce are seeing positive results. Aaron Maxwell, founder of Mobile Web Up, reported that one client has already seen 10 percent growth per month. Lauren Simonds, “Mobile Commerce Experts Talk Small Business,” Small Business Computing.com, May 3, 2011, accessed December 1, 2011, www.smallbusinesscomputing.com/emarketing/article.php/3932506/Mobile -Commerce-Experts-Talk-Small-Business.htm. Since early 2011, small companies have increasingly been drawn to quick-response (QR) codes to target customers on the go. These high-tech bar codes are scanned with smartphone cameras, after which company and/or product content pops up on the screen. The customer then chooses to act or not act based on the content. The Ethical Bean Coffee Company in Vancouver, British Colombia, uses this technology in its train ads. Customers scan the code in an ad, a coffee menu pops up on their screens, and they can order a cup of coffee to be picked up at one of the Ethical Bean coffee shops. There are some challenges with using this technology, including cost,Emily Glazer, “Target: Customers on the Go,” Wall Street Journal, May 16, 2011, accessed December 1, 2011, online.wsj.com/article/SB10001424052748704132204576285631212564952.html. but it is worth considering for the marketing communications strategy.
Mobile technologies, such as wireless Internet and cellular Internet access, have significantly impacted personal selling, making it possible for salespeople to access needed information at any time. Key business applications are increasingly being made available through a browser rather than being loaded on a salesperson’s computer—again being accessible anywhere or anytime. Online video conferencing and web or phone conferencing allow for electronic presentations in lieu of face-to-face meetings. Sales training can be delivered over the Internet, and RSS feeds or e-mail enable salespeople to be notified quickly when new training material is available. See “Trends in Selling.”
The marketing strategy of a small bank could include targeting the increasing number of small business owners that are starting to do their banking on the go. Customers can check balances, transfer funds, and take and send pictures of checks for remote deposit. It has been estimated that at least 50 percent of small businesses will do their banking through mobile devices by the end of 2013.Javier Espinoza, “Need to Bank? Phone It In,” Wall Street Journal, November 14, 2011, accessed December 1, 2011, online.wsj.com/article/SB10001424052970204485304576644853956740860.html. For the very small business, raising cash to proceed with the marketing strategy can actually be done through crowdfunding, the practice of securing small amounts of money from multiple contributors online. Margaret Broom of New Haven, Connecticut, used Peerbackers.com to raise money for renovating a new space for a yoga studio. In 45 days she raised \$10,000 from more than 100 contributors, with average contributions of \$15 to \$20. The funds do not need to be paid back because they are contributions. However, some businesses give their contributors products or services from the business as an appreciation.Sarah E. Needleman, “Raise Cash on Crowdfunding Sites,” Wall Street Journal, November 27, 2011, accessed December 1, 2011, online.wsj.com/article/SB10001424052970204443404577052013654406558.html?mod=googlenews_ws.
Video Clip \(1\):
How wireless technology can provide communication and distribution support.
KEY TAKEAWAYS
• Marketing strategy plays a key role in delivering customer value.
• Marketing strategy should be developed within the context of a cash-flow strategy.
• Digital technology and the e-environment continue to offer significant opportunities for small businesses.
EXERCISE
You run a small, specialized electronics firm that produces unique and highly sophisticated products. Your sales are evenly split between military contracts and commercial aviation. Two years ago, during a recent economic downturn, your business was under considerable cost pressure. To reduce costs, you switched from two American-based suppliers to a Taiwanese manufacturer. Last week, a national newspaper released a story that revealed that this Taiwanese manufacturer was using counterfeit chips produced in mainland China. This is clearly illegal, but things were made even worse by the speculation that the Chinese-made chips might be mechanisms that could be used in cyber warfare. It looks as though there will be at least one congressional investigation that will examine the national security issues associated with the counterfeit chips. Unfortunately, your firm was prominently mentioned in the article as one of the firms that had purchased a large number of these chips. This could have a major impact on a firm of your size.
1. What should you do?
2. How would you develop a marketing communications plan to deal with this crisis?
3. How would you deal with the anticipated cash-flow crisis?
4. How should you handle the issue of customer value?
Disaster watch
Robert has spent the last year building his Internet business. He registered his domain name shortly after developing his idea. Three months were then spent waiting for his web developer to create a custom website built to his specifications. Just when Robert thought his online venture was going to die on the vine, his web guru called to ask if Robert wanted to see the site.
Robert quickly typed in the URL of his domain. There, for all to see, was his website. The online catalog was complete, the merchant account had been set up—and has been for two weeks because he has been paying the monthly fees in anticipation of the site launch date. The e-mail at the domain is configured, and Robert’s online business is underway.
Search engine optimization helps to drive traffic to Robert’s site. He sends out e-mail messages to everyone on his mailing list to let them know that his online venture is now open for business. Sales started slowly, as expected, but they grew steadily. The twenty-third sale was as exciting as the first.
On the morning of the business’s one-year anniversary since buying his domain name, Robert goes to the office and turns on his computer with thoughts of checking his e-mail. His e-mail program announces an error. Something about “could not connect to server.”
Robert’s first thought was that perhaps the hosting company was having a network issue. He decides to wait for half an hour…but gets the same error. He decides to wait another ten minutes and try again. If it still does not work then, he plans to call his hosting company.
Ten minutes go by. The error keeps showing up. One more try. The error pops up again. Robert picks up the phone and calls the hosting company. Once he gets a tech on the phone, he explains the situation, saying that he needs his e-mail up and running so that he can follow up on the orders that came into the store last night. The next ten minutes are spent double-checking settings on the e-mail program. Still nothing works.
Eventually, someone at the hosting company thinks to check the domain name. DISASTER! The domain name had expired at midnight. No business can be conducted, and some people may think he has gone out of business.
What does Robert have to do now?Michael Raymond, “Costly Small Business Marketing Mistakes Every Entrepreneur Must Avoid,” Helium, accessed December 1, 2011, www.helium.com/items/1644285-current-domain-registration-expired-domain-names. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/07%3A_Marketing_Strategy/7.10%3A_The_Three_Threads.txt |
The New Britain Rock Cats
Source: Reprinted with permission from the New Britain Rock Cats official website: http://web.minorleaguebaseball.com/index.jsp?sid=t538.
The New Britain Rock Cats were founded in 1983 in New Britain, Connecticut. They are the double-A minor league baseball affiliate of the Minnesota Twins major league baseball club, competing in the Eastern League. The 2011 season marked the 29th anniversary of Eastern League Baseball in New Britain.
There is a rich history of baseball in New Britain, and the Rock Cats are the Nutmeg State’s oldest, continuously operating professional sports franchise. From Cy Young Award–winners to most valuable players (MVPs) and batting champions to rookie of the year award winners and all-stars, New Britain has been an enormously productive foundation for major league baseball. Over four million fans have seen professional baseball in New Britain over the years. The Rock Cats have many notable alumni, including MVPs Jeff Bagwell (third baseman) and Mo Vaughn (first baseman). All-stars include Brady Anderson (outfielder), Ellis Burks (outfielder), Aaron Sele (right-handed pitcher), John Valentin (shortstop), and Cy Young Award winner Roger Clemens.
In 2000, the club was sold to a group of investors headed by a local attorney, Coleman Levy, and William Dowling, a former New York Yankees executive vice president. Dowling is the president and CEO of the club, and Levy is the vice president. With a substantially new front office and new increased promotions, the club saw every attendance record fall, passing the 300,000 mark for the past 3 years.
The Rock Cats see themselves as selling affordable family entertainment, not baseball. They target women and children. They integrated the Internet into their marketing activities three years ago and have found it very useful for selling tickets. They also have a Facebook and Twitter presence. About 3 years ago, they spent \$5,000 for a professionally prepared marketing research report. As Dowling commented, “It made the company more sophisticated.”
The marketing planning process is relatively informal, with everyone participating. There is no formal document. Dowling’s philosophy is that if something costs less than \$1,000, “go do it.” If it costs more than \$1,000, “justify it.” The Rock Cats are run out of a small office in New Britain. The communication among the staff is regular and effective. Here is an instance in which a formal marketing plan does not seem necessary. Whatever they are doing, it is working just fine.William Dowling (Rock Cats president and CEO), personal interview, March 15, 2011; “Rock Cats History,” Minor League Baseball, accessed December 2, 2011, web.minorleaguebaseball.com/team5/page.jsp?ymd=20100316&content_id =8806396&vkey=team5_t538&fext=.jsp&sid=t538; “New Britain Rock Cats,” Wikipedia, accessed December 2, 2011, en.Wikipedia.org/wiki/New_Britain_Rock_Cats. But, as you see in the video things change quickly in the minor league baseball business and the Rock Cats are now the New Britain Bees and play a summer schedule in a collegiate affiliated league while the Rock Cats have moved up the road to Hartford and are now the Hartford Yard Goats affililiated with the Colorado Rockies
Video Clip 8.1
Rock Cats Baseball
A fun look at what the Rock Cats offer to fans.
8.02: The Need for a Marketing Plan
Learning Objectives
1. Understand why a small business should have a marketing plan.
2. Understand the implications of not having a marketing plan.
Let’s face it, as a small business owner, you are really in the business of marketing.John Jantsch, Duct Tape Marketing: The World’s Most Practical Small Business Marketing Guide (Nashville, TN: Thomas Nelson, Inc., 2006), back cover copy.
John Jantsch
Many small businesses do not have a marketing plan, choosing instead to market their products and services on an intuitive, sometimes seat-of-the-pants basis. As long as there is regular and effective communication with the rest of the people in the organization, a formal written plan may not be necessary. However, as the business grows and regular and effective communication becomes more difficult, a written marketing plan should be seriously considered. For the small businesses that do have a marketing plan, few actually use it.Becky McCray, “Simplify Your Small Business Marketing Plan,” Small Biz Survival, February 12, 2010, accessed December 2, 2011, www.smallbizsurvival.com/2010/02/simplify-your-small-business-marketing.html.
There are many reasons why so many small businesses do not have marketing plans. Among the reasons are the following:Adapted from Danielle MacInnis, “74% of Small Business [sic] Have No Marketing Plan!” Marketing Blog for Small Businesses, February 7, 2011, accessed December 2, 2011, www.daniellemacinnis.com/small-business-marketing/74-of-small-business -have-no-marketing-plan.
• They do not have enough knowledge of marketing.
• They take a scatter-gun approach to marketing.
• They do not know how to go about developing a marketing plan.
• They do not have enough money to do marketing properly.
• They do not have enough time to do marketing properly.
• They do not have good people or resources to help them with marketing.
This tells us that understanding what a marketing plan is all about and how a marketing plan can be put together simply and inexpensively are invaluable parts of a small business owner’s tool kit.
What Is a Marketing Plan?
A marketing plan “is a written document that summarizes what the marketer has learned about the marketplace and indicates how the firm plans to reach its marketing objectives. It contains tactical guidelines for the marketing programs and financial allocations over the planning period.”Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 56. A marketing plan provides a specific marketing direction for a small business and is a very valuable tool if it is done correctly. Because the ultimate purpose of the plan is to generate efficient, profitable action, the marketing plan should consist of usable, practical instructions that are designed to ensure that resources are properly applied.“How to Write Small Business Marketing Plans,” SmallBusiness-Marketing-Plans.com, accessed December 2, 2011, www.smallbusiness-marketing-plans.com.
Marketing plans can range from a one-page summary to more than one hundred pages. Although it is said by some that the ideal marketing plan length for a stand-alone document (i.e., a document that is not part of the total business plan for a company) is twenty to fifty pages,“How to Write Small Business Marketing Plans,” SmallBusiness-Marketing-Plans.com, accessed December 2, 2011, www.smallbusiness-marketing-plans.com. the length of a marketing plan for a small business can be any length that will satisfy the needs of the business. The page count of the plan may not be a good way to measure the adequacy of the plan. The marketing plan should be measured by readability and summarization. A good marketing plan will provide the reader with a good general idea of its main contents even after only a quick skim in fifteen minutes or less.Tim Berry, “How Long Should a Business Plan Be?,” BPlans, accessed December 2, 2011, articles.bplans.com/writing-a-business-plan/how-long-should-a-business -plan-be/49. No matter the length, the plan should be practical, to the point, with useful graphics as appropriate, and worded clearly with no flowery or legalistic language.“How to Write Small Business Marketing Plans,” SmallBusiness-Marketing-Plans.com, accessed December 2, 2011, www.smallbusiness-marketing-plans.com.
The plan should cover one year, which is often the best way to think about marketing for the small company. This is not to say that you should not also think about the long term. It just means that things change more rapidly in the short term. People leave, markets evolve, and customers come and go. Consideration should be given to two to four years down the road.“How to Create a Marketing Plan,” Entrepreneur, August 7, 2001, accessed June 1, 2012, http://www.entrepreneur.com/article/186830.
Because small business owners have very little time to spend on writing an elaborate marketing plan, it is worth considering using software or online templates to put the plan together. One software program is Marketing Plan Pro, which is now included as part of Sales and Marketing Pro. The number one best-selling marketing plan software tool for building small business marketing plans for several years, Marketing Plan Pro provides step-by-step guidance, easy forecasts and budgets, customization options, execution guidance, and several sample plans across a wide variety of business types. Marketing plan assistance is also available through the Small Business Administration (SBA) and the Service Corps of Retired Executives (SCORE) program. SCORE—a nonprofit association dedicated to educating entrepreneurs and helping small businesses start, grow, and succeed—is an SBA resource partner that has been mentoring small business owners for more than forty years.“About SCORE,” Score.org, accessed December 1, 2011, www.score.org/about-score.
Why Have a Marketing Plan?
A marketing plan is a very important part of the small business roadmap to success. The plan drives action and points the way.Joanna L. Krotz, “5 Easy Steps to Create a Marketing Plan,” Microsoft, accessed December 2, 2011, www.microsoft.com/business/en-us/resources/marketing/market-research/5-easy-steps-to-create-a-marketing-plan .aspx?fbid=WTbndqFrlli. There are many good reasons for developing a marketing plan, including the following:“Marketing,” University of Missouri, January 2010, accessed December 2, 2011, www.missouribusiness.net/sbtdc/docs/marketing.pdf; Entrepreneur, “How to Create a Marketing Plan,” Entrepreneur, August 7, 2001, accessed December 2, 2011, www.entrepreneur.com/article/43018; Joanna L. Krotz, “5 Easy Steps to Create a Marketing Plan,” Microsoft, accessed December 2, 2011, www.microsoft.com/business/en-us/resources/marketing/market-research/5-easy-steps-to-create-a-marketing -plan.aspx?fbid=WTbndqFrlli; Emily Suess, “Marketing Plan Basics for Small Business,” Small Business Bonfire, April 13, 2011, accessed December 2, 2011, smallbusinessbonfire.com/marketing-plan-basics-for-small-business-owners; “How to Write Small Business Marketing Plans,” SmallBusiness-Marketing-Plans.com, accessed December 2, 2011, www.smallbusiness-marketing-plans.com.
• It forces you to identify the target market. A company’s best customers, and hopefully the ideal customer, should be in the target market.
• You get a higher return on investment (ROI). Every dollar will work harder when it is focused.
• It forces you to think about both short- and long-term marketing strategies. Focusing only on the short term can be devastating to the future of the company.
• It provides a basis on which to evaluate a company against its industry or market in terms of strengths, weaknesses, opportunities, and threats.
• You can eliminate waste by building efficiency. Limited resources can be allocated to create the greatest return.
• It will be easier to see where past decisions have helped or hindered the growth of a business. The plan will provide a guide for measuring progress and outcomes.
• It will help you to minimize risk, mistakes, and failures.
• It helps you to establish a timeline, keeping people accountable for the growth and success of operation.
• It gives clarity to who does what, when, and with what marketing tools.
• It lays out a company’s game plan. If people leave, if new people arrive, if memories falter, if events bring pressure to alter the givens, the information in the written marketing plan is a reminder of what you agreed on.
What If There Is No Marketing Plan?
In Alice in Wonderland, Alice encounters the Cheshire cat. He asks her where she is going. She answers that she does not know. The Cheshire cat answers that any road will take her there. It is clear that Alice did not have a marketing plan. David Campbell has a similar philosophy as reflected in the title of his book: If You Don’t Know Where You’re Going, You’ll Probably End Up Somewhere Else. David Campbell, If You Don’t Know Where You’re Going, You’ll Probably End Up Somewhere Else (Allen, TX: Thomas Moore Publishing, 1974). Without a marketing plan, a small business could be moving at great speed…but in the entirely wrong direction.
Because many small businesses seem to operate successfully without a marketing plan, depending on how you want to define successfully, the absence of a marketing plan does not mean automatic failure. However, there are some distinct disadvantages to not having a marketing plan. The following are some examples:
• Not having a marketing plan, whether it be a stand-alone document or a section in the business plan, will put you at a significant disadvantage when trying to get any type of business loan.
• Not having a marketing plan can push a business into a meandering mode that could result in slowed growth, missed opportunities, and ignored threats.
• The target market may not be defined correctly.
• Not having a marketing plan may force you to focus on the short term with little or no attention to the long term. This can be devastating to the future of a company.
• Potential efficiencies will not be realized.
• Risk will likely increase.
In short, not having a marketing plan means that you will not realize the advantages of having one. Even if you are an owner-only business, a marketing plan can provide a discipline and a structure for growing the business—if that is desired. On the other hand, if an owner is perfectly satisfied with where and how things are, a marketing plan will most likely not be helpful. Just remember that change is constant. Without a marketing plan, a business may not be ready for change.
KEY TAKEAWAYS
• Many small businesses do not have a marketing plan.
• There are many reasons why small businesses do not have a marketing plan. One very important reason is that they do not know how to develop a plan.
• A marketing plan provides a specific marketing direction for a small business. The ultimate purpose of the plan is to generate efficient, profitable action.
• Although a marketing plan should cover one year in detail, this does not mean that a business should ignore the longer term.
• There are many reasons why small businesses should have a marketing plan, not the least of which is that a marketing plan can help the business minimize risk, mistakes, and failures.
• Without a marketing plan, a small business could be moving at great speed…but in the wrong direction.
• Not having a marketing plan means that the business cannot realize the many benefits of having one.
• A marketing plan may not be for all businesses. If one is happy with where and how a business is, one may think that a marketing plan is not needed. Remember, though, that change will happen, and a business may not be ready for it without a marketing plan.
EXERCISE
1. At Frank’s All-American BarBeQue, Frank is pleased with the profitability of the business and the standing that the company has in the local community. Not as pleased is Frank’s son, Robert, who thinks that the business can be bigger and better. The new store that is opening in neighboring Darien, Connecticut, is a good start, but Robert still thinks that the business is not realizing its full potential. A business plan has been prepared except for the marketing plan section. Robert wants to develop the marketing plan for Frank’s, but his father is balking at the idea. His father’s position is, “If it ain’t broke, why fix it?” Taking the position of Robert, make the case for preparing a marketing plan for Frank’s. Think critically when developing your argument, integrating specifics from Frank’s business. Resist the temptation to simply list the advantages of having a plan versus the disadvantages of not having a plan. Frank will need to see something much more persuasive than this. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/08%3A_The_Marketing_Plan/8.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Understand the components of a marketing plan.
Although there is no universally accepted format for a marketing plan, the requirements can be grouped into the seven sections identified in Figure 8.1 "The Marketing Plan". The marketing plan can be a stand-alone document or a section of the business plan. If it is part of the business plan, it will duplicate information that is presented in other sections of the business plan.
A solid marketing strategy is the foundation of a well-written marketing plan,Cash Miller, “Why Does Your Business Need a Good Marketing Plan?,” Yesformn, October 27, 2010, accessed December 2, 2011, www.yesformn.org/why-does-your -business-need-a-good-marketing-plan.php. and the marketing strategy should have onground and online components if the small business has or wants to have a web presence. The online portion of the marketing plan should be a plan that can be implemented easily, be changed rapidly as appropriate, and show results quickly.“An Online Marketing Plan for the Small Business Owner,” WebMarketingNow, accessed December 1, 2011, www.webmarketingnow.com/who/who_business _owner.html.
Executive Summary
The executive summary is a one- to two-page synopsis of a company’s marketing plan. The summary gives a quick overview of the main points of the plan, a synopsis of what a company has done, what it plans to do, and how it plans to get there.“How to Write a Marketing Plan,” Arizona Office of Tourism, accessed December 1, 2011, www.azot.gov/documents/Marketing_Tool_Kit.pdf. The executive summary is for the people who lack the time and interest to read the entire marketing plan but who need a good basic understanding of what it is about.“Marketing Plan: The Executive Summary,” Small Business Notes, accessed December 1, 2011, www.smallbusinessnotes.com/starting-a-business/marketing-plan-the -executive-summary.html.
Executive Summary Example
Sigmund’s Gourmet Pasta
Note: The marketing plan for Sigmund’s Gourmet Pasta is a sample small business marketing plan provided by and copyrighted by Palo Alto Software. Permission has been given to the authors to use this plan as the basis for this chapter. This plan will be used throughout this chapter to illustrate marketing plan concepts. Additional complete sample marketing plans for small businesses are available at http://www.mplans.com.
Sigmund’s Gourmet Pasta will be the leading pasta restaurant in Eugene, Oregon, with a rapidly developing consumer brand and growing customer base. The signature line of innovative, premium pasta dishes include pesto with smoked salmon, pancetta and peas linguine in an Alfredo sauce, lobster ravioli in a lobster sauce, and fresh mussels and clams in a marinara sauce. Sigmund’s Gourmet Pasta also serves distinct salads, desserts, and beverages. All desserts are made on-site.
Sigmund’s Gourmet Pasta will reinvent the pasta experience for individuals, families, and takeout customers with discretionary income by selling high-quality, innovative products at a reasonable price; designing tasteful, convenient locations; and providing industry-benchmark customer service. Our web presence enhances our brand.
To grow at a rate consistent with our objectives, Sigmund’s is offering an additional \$500,000 in equity. Existing members will be given the first option to subscribe to the additional equity to allow each of them to maintain their percentage of ownership. The portion not subscribed by existing members will be available to prospective new investors.Adapted from “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant _marketing_plan/executive_summary_fc.php.
Vision and Mission
The vision statement tries to articulate the long-term purpose and idealized notion of what the business hopes to be in terms of growth, values, employees, contributions to society, and so forth—that is, where the owner sees the business going. Self-reflection by the business founder is a vital activity if a meaningful vision is to be developed.Jay Ebben, “Developing Effective Vision and Mission Statements,” Inc., February 1, 2005, accessed December 2, 2011, www.inc.com/resources/startup/articles/20050201/missionstatement.html.
Vision Statement Examples
Mobile News Games: Developer of Mobile Games Relating to Current News Events
“Our vision is to provide people with a brief escape of fun over the course of their normal day. We do this by providing them with timely interactive games that they can access on their mobile devices—games that are easy to play and have some connection with current pop culture news.”“Sample Marketing Plan,” MoreBusiness.com, accessed December 1, 2011, www.morebusiness.com/templates_worksheets/bplans/printpre.brc.
Neon Memories Diner
“Neon Memories Diner is a place for family togetherness organized around a common love of the traditional American diner and the simpler times of the ’50s and ’60s. Neon Memories Diner transcends a typical theme restaurant by putting real heart into customer service and the quality of its food so that its unique presentation and references to times past are just part of the picture.”“Restaurant Marketing Plan: Neon Memories Diner,” MPlans.com, accessed December 2, 2011, www.mplans.com/restaurant_marketing_plan/marketing_vision_fc.php.
By contrast, the mission statement for the marketing plan looks to articulate the more fundamental nature of the business (i.e., why the business exists). A company’s mission is its sense of purpose—the reason why the owner gets up every day and does what he or she does. It captures the owner’s values and visions, along with that of the employees (if applicable) and community plus suppliers and stakeholders. It literally is the foundation of a company’s future.Corte Swearingen, “Writing a Mission Statement,” SmallBiz Marketing Tips, accessed December 2, 2011, www.small-biz-marketing-tips.com/writing-a-mission- statement.html. As such, the mission statement is an important foundation of a business’s marketing plan. It is common for the mission statement to appear in the marketing strategy section of the marketing plan. It is also common for the plan to include either a vision statement or a mission statement but not both.
Mission Statement Examples
Disney
“To make people happy.”Corte Swearingen, “Writing a Mission Statement,” SmallBiz Marketing Tips, accessed December 2, 2011, www.small-biz-marketing-tips.com/writing-a-mission -statement.html.
Coca-Cola
“To Refresh the World…in body, mind, and spirit.”Corte Swearingen, “Writing a Mission Statement,” SmallBiz Marketing Tips, accessed December 2, 2011, www.small-biz-marketing-tips.com/writing-a-mission -statement.html.
Organic Body Products, Inc. (Small Business)
“To provide high-quality skincare and body care products to women who want what goes on their bodies to have as high a quality as what goes in their bodies.”Kristie Lorette, “Examples of How to Write a Marketing Plan,” Chron.com, accessed December 2, 2011, smallbusiness.chron.com/examples-write-marketing-plan -1689.html.
Sigmund’s Gourmet Pasta (Small Business)
“Sigmund’s Gourmet Pasta’s mission is to provide the customer the finest pasta meal and dining experience. We exist to attract and maintain customers. When we adhere to this maxim, everything else will fall into place. Our services will exceed the expectations of customers.”“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Situation Analysis
The situation analysis gives a picture of where a company is now in the market and details the context for its marketing efforts (see Figure 8.2 "Situation Analysis"). Although individual analyses will vary, the contents will generally include relevant information about current products or services, sales, the market (defining it and determining how big it is and how fast it is growing), competition, target market(s), trends, and keys to success. These factors can be combined to develop a SWOT analysis—an identification of a company’s strengths, weaknesses, opportunities, and threats—to help a company differentiate itself from its competitors.
Figure 8.2
As the title implies, the market summary summarizes what is known about the market in which a company competes, plans to compete, or both. This summary may be all that is read, so it must be short and concise. The market summary should include a description of the market and its attributes, market needs, market trends, and market growth. See Figure 8.3 "Market Summary".
Market Summary Example
Introductory Paragraph: Sigmund’s Gourmet Pasta
Sigmund’s Gourmet Pasta possesses good information about the market and knows a great deal about the common attributes of our most prized and loyal customers. Sigmund’s Gourmet Pasta will leverage this information to better understand who is served, their specific needs, and how Sigmund’s can better communicate with them.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
The Market and Its Attributes
This section of the marketing plan is where a company’s customers are identified. If a business has an online presence or wants to have one, information needs to be generated for online customers as well. Some, perhaps most but not all, of a company’s online customers will come from the company’s onground customers. This depends on the company’s marketing strategy. However, a web presence can considerably expand a company’s market.
The information that should be provided about customers is as follows:Adapted from “Marketing,” University of Missouri, January 2010, accessed December 2, 2011, www.missouribusiness.net/sbtdc/docs/marketing.pdf.
1. All relevant demographic (e.g., age and gender) and lifestyle or behavior (e.g., activities, interests, and spending patterns) information. This information can be linked to important differences in buyer behavior.
Demographics for Sigmund’s Gourmet Pasta
• Male and female
• Ages 25–50, this segment makes up 53 percent of the Eugene market according to the Eugene Chamber of Commerce
• Young professionals who work close to the location
• Yuppies
• Have attended college and/or graduate school
• Income over \$40,000“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Behavior and Lifestyle Factors for Sigmund’s Gourmet Pasta
• Eat out several times a week
• Tend to patronize higher-quality restaurants
• Are cognizant about their health
• Enjoy a high-quality meal without the mess of making it themselves
• When ordering, health concerns in regard to foods are taken into account
• There is a value attributed to the appearance or the presentation of food“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
1. The location of the customers (local, regional, national, or international). There are often distinct differences in buyer behavior based on geographic location, so it is important to know what those differences are to tap into them. For example, grits are a common breakfast item in the South, but they are not a menu staple anywhere else in the United States.
Geographics for Sigmund’s Gourmet Pasta
• Sigmund’s immediate geographic target is the city of Eugene with a population of 130,000.
• A 15-mile geographic area is in need of Sigmund’s services.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
1. An assessment of the size of the market and its estimated growth. There should be enough of a market to justify a business’s existence in the first place. Even a niche market must be large enough to offer profitability potential. At the same time, a company will want the market to grow so that the business can grow (assuming growth is desired). If, on the other hand, a company wants to remain small, market growth is not as important—except that it may present opportunities for new competitors to enter the marketplace.
Market Size for Sigmund’s Gourmet Pasta
• The total targeted population is estimated at 46,000.
• The target markets are individuals, families, and takeout.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Estimated Market Growth for Sigmund’s Gourmet Pasta
In 2010, the global pasta market reached \$8 billion. Pasta sales are estimated to grow by at least 10 percent for the next few years. This growth can be attributed to several different factors. The first factor is an appreciation for health-conscious food. Although not all pasta is “good for you,” particularly cream-based sauces, pasta can be very tasty yet health conscious at the same time. Pasta is seen as a healthy food because of its high percentage of carbohydrates relative to fat.
Another variable that contributes to market growth is an increase in the number of hours our demographic is working. Over the last five years, the number of hours spent at work of our archetype customer has significantly increased. As the number of work hours increases, there is a high correlation of people who eat out at restaurants. This is intuitively explained by the fact that with a limited number of hours available each day, people have less time to prepare their meals, and eating out is one way to maximize their time.Adapted from “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta _restaurant_marketing_plan/marketing_strategy_fc.php.
Table \(1\): Projected Market Growth—Sigmund’s Gourmet Pasta*
Potential Customers Growth (%) 2011 2012 2013 2014 2015 CAGR (%)**
Individuals 8 12,457 13,454 14,530 15,692 16,947 8.00
Families 9 8,974 9,782 10,662 11,622 12,668 9.00
Takeout 10 24,574 27,031 29,734 32,707 35,978 10.00
TOTAL 9.27 46,005 50,267 54,926 60,021 65,593 9.27
*All numbers are hypothetical.
** Compound annual growth rate.
Source: Adapted from “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, http://www.mplans.com/pasta_restaura...trategy_fc.php.
1. An identification of market needs and how a business plans to meet them.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php. Without knowing and understanding market needs, it is extremely difficult to create a marketing mix that will successfully meet those needs. There are instances of small businesses that are successful because of an intuitive sense for what the market needs, but these businesses may eventually experience limited growth opportunities because their intuition can take them only so far. Market needs change, so small businesses must adapt quickly to those changes. They cannot adapt to changes they do not know about.
Identifying and Meeting Market Needs for Sigmund’s Gourmet Pasta
Sigmund’s Gourmet Pasta is providing its customers with a wide selection of high-quality pasta dishes and salads that are unique and pleasing in presentation, offering a wide selection of health-conscious choices, and using top-shelf ingredients. Sigmund’s Gourmet Pasta seeks to fulfill the following benefits that are important to their customers:
• Selection. There is a wide choice of pasta and salad options.
• Accessibility. The patron can gain access to the restaurant with minimal waits and can choose the option of dine in or takeout.
• Customer service. Patrons will be impressed with the level of attention that they receive.
• Competitive pricing. All products/services will be competitively priced relative to comparable high-end pasta and Italian restaurants.
1. An identification of market trends.Adapted from “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta _restaurant_marketing_plan/marketing_strategy_fc.php. Just as it is important to understand market needs, a small business should be able to identify where the market is going so that its marketing mix can be adjusted accordingly. Capitalizing on market trends early in the game can offer a powerful competitive advantage.
Identifying Market Trends for Sigmund’s Gourmet Pasta
The market trend for restaurants is headed toward a more sophisticated customer. The restaurant patron today relative to yesterday is more sophisticated in several different ways.
• Food quality. The preference for high-quality ingredients is increasing as customers learn to appreciate the qualitative difference.
• Presentation/appearance. As presentation of an element of the culinary experience becomes more pervasive, patrons are learning to appreciate this aspect of the industry.
• Health consciousness. As Americans in general are more cognizant of their health, evidenced by the increase in individuals exercising and health-club memberships, patrons are requesting more healthy alternatives when they eat out. They recognize that an entrée can be both quite tasty and reasonably good for you.
• Selection. People are demanding a larger selection of foods. They no longer accept a limited menu.
The reason for this trend is that within the last few years, restaurant offerings have increased, providing customers with new choices. Restaurant patrons no longer need to accept a limited number of options. With more choices, patrons have become more sophisticated. This trend is intuitive as you can observe a more sophisticated patron in larger city markets such as Seattle, Portland, or New York, where there are more choices. People are also increasingly expecting a web presence for restaurants. This presence includes a website, a membership on Facebook, and oftentimes a Twitter presence. The importance of a website and the use of social media cannot be underestimated.
Competition
Every marketing plan should include an assessment of the competition: who they are, what they offer, their growth rates (if known), and their market share (if known). Market share is defined as the percentage of total sales volume in a market that is captured by a brand, a product, or a company.“Market Share,” BusinessDictionary.com, accessed December 1, 2011, www.businessdictionary.com/definition/market-share.html. Think of the market as a pie, with each slice being a “share” of that pie. The larger the slice, the larger the percentage of sales volume captured by a brand, a product, or a company. With all this knowledge, a business will be in the best position to differentiate itself in the marketplace. However, while the sales figures of a business are easily accessible, it is not likely that the owner will have either total market sales figures or growth rate, sales figures, and market share information for the competition. This information, if available at all, is usually available from trade associations and market research firms,“Market Share,” QuickMBA, accessed December 1, 2011, www.quickmba.com/marketing/market-share. with the likelihood being even less if the information desired is about other small businesses. Competitor websites and Internet searches may prove helpful, but because most small businesses are privately held, the information available online will be limited. As a result, you will be restricted in the information that you can collect about the competition to things that can easily be observed in person or are available on company websites. Examples include product selection, price points, service quality, and product quality.
Competition should be addressed in terms of being direct or indirect. Direct competition refers to competition from similar businesses or products, whereas indirect competition refers to competition from alternative, substitutable businesses or products. In the case of Sigmund’s Gourmet Pasta, direct competition would come from other restaurants that serve pasta. Indirect competition would come from other types of full-service restaurants, fast food, the freezer- or prepared-foods areas in the grocery store, delis, preparation services that target the home, and even online businesses that sell prepared foods (DineWise). Many if not most small business marketing plans address only direct competition.
Direct Competition for Sigmund’s Gourmet Pasta
1. National Competition
• Pastabilities. Offers consumers their choice of noodles, sauces, and ingredients, allowing customers to assemble their dishes as they wish. Food quality is average.
• PastaFresh. Has a limited selection, but the dishes are assembled with high-quality ingredients. The price point is high, but the food is quite good.
• Pasta Works. Offers pasta that is reasonably fresh, reasonably innovative, and at a lower price point. The company was sold a few years ago, and consequently the direction of management has been stagnant lately, which has resulted in excessive employee turnover.
• Perfect Pasta. Offers medium-priced pasta dishes that use average ingredients, no creativity, and a less than average store atmosphere. Sigmund’s is not sure how this company has been able to grow in size as their whole product is mediocre at best.
2. Local Competition
• Restaurant A. This is an upscale Italian restaurant with a limited selection of pasta dishes. Although the selection is limited and pricey, the dishes are quite good.
• Restaurant B. An Italian restaurant with a decent pasta selection; however, the quality is inconsistent.
• Restaurant C. An upscale restaurant with a large wine selection and good salads. Everything else is mediocre at best and overpriced. Service can often be poor.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Product or Service Offering
The marketing plan must be very clear about the product or the service that is being offered to the marketplace because the product drives the creation of the marketing mix and the marketing strategy. An error in product identification and definition can wreak havoc in the company and in the marketplace because misdirected marketing actions can occur. The responsibility for the product definitions rests squarely with the owner. For example, if a business is a live theater that features very sophisticated plays, would you define the product as entertainment or art? The answer to this question will have major implications for a company’s marketing strategy.
The product or the service offering must also consider a company’s website because a web presence will be an important part of what is offered to customers.
Service Offering for Sigmund’s Gourmet Pasta
Sigmund’s has created gourmet pastas and salads that are differentiated and superior to competitors. Customers can taste the quality and freshness of the product in every bite. The following are the characteristics of the product:
• Sigmund’s pasta dough is made with Italian semolina flour.
• All cheeses are imported.
• Vegetables are organic and fresh with three shipments a week.
• Meats are all top-shelf varieties and organic when possible.
• Wines are personally selected by the owner.The authors of this textbook added this product characteristic.
At Sigmund’s, food is not a product; the experience of dining is a service. Sigmund’s prides itself on providing service that is on par with fine dining. This is accomplished through an extensive training program and hiring only experienced employees.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
At a Glance—The Prototype Sigmund’s Store
• Location: an upscale mall, a suburban neighborhood, or an urban retail district
• Design: bright, hip, clean
• Size: 1,200–1,700 square feet
• For people who dine in, an interactive dining experience will be available through the iPad. A virtual wine cellar application will allow diners to flip through Sigmund’s assortment of wines and make an educated decision. Diners will be able to spin the bottles around to view the back label, read reviews, view the vineyard on Google maps, search wine by price and region, and see information about food pairings.The authors of this textbook added this dimension of Sigmund’s Prototype Store, drawing from the following two articles: Brodie Beta, “How Restaurants Are Using the iPad,” The Next Web, May 1, 2011, accessed December 2, 2011, thenextweb.com/apple/2011/01/05/how-restaurants-are-using-the-ipad/; “Apple iPad Restaurant Menus: The New Way to Order Food,” QuickOnlineTips.com, June 6, 2010, accessed December 2, 2011, www.quickonlinetips.com/archives/2010/06/apple-ipad -restaurant-menus.
• Employees: six to seven full time
• Seating: 35–45
• Types of transactions: 80 percent dine in, 20 percent takeout
Sigmund’s websiteThis information about the Sigmund’s website is a combination of the ideas of the authors of this textbook and the following two sample marketing plans: “Locally Produced Clothing Retailer Marketing Plan: Local Threads,” MPlans.com, accessed December 2, 2011, www.mplans.com/locally_produced_clothing_retailer _marketing_plan/marketing_vision_fc.php; “Restaurant Marketing Plan: Neon Memories Diner,” MPlans.com, accessed December 2, 2011, www.mplans.com/restaurant_marketing_plan/marketing_vision_fc.php. will educate prospects with an eye toward encouraging them to try the restaurant and then return. Site visitors will be informed about the menu and the restaurant’s commitment to quality in using homemade pasta made with Italian semolina flour, imported cheeses, organic vegetables that are delivered three times a week, and top-shelf meats. The website will not sell things directly.
Prospective customers will be encouraged through the warm and friendly atmosphere of the website. A photo gallery will provide a visual tour of the restaurant to demonstrate its décor and atmosphere. The pages of the website will include the following:
• The mission and vision of the restaurant, including a profile of the founder, emphasizing wine expertise
• A discussion of the commitment to top-quality ingredients and a top-quality customer dining experience
• A slide show virtual tour of the restaurant
• Dining-in and takeout menus
• Directions, hours, and contact information (both telephone and e-mail)
• Links to Facebook and Twitter
• Customer comments
SWOT Analysis
A SWOT analysis combines the key strengths and weaknesses within a company with an assessment of the opportunities and threats that are external to the company. This analysis can provide powerful insights into the potential and critical issues affecting a business.Tim Berry, “How to Perform a SWOT Analysis,” MPlans.com, accessed December 2, 2011, articles.mplans.com/how-to-perform-a-swot-analysis. A strength is an asset or a resource, tangible or intangible, internal to a company that is within its control. What does the company do well? What advantages does the company have over its competition? You should look to identify the positive aspects internal to a business that add value or offer a competitive advantage.“How to Write a Marketing Plan,” Arizona Office of Tourism, accessed December 1, 2011, www.azot.gov/documents/Marketing_Tool_Kit.pdf; Tim Berry, “How to Perform a SWOT Analysis,” MPlans.com, accessed December 2, 2011, articles.mplans.com/how-to-perform-a-swot-analysis. Examples of strengths are the quality of employees, company reputation, available capital and credit, established customers, unique channels of distribution, intellectual property, location, and facilities.
Strengths for Sigmund’s Gourmet Pasta
• Strong relationships with vendors that offer high-quality ingredients and fast/frequent delivery schedules
• Excellent staff who are highly trained and very customer attentive
• Great retail space that is bright, hip, clean, and located in an upscale mall, a suburban neighborhood, or an urban retail district
• High customer loyalty among repeat customers
• High-quality food offerings that exceed competitors’ offerings in quality, presentation, and price“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Video Link \(1\):
Rebirth of the American-Made Baseball Mitt
The strengths of the Insignia company.
A weakness is a factor internal to a company that may cause it to have a less competitive position in the marketplace. A company can have control over this factor and should look to improve or remove it to successfully accomplish its marketing objectives. Weaknesses detract from the value of a business. Examples of weaknesses are lack of expertise, limited resources, bad location, poor facilities, inferior customer service and customer experience, difficulty in hiring and retaining good people, and weak brand recognition.
Weaknesses for Sigmund’s Gourmet Pasta
• Sigmund’s name lacks brand equity. Brand equity is the commercial value of all associations and expectations (positive and negative) that people have of a brand based on all the experiences they have had with the brand over time.“The Language of Branding: Brand Equity,” Branding Strategy Insider, January 20, 2008, accessed December 2, 2011, www.brandingstrategyinsider.com/brand_equity. The greater the positive brand equity, the more power in the marketplace.
• A limited marketing budget to develop brand awareness.
• The struggle to continually appear to be cutting edge.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
An opportunity is an attractive external factor that represents the reason a business exists and prospers. You have no control over opportunities, but you can take advantage of them to benefit the business. Opportunities will come from the market, the environment, or the competition, and they reflect the potential that can be realized through marketing strategies.Tim Berry, “How to Perform a SWOT Analysis,” MPlans.com, accessed December 2, 2011, articles.mplans.com/how-to-perform-a-swot-analysis. Examples of opportunities include market growth, a competitor going out of business, lifestyle changes, demographic changes, and an increased demand for a product or a service.
Opportunities for Sigmund’s Gourmet Pasta
• Growing market with a significant percentage of the target market still not aware that Sigmund’s Gourmet Pasta exists.
• Increasing sales opportunities in takeout business that can be enhanced even further by our web presence.
• The ability to spread overhead over multiple revenue centers. Sigmund’s will be able to spread the management overhead costs among multiple stores, decreasing the fixed costs per store.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Video Link \(2\):
Vinyl Makes a Comeback
A small company in Brooklyn, New York, takes advantage of the opportunity presented by the surging interest in vinyl records.
A threat is an external factor beyond a company’s control that could place a marketing strategy, or the business itself, at risk. Threats come from an unfavorable trend or development that could lead to deteriorating revenues or profits (such as high gasoline prices); a new competitor that enters the market; a public relations (PR) nightmare that leads to devastating media coverage; a gender discrimination lawsuit; a shift in consumer tastes and behavior that reduces sales; government regulation; an economic slump; or the introduction of a “leap frog” technology that may make a company’s products, equipment, or services obsolete.Tim Berry, “How to Perform a SWOT Analysis,” MPlans.com, accessed December 2, 2011, articles.mplans.com/how-to-perform-a-swot-analysis. Threats can come from anywhere and at any time, and a small business may be particularly vulnerable because of its size. At the same time, a small business may be nimble enough to effectively deal with threats because of its small size.
Threats for Sigmund’s Gourmet Pasta
• Competition from local restaurants that respond to Sigmund’s Gourmet Pasta’s superior offerings
• Gourmet pasta restaurant chains found in other markets coming to Eugene
• A slump in the economy reducing the customer’s disposable income for eating out“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Video Link \(3\):
Historic Paper Company Thrives
Surviving threats and taking advantage of opportunities.
Performing a SWOT analysis is a valuable exercise. It might help an owner identify the most promising customers, perhaps even the ideal customer. The analysis is meant to improve a customer’s experience with a company, so the person who will benefit most from a SWOT analysis is the customer.Corte Swearingen, “Marketing SWOT Analysis,” SmallBiz Marketing Tips, accessed December 2, 2011, www.small-biz-marketing-tips.com/marketing-swot-analysis .html.
Keys to Success and Critical Issues
The keys to success are those factors that, if achieved, will lead to a profitable and a sustainable business. Identifying these factors should be based on an understanding of the industry or the market in which a small business is competing because these things play a critical role in success and failure.
Focusing on three to five of the most important success factors makes sense for a small business. However, the actual number will be a function of the business. Whatever the number, the keys to success may change from time to time or year to year as the industry or the market changes.Kris Bovay, “Build a Successful Marketing Plan—15 Key Business Success Factors,” eZine @rticles, accessed December 2, 2011, ezinearticles.com/?Build-a -Successful-Marketing-Plan—15-Key-Business-Success-Factors&id=2156709. Examples of key success factors include the hiring and retention of excellent employees, successful new product introductions, a strong supplier network, a low-cost structure, retaining existing customers, a strong distribution network or channel,Kris Bovay, “Build a Successful Marketing Plan—15 Key Business Success Factors,” eZine @rticles, accessed December 2, 2011, ezinearticles.com/?Build-a -Successful-Marketing-Plan—15-Key-Business-Success-Factors&id=2156709. a cutting edge manufacturing process, and customer service.
Keys to Success for Sigmund’s Gourmet Pasta
Location, location, location.
Sigmund’s site selection criteria are critical to its success. Arthur Johnson, the former vice president of real estate for Starbucks, helped us identify the following site selection criteria:
• Daytime and evening populations
• Shopping patterns
• Car counts
• Household income levels“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Critical Issues for Sigmund’s Gourmet Pasta
Sigmund’s Gourmet Pasta is still in the speculative stage as a retail restaurant. Its critical issues are as follows:
• Continue to take a modest fiscal approach; expand at a reasonable rate, not for the sake of expansion in itself but because it is economically wise to do so
• Continue to build brand awareness that will drive customers to existing stores as well as ease the marketing efforts of future stores“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Marketing Strategy
The marketing strategy section of the marketing plan involves selecting one or more target markets, deciding how to differentiate and position the product or the service, and creating and maintaining a marketing mix that will hopefully prove successful with the selected target market(s)—all within the context of the marketing objectives. It also includes a web strategy for the small businesses that have or want to have a web presence. By aligning online marketing with onground efforts, a company will be in a much stronger position to accomplish marketing and overall company objectives. It will also be presenting a consistent style and message across all points of contact with its target audience.Bobette Kyle, “Internet Marketing Strategy: Developing a Website Marketing Plan,” WebSiteMarketingPlan.com, accessed December 1, 2011, www.websitemarketingplan.com/marketing_management/MarketingPlanningArticle.htm.
Introduction to Marketing Strategy for Sigmund’s Gourmet Pasta
Sigmund’s advertising budget is very limited, so the advertising program is simple. Sigmund’s will do direct mail, banner ads, and inserts in the Register Guard, which are likely to be the most successful of the campaigns. (We will also use our website and social media to promote the business.) Lastly, Sigmund’s will leverage personal relationships to get articles about Sigmund’s in the Register Guard. Friends who have had their restaurants featured in the Register Guard have seen a dramatic increase of sales immediately after the article was published.Adapted from “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta _restaurant_marketing_plan/marketing_strategy_fc.php.
Marketing Objectives
Marketing objectives are what a company wants to accomplish with its marketing strategy. They lay the groundwork for formulating the marketing strategy, and although formulated in a variety of ways, their achievement should lead to sales. The creation of marketing objectives is one of the most critical steps a business will take. Both online and onground objectives must be included. A business must know, as precisely as possible, what it wants to achieve before allocating any resources to the marketing effort.
Marketing Objectives for Sigmund’s Gourmet Pasta
1. Maintain positive, steady growth each month.
2. Generate at least \$40,000 in sales each month.
3. Experience an increase in new customers who become long-term customers.
4. Realize a growth strategy of one store per year.Adapted from “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta _restaurant_marketing_plan/marketing_strategy_fc.php.
5. Achieve one thousand Facebook fans in six months.This is an addition to “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta _restaurant_marketing_plan/marketing_strategy_fc.php.
6. Achieve a Twitter follower base of five hundred people in six months.This is an addition to “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta _restaurant_marketing_plan/marketing_strategy_fc.php.
You should note that the first and third objectives in this sample marketing plan do not meet some of the SMART criteria—specific, measurable, achievable, realistic, and time-based (a stated time frame for achievement). These two objectives are not specific enough to be measurable, and they may not be realistic. This will make it difficult to determine the extent to which they have been or can be accomplished.
Target Market
The target market is the segment that has been identified as having the greatest potential for a business. A segment is a relatively homogeneous subgroup that behaves much the same way in the marketplace. The identification of segments is a necessary precursor to selecting a target market. The more precise the target market is, the easier it will be to create a marketing mix that will appeal to the target market.
Target Markets for Sigmund’s Gourmet Pasta
The market can be segmented into three target populations.
1. Individuals. People who dine by themselves.
2. Families. A group of people, either friends or a group of nuclear relatives, dining together.
3. Takeout. People who prefer to eat Sigmund’s food in their own homes or at a location other than the actual restaurant.
Sigmund’s customers are hungry individuals between the ages of 25 and 50, making up 53 percent of Eugene (according to the Eugene Chamber of Commerce). Age is not the most defined demographic of this customer base, as all age groups enjoy pasta. The most defined characteristic of the target market is income. Gourmet pasta stores have been very successful in high-rent, mixed-use urban areas, such as Northwest 23rd Street in Portland. These areas have a large day and night population consisting of business people and families who have household disposable incomes over \$40,000.
Combining several key demographic factors, Sigmund’s profile of the primary customer is as follows:
• Sophisticated families who live nearby
• Young professionals who work close to the location
• Shoppers who patronize high-rent stores“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Positioning
The positioning section of the marketing plan reflects the decisions that have been made about how a company plans to “place” its business in a consumer’s mind in relation to the competition. Is a particular business seen as a high-priced or a low-priced alternative? Is a business considered a high-quality or a medium-quality alternative? Is the delivery time to customers better, worse, or the same as that of the competition? There are many different approaches to positioning that the small business owner should consider, but the selected approach should be the one that puts the company or the brand in the best light. Keep in mind that a good positioning strategy will come from a solid understanding of the market, the customer, and the competition because this knowledge will provide a basis for comparing one business with others.
Positioning for Sigmund’s Gourmet Pasta
Sigmund’s Gourmet Pasta will position itself as a reasonably priced, upscale, gourmet pasta restaurant. Eugene consumers who appreciate high-quality food will recognize the value and unique offerings of Sigmund’s Gourmet Pasta. Patrons will be singles and families, ages twenty-five to fifty.
Sigmund’s Gourmet Pasta positioning will leverage its product and service competitive edge:
• Product. The product will have the freshest ingredients, including homemade pasta, imported cheeses, organic vegetables, and top-shelf meats. The product will also be developed to enhance presentation. Everything will be aesthetically pleasing.
• Service. Customer service will be the priority. All employees will ensure that customers are having the most pleasant dining experience. All employees will go through an extensive training program, and only experienced people will be hired.
By offering a superior product, coupled with superior service, Sigmund’s will excel relative to the competition.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Video Clip \(4\):
Small Business Market Position
Market position refers to how the general public views the business or the product.
Video Clip \(5\):
Small Business Market Position Tips
Choose a unique position for a business or a product.
Video Clip \(6\):
Choosing a Small Business Market Position
Look ten to fifteen years into the future when thinking about positioning.
Marketing Strategy Pyramid
The marketing strategy pyramid assumes that the marketing strategy is built on concrete tactics that are built on specific, measurable marketing programs—activities with budgeted expenses, well-defined responsibilities, deadlines, and measurable results.Tim Berry, “What Is the Marketing Strategy Pyramid, Where Did It Come From?,” BPlans, accessed June 1, 2012, http://www.bplans.com/ask-bplans/640/what-is-the -marketing-strategy-pyramid-where-did-it-come-from.
The strategy at the top of Figure \(5\) focuses on well-defined markets and user needs. The second level consists of the tactics that you use to satisfy user needs and communicate with the target market. The third level is where specific programs are defined.Tim Berry, “What Is the Marketing Strategy Pyramid, Where Did It Come From?,” BPlans, accessed June 1, 2012, http://www.bplans.com/ask-bplans/640/what-is-the -marketing-strategy-pyramid-where-did-it-come-from. It is this framework that is built into the sample marketing plans that are available through Palo Alto Software in Sales and Marketing Pro and at www.mplans.com. However, it is a solid approach that can be used in any marketing planning situation.
Strategy Pyramid for Sigmund’s Gourmet Pasta
The single objective is to position Sigmund’s as the premier gourmet pasta restaurant in the Eugene, Oregon, area, commanding a majority of the market share within five years. The marketing strategy will seek to first create customer awareness regarding the services offered, develop that customer base, and work toward building customer loyalty and referrals.
The message that Sigmund’s will seek to communicate is that Sigmund’s offers the freshest, most creative, health-conscious, reasonably priced, gourmet pasta in Eugene. This message will be communicated through a variety of methods. The first will be direct mail. The direct mail campaign will be a way to communicate directly with the consumer. Sigmund’s will also use banner ads and inserts in the Register Guard. This will be particularly effective because the Register Guard is a popular local paper that is consulted when people are looking for things to do in Eugene. The restaurant’s website will also encourage patronage because the warm and friendly atmosphere of the site will reflect the atmosphere of the actual restaurant. Facebook and Twitter followers along with customer comments will also add to brand awareness.The website and social media are additions to “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
The last method for communicating Sigmund’s message is through a grassroots PR campaign. This campaign will leverage personal relationships with people on the staff of the Register Guard to get a couple of articles written about Sigmund’s. One will be from the business point of view, talking about the opening of the restaurant and the people behind the venture. This is likely to be run in the business section. The second article will be a food review. In speaking with many different retailers and restaurateurs, significant increases of traffic have followed articles in the Register Guard. Because of this level of effectiveness and low/zero cost, Sigmund’s will work hard to get press in the Register Guard.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Marketing Mix
A company’s marketing mix is its unique approach to product, price, promotion, and place (distribution)—the four Ps. The marketing mix is the central activity in the implementation of a company’s marketing strategy, so the decisions must be made carefully. It is through the marketing mix that marketing objectives will be achieved. The final determination of the marketing mix requires inputs from other areas, such as purchasing, manufacturing, sales, human resources, and finance.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 57.
Marketing Mix for Sigmund’s Gourmet Pasta
Sigmund’s marketing mix consists of the following approaches to pricing, distribution, advertising and promotion, and customer service.
• Pricing. Sigmund’s pricing scheme is that the product cost is 45 percent of the total retail price.
• Distribution. Sigmund’s food will be distributed through a model in which customers can either call in their orders or place them onlineThe authors of this textbook added the capability to place an order online. and come to the restaurant to pick them up or come into the restaurant, place their orders, and wait for them to be completed.
• Advertising and promotion. The most successful advertising will be banner ads and inserts in the Register Guard as well as a PR campaign of informational articles and reviews within the Register Guard and coupons available on the website. The first-timer discount coupon and code will be prominently displayed on the website’s home page to encourage prospects to become customers. Coupons will also be available for repeat customers once per month.The addition of coupons is a combination of ideas from the authors of this textbook and the following sample marketing plan: “Restaurant Marketing Plan: Neon Memories Diner,” MPlans.com, accessed June 1, 2012, http://www.mplans.com/restaurant_mar..._vision_fc.php. Holiday specials will be offered on Valentine’s Day, Easter, Mother’s Day, and Father’s Day.
• Social media. Sigmund’s Gourmet Pasta will establish a Facebook page that will allow users to engage directly with the company by posting likes, dislikes, and ideas to the Wall, which will be answered directly by management. Customers will be encouraged to become fans of the Facebook page and then share the page with their friends.The Facebook plan was drawn from the following two sample marketing plans: “Locally Produced Clothing Retailer Marketing Plan: Local Threads,” MPlans.com, accessed December 2, 2011, www.mplans.com/locally_produced _clothing_retailer_marketing_plan/marketing_vision_fc.php; “Restaurant Marketing Plan: Neon Memories Diner,” MPlans.com, accessed December 2, 2011, http://www.mplans.com/restaurant_mar..._vision_fc.php. Sigmund’s will also establish a Twitter presence.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php. The authors of this textbook added Twitter to the social media plan.
Video Clip \(7\):
How To Use Twitter For Business
A tutorial about using Twitter for business.
Video Clip \(8\):
What a Business Needs to Do to Connect More on Twitter
A humorous look at why a business should use a picture, not its business logo, on Twitter.
Marketing Research
Marketing research is about gathering the information that is needed to make business decisions, which should be an ongoing process. A marketing plan should be based on marketing research. The research can range from something very simple conducted by the owner or an employee to a more sophisticated study that is prepared by a marketing research firm. The overall goal of the research, however, is to help a company offer products that people will want, at an appealing price, in the place where they want to buy them. The research should also help a company decide how to promote its products so that people will be aware of them. People cannot buy what they do not know about.
Marketing Research for Sigmund’s Gourmet Pasta
During the initial phases of developing the marketing plan, several focus groups were held to gain insight into a variety of patrons of restaurants. These focus groups provided useful insight into the decisions and decision-making processes of consumers.
An additional source of dynamic market research is a feedback mechanism based on a suggestion card system. The suggestion card system has several statements that patrons are asked to rate in terms of a given scale. There are also several open-ended questions that allow the customer to freely offer constructive criticism or praise. Sigmund’s will work hard to implement reasonable suggestions to improve its service offerings as well as show its commitment to customers that their suggestions are valued. This suggestion system will also be incorporated into our website so that customers can provide feedback online.The authors of this textbook added the online suggestion system.
The last source of market research is competitive analysis and appreciation. Sigmund’s will continually patronize local restaurants for two reasons. The first is for competitive analysis, providing Sigmund’s with timely information regarding the service offerings of other restaurants. The second reason is that local business owners, particularly restaurant owners, are often part of an informal fraternal organization where they support each other.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Financials
The financials section of the marketing plan should provide a financial overview of the company as it relates to the marketing activities. Typically addressed in this section are the breakeven analysis, a sales forecast, and an expense forecast and how they link to the marketing strategy.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Breakeven Analysis
A breakeven analysis is used to determine the amount of sales volume a company needs to start making a profit.Susan Ward, “Breakeven Analysis,” About.com, accessed December 1, 2011, sbinfocanada.about.com/cs/startup/g/breakevenanal.htm. A company has broken even when its total sales or revenues equal its total expenses. However, a breakeven analysis is not a predictor of demand, so if a company goes into the marketplace with the wrong product or the wrong price, it may never reach the break-even point.Daniel Richards, “How to Do a Breakeven Analysis,” About.com, accessed December 1, 2011, entrepreneurs.about.com/od/businessplan/a/breakeven.htm.
The most relevant types of costs that must be considered when preparing a breakeven analysis are fixed costs and variable costs. Fixed costs are costs that must be paid whether or not any units are produced or any services are delivered. They are “fixed” over a specified period of time or range of production. Rent, insurance, and computers would be considered fixed costs because they are outlays that must occur before a company makes its first sale.Daniel Richards, “How to Do a Breakeven Analysis,” About.com, accessed December 1, 2011, entrepreneurs.about.com/od/businessplan/a/breakeven.htm; Susan Ward, “Breakeven Analysis,” About.com, accessed December 1, 2011, sbinfocanada.about.com/cs/startup/g/breakevenanal.htm.
Variable costs are recurring costs that must be absorbed with each unit or service sold. These costs vary directly with the number of units of product or the amount of service provided.Daniel Richards, “How to Do a Breakeven Analysis,” About.com, accessed December 1, 2011, entrepreneurs.about.com/od/businessplan/a/breakeven.htm; Susan Ward, “Breakeven Analysis,” About.com, accessed December 1, 2011, sbinfocanada.about.com/cs/startup/g/breakevenanal.htm. Labor costs and the cost of materials are examples of variable costs.
Breakeven Analysis for Sigmund’s Gourmet Pasta
Figure 8.6 Sigmund’s Breakeven Analysis
The breakeven analysis indicates that \$23,037 in monthly revenue will be required to reach the break-even point. The analysis assumes a 45 percent annual variable cost and a \$22,000 estimated monthly fixed cost.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Sales Forecast
A company’s sales forecast is the level of sales that a company expects based on a chosen marketing plan and an assumed marketing environment. The sales forecast does not establish a basis on which to decide how much should be spent on marketing. Rather, it is the result of an assumed marketing expenditure plan. Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 112. A sales forecast can be very helpful in creating important milestones for a business. However, it is still an educated guess. No matter what a company forecasts, it will typically make less than expected. “Expense and Sales Forecasting,” Chic-CEO.com, accessed December 2, 2011, www.chic-ceo.com/expense-and-sales-forecasting.
Sales Forecast for Sigmund’s Gourmet Pasta
The first two months will be used to get the restaurant up and running. By the third month, things will get busier. Sales will gradually increase, with profitability being achieved by the beginning of the new year.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Table \(2\): Sigmund’s Forecast of Sales and Direct Cost of Sales
Category 2011 2012 2013
Sales
Individuals \$103,710 \$262,527 \$327,424
Families \$150,304 \$380,474 \$474,528
Total sales \$254,014 \$643,001 \$801,952
Direct Cost of Sales
Individuals \$46,669 \$118,137 \$147,341
Families \$67,637 \$171,213 \$213,538
Total direct cost of sales \$114,306 \$289,350 \$360,879
Note: Sigmund’s separated sales on the basis of its target market, but it did not include a separate sales forecast for takeout. It should have.
Source: “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta: Situation Analysis,” Mplans.com, accessed December 1, 2011, http://www.mplans.com/pasta_restaura...nalysis_fc.php.
Expense Forecast
A company’s expense forecast is a tool that can be used to keep its operations on target. The forecast will provide indicators when corrections or modifications are needed for the proper implementation of the marketing plan. An expense forecast is vital for a company and its sales goals because it will keep the company on track and keep costs down; however, a company will typically spend much more than expected.“Expense and Sales Forecasting,” Chic-CEO.com, accessed December 2, 2011, www.chic-ceo.com/expense-and-sales-forecasting. If a company is not sure what to include in its expense forecast, there are online templates that can provide assistance (see www.chic-ceo.com/userfiles/ExpenseForecast.pdf for sample templates).
Expense Forecast for Sigmund’s Gourmet Pasta
Marketing expenses are to be budgeted so that they are ramped up for months two through four and then lower and plateau from month five to month ten. Restaurants typically have increased business in the fall. This generally occurs because during the summer, when the weather is nice and it does not get dark until late, people tend to eat out less. From month ten to month twelve, the marketing costs will increase again.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Table \(3\):Sigmund’s Marketing Expense Budget
Category 2011 2012 2013
Direct mail \$5,267 \$5,605 \$5,421
Banner ads \$11,704 \$12,455 \$12,047
Other \$7,022 \$7,473 \$7,228
Total sales and marketing expenses \$23,993 \$25,533 \$24,696
Percentage of sales 9.45% 3.97% 3.08%
Note: These marketing expenses do not account for website, social media, or coupon redemption expenses, and they do not reflect the cost of preparing marketing materials (e.g., the direct mail pieces, the coupons, and the banner ads). For the sake of convenience, we can include these expenses in the “Other” category. However, there should be separate figures for these expenses. Also, it should be made clear what kinds of expenses are included as “Other.”
Source: “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta: Situation Analysis,” Mplans.com, accessed December 1, 2011, http://www.mplans.com/pasta_restaura...nalysis_fc.php.
Implementation, Evaluation, and Control
This last section of a marketing plan outlines what a company will do to implement the plan, evaluate its performance, and monitor and adjust plan implementation through controls. In other words, this section of the plan is all about numbers, results, and timelines.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 57; Emily Suess, “Marketing Plan Basics for Small Business,” Small Business Bonfire, April 13, 2011, accessed December 2, 2011, smallbusinessbonfire.com/marketing-plan-basics-for-small-business-owners.
Implementation
Implementation is about the day-to-day activities that effectively put a marketing plan into action and focuses on who, where, when, and how: Who will do that? Where to start and when? When to do that? How to do that?Steve Arun, “How to Successfully Implement Your Marketing Plan,” VA4Business, March 14, 2010, accessed December 2, 2011, www.va4business.com/business/428/how-to-successfully-implement-your-marketing-plan. Effective implementation can give a business the edge in a market with similar marketing plans simply because any company that is better and faster at execution is sure to have the advantage in terms of market share.“Implementing Your Marketing Plan,” Marketing Plan Success, accessed December 2, 2011, www.marketing-plan-success.com/articles/controls-implementation.php. This will be true for a small business of any size. There is, however, no such thing as a one-time implementation of a marketing plan. Rather, it is a process that evolves with the product or the service.Steve Arun, “How to Successfully Implement Your Marketing Plan,” VA4Business, March 14, 2010, accessed December 2, 2011, www.va4business.com/business/428/how-to-successfully-implement-your-marketing-plan.
Several steps are recommended for the proper implementation of a marketing plan. Examples include the following:“Implementing Your Marketing Plan,” Marketing Plan Success, accessed December 2, 2011, www.marketing-plan-success.com/articles/controls-implementation.php; Steve Arun, “How to Successfully Implement Your Marketing Plan,” VA4Business, March 14, 2010, accessed December 2, 2011, www.va4business.com/business/428/how-to-successfully-implement-your-marketing-plan.
1. Be sure to always check progress. Know what is working and what is not working. Doing so will help you stay on top of programs that need work and can build on programs that are working.
2. Be sure to reward employees for jobs well done. When goals are met, deadlines are met, and so forth, make sure to congratulate the people responsible for these goals and deadlines.
3. Always try new things. A company should never sit on its hands. The market is always changing, so a company should also change. Learn to adapt.
4. Don’t jump ship too soon. Give the plan time to work. If it is not working, do not give up. Work with the team. Let them help the company succeed.
5. Be open to ideas. Some employees may have a better idea about the reality of the market than the owner has. Listen to them. Hear what they have to say.
Implementation Milestones for Sigmund’s Gourmet Pasta
The following milestones identify the key marketing programs. It is important to accomplish each one on time and on budget.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Table \(4\): Sigmund’s Implementation Milestones
Milestones Start Date End Date Budget Manager Department
Advertising
Marketing plan completion 1/1/2011 2/1/2011 \$0 Kevin Marketing
Banner ad campaign #1 2/1/2011 4/1/2011 \$3,754 Kevin Marketing
Banner ad campaign #2 10/1/2011 1/1/2011 \$4,900 Kevin Marketing
Total advertising budget \$8,654
Direct Marketing
Direct mail campaign #1 2/1/2011 4/1/2011 \$1,689 Kevin Marketing
Insert campaign #1 2/1/2011 4/1/2011 \$2,252 Kevin Marketing
Direct mail campaign #2 10/1/2011 1/1/2011 \$2,205 Kevin Marketing
Insert campaign #2 10/1/2011 1/1/2011 \$2,940 Kevin Marketing
Total direct marketing budget \$9,086
Web development Outside firm Marketing
Totals \$17,741
Note: The authors of this textbook added the web development milestone to acknowledge that this activity still needs to be scheduled and budgeted. It was not part of the original sample marketing plan. Under normal conditions, the dates and numbers for web development would also be included.
Source: “Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta: Situation Analysis,” Mplans.com, accessed December 1, 2011, http://www.mplans.com/pasta_restaura...nalysis_fc.php.
Evaluation
You can’t manage what you don’t measure.“Measuring Brand Performance,” Branding Strategy Insider, February 22, 2011, accessed December 2, 2011, www.brandingstrategyinsider.com/brand_equity.
Peter Drucker
The evaluation section of the marketing plan is about assessing the strengths and weaknesses of a marketing plan to improve its effectiveness.“About Us,” American Evaluation Association, accessed December 2, 2011, www.eval.org/aboutus/organization/aboutus.asp. Without an evaluation process, a company will not know whether its marketing campaign is effective or whether it is spending too much or too little money to achieve its goals. The evaluation process, if done correctly, will allow a company to continually improve its tactics and assess the results of its marketing efforts. Thus it is important to set up a timely process to track, capture, and analyze collected data as it is collected. If this is done on a regular basis, a marketing activity (e.g., banner advertising) that doesn’t work can be changed to more effective tactics (e.g., advertising in the local paper) that do work.“Marketing Plan: Evaluation,” Will It Fly, accessed December 1, 2011, www.willitfly.com/wif/educelbrief.jsp?briefId=93&sponsorId=61&modId=241& modNm=Marketing%2BPlan§ionNm=Evaluation.
There are many ways to evaluate how well a company is doing. The following are some of the ways:Adapted from Stuart Ayling, “7 Ways to Evaluate Your Marketing Plan,” WebSiteMarketingPlan.com, accessed December 2, 2011, www.websitemarketingplan.com/mplan/evaluateplan.htm.
1. Look at sales (or fee) income. Sales or fee income should be increasing. However, some small businesses will have longer sales cycles than others, so it might be better to measure the number of new leads generated, or the number of appointments, or the number of billable hours achieved. Also remember that discounts, variances in fees, and promotional pricing will affect total sales volume. If a company is selling online and onground, look at the path of both income streams.
2. Ask clients or customers. Find out where and how clients and customers heard about the business. Most businesses never ask this question, so they miss out on valuable insights into how clients and customers pick a product or a service.
3. Does advertising and/or promotional activity produce direct responses? It should. If not, a company should work to find out why not. This is also relevant for a web presence. A company should want to know how site visitors found out about the company.
4. Check the conversion rate. How successful is a business at closing the sale? Has it improved? If a company is selling online, how many site visitors are actually buying something?
5. Does the plan have a positive return on investment (ROI)? Does it bring in enough new or repeat business to justify the expense? A company should evaluate the cost-effectiveness of each specific online and onground marketing activity so that it can change or eliminate unproductive activities. There are online tools available to help companies with this evaluation. As an example, a free ROI calculator is available at www.cymbic.com/tools/roi_calc.php.
To best evaluate the effectiveness of a marketing plan, it will be necessary to track each type of marketing activity in the plan. The data and techniques will vary widely depending on product type and market—and whether a company has an online presence only or both an onground presence and an online presence. However, most small businesses should select the simplest route possible because of the lower costs and the limited need for very sophisticated tracking. The following are some common and very doable tracking techniques for the small business:
• Advertising efficiency. The number of inquiries generated by an advertisement and the cost per inquiry. This applies to both online and traditional advertising.John Vencil, “The Marketing Plan VII—Evaluation,” VPI Strategies, 2003, accessed December 2, 2011, www.vpistrategies.com/articles_pdf/Mktg7_Eval.pdf.
• Sales promotion efficiency. The number of inquiries generated by a promotion (e.g., a coupon or a banner ad) and the percentage of coupons or vouchers redeemed. This also applies to online and traditional sales promotion activities.John Vencil, “The Marketing Plan VII—Evaluation,” VPI Strategies, 2003, accessed December 2, 2011, www.vpistrategies.com/articles_pdf/Mktg7_Eval.pdf.
• Sales closure rate. The number of sales closed compared to sales leads. Collect data for both online and onground sales.
• Direct marketing. The number of inquiries or customers generated by a direct marketing activity. Direct marketing uses a variety of channels, such as direct mail, telemarketing, e-mail, interactive television, websites, mobile devices, door-to-door leaflet marketing, broadcast faxing, voicemail marketing, and coupons.
• Web analytics. One of the big benefits of having a web presence is that there is a vast amount of tracking and statistics available to the site owner. Small-business owners will want to know things such as where site traffic comes from, how they got to the site, what search words or phrases were used, how many people are viewing the site, how many people are buying if you are selling something, the geographic location of site visitors, and the time each visitor spends on the site. Website analysis tools can track the ways people use a website while helping the owner make sense of the mountain of data that a site generates.Justin Whitney, “What Is Web Analytics,” AllBusiness.com, accessed December 2, 2011, www.allbusiness.com/marketing-advertising/marketing-advertising/11382028 -1.html.
Video Link \(9\):
Using Web Analytics Tools
How analytics tools can help you make informed decisions about online endeavors.
Small-business owners may choose to have the web analytics performed by an outside vendor or use inexpensive analytics tools such as Google Analytics.
Video Clip \(10\):
Three Important Questions to Ask Google Analytics
How Google Analytics helps to answer the three most important questions about a website
• Social media metrics. If social media is part of a company’s marketing plan, the owner will want to find out whether it is worth all the time and effort involved. The goal is to be able to draw lines and connect the dots between social media participation and sales or perhaps something else like brand recognition. Community eBook, Practical Social Media Measurement & Analysis (Fredericton, New Brunswick, Canada: Radian6, 2010), 9, accessed December 2, 2011, www.radian6.com/wp-content/uploads/2010/03/Radian6_eBook_March2010.pdf. Twitter metrics are fairly simple, beginning with the number of followers you have. However, it is the number of retweets you get that will be an indication of the messages that are actually resonating with customers. This is a measure of social influence. Klout is a free tool that measures your online influence on a scale of 1 to 100. This information can guide you to identifying strengths and weaknesses. Anoop George Joseph, “Twitter Metrics,” Web Technology and Softwares—A Technical Blog, December 16, 2011, accessed June 1, 2012, webtechsoftwares.wordpress.co...itter-metrics/; “The Klout Score,” accessed June 1, 2012, klout.com/understand/score. It is also important to tap into the analytics provided by LinkedIn and Facebook.Viveka Von Rosen, “ROI and Measuring your LinkedIn Presence,” #LinkedInChat, February 21, 2012, accessed May 30, 2012, http://linkedintobusiness.com/roi-an...edin-presence/; Jenn Deering Davis, Ph.D., “5 Most Essential Facebook Marketing Metrics,” AllFacebook, April 17, 2012, accessed May 30, 2012, http://allfacebook.com/facebook-metr...entials_b86156. Perhaps the best approach for a small business to measure its social media effectiveness is to choose an easy-to-understand and easy-to-use web analytics package. Google Analytics was mentioned previously. Another good choice would be the software available from HubSpot because this company focuses specifically on the needs of small and medium-sized businesses.
Marketing Calculators
The Internet is a wonderful place. You can find most anything there. The following are three free marketing calculators that you might find useful in measuring the effectiveness of marketing: These calculators were obtained from and self-described at www.mplans.com/marketing_calculators.
1. Pay-per-click ROI calculator. This calculator determines the ROI for pay-per-click advertising campaigns. Based on a campaign’s results and costs, the ROI can be calculated.
2. Conversion rate calculator. Even the most successful websites convert only a fraction of their visitors into paying customers. A company can increase its sales by upping its conversion rate, attracting more traffic to the site, or encouraging buyers to spend more money. This handy calculator experiments with these variables. Enter the number of visitors and total orders and see what an increase in conversion can do.
3. E-mail marketing ROI calculator. E-mail marketing campaigns to interested prospects who have opted to receive a company’s e-mail messages is a great way to increase direct sales. This simple calculator makes it easy to see the ROI from various campaigns, based on expected costs and response levels. It can be used to test different scenarios and test results.
Evaluation for Sigmund’s Gourmet Pasta
Unfortunately, the marketing plan for Sigmund’s Gourmet Pasta does not address the evaluation of its marketing activities. They should have provided information about the plans for measuring and evaluating the effectiveness of its banner ads, direct mail, and insert campaigns. The website and social media activities added by the authors of this textbook would have to be measured and evaluated for their effectiveness as well.“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
Controls
There is no planning without control, the process of monitoring a proposed plan as it proceeds and adjusting it when necessary.“Marketing Controls,” MarketingTeacher.com, accessed December 2, 2011, www.marketingteacher.com/lesson-store/lesson-control.html. Every business needs someone to take responsibility for pushing things along. A good schedule and budget should make it easy to monitor progress, but when things fall behind schedule or there are cost overruns, you must be ready to do something about it and adapt the plan accordingly. From time to time, the owner must step back and ask whether the plan is working. What can you learn from mistakes, and how can you use what you know to make a better marketing plan for the future?“How to Write a Marketing Plan,” Arizona Office of Tourism, accessed December 1, 2011, www.azot.gov/documents/Marketing_Tool_Kit.pdf.
In addition to setting a schedule and measuring and evaluating the effectiveness of marketing activities, a marketing plan needs to say how it will be controlled. Although there are many approaches to control, the small business owner will likely look to activities such as sales analysis (monthly and annual revenue), expense analysis (monthly and annual expenses), feedback from customer satisfaction surveys, and the observation of competitor activities in response to the marketing plan (marketing research). The organization of the marketing function itself can also be seen as a means of control.
Marketing Plan Control for Sigmund’s Gourmet Pasta
The marketing plan for Sigmund’s Gourmet Pasta includes implementation milestones, the marketing organization, and contingency planning as controls for their marketing plan. Implementation was discussed previously. Contingency planning is a formal process to manage a crisis, whether it comes from inside or outside a company. A contingency plan involves potential problem identification, prioritizing the problems in a list of most probable, and developing planned steps to limit the harm to a company if the potential problem becomes real.Larry A. Bauman, “Contingency Planning Occurs before the Crisis Begins,” Small Business Success, accessed December 1, 2011, www.smallbusinesssuccess.biz/articles_week/business_contingency_planning.htm. It would have been helpful if Sigmund’s marketing plan had included other controls as well. The more specific a marketing plan is about its controls, the better the chances that those controls will be carried out successfully.
Marketing Organization
Kevin Lewis, the owner, is primarily responsible for marketing activities. This is in addition to his other responsibilities, and he depends on some outside resources for graphic design work and creativity.
Contingency Planning
Difficulties and risks include the following:
• Problems generating visibility
• Overly aggressive and debilitating actions by competitors
• An entry into the Eugene market of an already existing, franchised gourmet pasta restaurant
Worst-case risks may include the following:
• Determining that the business cannot support itself on an ongoing basis
• Having to liquidate equipment or intellectual property to cover liabilities“Pasta Restaurant Marketing Plan: Sigmund’s Gourmet Pasta,” Mplans.com, accessed December 1, 2011, www.mplans.com/pasta_restaurant_marketing_plan/marketing_strategy_fc.php.
KEY TAKEAWAYS
• There is no universally accepted format for a marketing plan. The plan can be a stand-alone document or a section of the business plan.
• A marketing plan has several critical sections: executive summary; vision and mission; situation analysis; marketing objectives; marketing strategy; financials; and implementation, evaluation, and control.
• The executive summary is a one- to two-page synopsis of the marketing plan.
• The vision statement tries to articulate the long-term purpose and idealized notion of what a business hopes to be—that is, where the owner sees the business going.
• The mission statement looks to articulate the more fundamental nature of a business—that is, why the business exists.
• The situation analysis gives a picture of where a business is now in the market and provides the context for marketing efforts. This analysis includes a market summary, competition, product offerings, the SWOT analysis, keys to success, and critical issues.
• The marketing strategy section of the plan involves selecting one or more target markets, deciding how to differentiate and position a product or a service, and creating and maintaining a marketing mix that will hopefully prove successful with the selected target market(s)—all within the context of marketing objectives. It also includes a web strategy for small businesses that have or want to have a web presence.
• The financials section of the marketing plan should provide a financial overview of a company as it relates to its marketing activities. For the small business, this should typically include a breakeven analysis, a sales and direct cost of sales forecast, and a forecast of marketing expenses.
• The implementation, evaluation, and control section of the marketing plan should include how a company will put the plan into action, evaluate whether the plan is working, and monitor and adjust implementation of the plan through marketing plan controls.
EXERCISE
1. In a group of four or five students, develop a marketing plan for Frank’s All-American BarBeQue. Be sure to draw from the business plan in the Appendix (Chapter 16 "Appendix: A Sample Business Plan"). | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/08%3A_The_Marketing_Plan/8.03%3A_The_Marketing_Plan.txt |
Learning Objectives
1. Understand how having a marketing plan contributes to customer value.
2. Understand how having a marketing plan can impact cash flow.
3. Understand how digital technology and the e-environment impact the marketing plan.
Customer Value Implications
Marketing is all about ascertaining and providing customer value, so it should be no surprise that there needs to be a strong linkage between a small business marketing plan and customer value. Customer value is the amount of benefits that a customer realizes from a product or a service as compared to the costs associated with acquiring those benefits. Because a marketing plan provides a specific marketing direction for a small business, the plan necessarily captures how it plans to deliver value to customers. The specific consideration of product, price, place, and promotion should all be geared to appealing to the target market or markets. This “appeal” must be based on understanding the value that customers are seeking—as the business understands it. The product should also be positioned in a way that reflects value by setting it apart from the competition for easy recognition and comparison. In short, the marketing plan should be the embodiment of a business’s customer value proposition—that is, the whole cluster of benefits a business is promising to deliver to a customer.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 123.
Cash-Flow Implications
It is not uncommon for a business to spend three times as much as expected and make three times less than expected.“Expense and Sales Forecasting,” Chic-CEO.com, accessed December 2, 2011, www.chic-ceo.com/expense-and-sales-forecasting. This combination is not good for any company’s cash flow. It is, therefore, critical that marketing plan expenses be as tight as possible without sacrificing quality (as defined by the business), with every effort being made to keep costs low. This implies the efficient use of employee time on marketing activities, competitive bidding for outside vendors, very careful attention paid to the costs of media and their effectiveness so that promotional campaigns that are not working are replaced with campaigns that look more promising and more cost-effective, and web presence measurement and evaluation to ascertain what efforts are not working so that the costs of those efforts can be replaced with something more cost-effective.
Digital Technology and E-Environment Implications
Digital technology and the e-environment are becoming more important to the small business every day. With specific respect to the marketing plan, technology can enter the process at multiple points. The following are a few examples:
• Digital technology makes it easy to develop a plan that is responsive to the needs of any size small business. Sales and Marketing Pro from Palo Alto Software is specifically geared to the needs of small business. The templates can be edited to fit the needs of the business, and both companies provide excellent customer support.
• When implementing the plan, digital technology makes it possible for salespeople to have quick access to the right information about inventory and pricing through a company’s website, smartphones, and iPads.Adapted from “Use of Technology in Marketing,” Microsoft Business, accessed December 2, 2011, www.microsoft.com/business/en-us/resources/ArticleReader/website/default.aspx?Print=1&ArticleId=techstrategiestopoweryourmarketingmuscleanddollars &fbid=knBWf5av0wR.
• Technology can help a company quickly customize offers for top-tier customers or personalize discounts for those who buy a specific product.Adapted from “Use of Technology in Marketing,” Microsoft Business, accessed December 2, 2011, www.microsoft.com/business/en-us/resources/ArticleReader/website/default.aspx?Print=1&ArticleId=techstrategiestopoweryourmarketingmuscleanddollars &fbid=knBWf5av0wR.
• New technology tools and document management services can now analyze customer preferences, niche markets, regional buying habits, and more to help small businesses focus efforts and resources. The possible result is a more focused marketing plan.Adapted from “Use of Technology in Marketing,” Microsoft Business, accessed December 2, 2011, www.microsoft.com/business/en-us/resources/ArticleReader/website/default.aspx?Print=1&ArticleId=techstrategiestopoweryourmarketingmuscleanddollars &fbid=knBWf5av0wR.
• Software solutions are also available for managing sales (e.g., Salesforce). These solutions are typically very inexpensive.
The e-environment has also had an impact on developing the marketing plan. The following are some examples:
• Online options provide new channels for small businesses to communicate and market their products and services and also offer the capability to deliver customized, one-to-one messages.“How Has Online Technology Changed Small Business Marketing and Advertising?,” Torian Group.com, accessed December 1, 2011, www.toriangroup.com/Portals/0/Documents/How%20Has%20Online%20Technology%20Changed%20Small %20Business%20Marketing%20and%20Advertising.pdf.
• Small businesses can now plan to reach out to their target markets for little to no cost due to several new options for promotion that previously did not exist (e.g., e-mail, blog postings, podcasting, and online community forums).“How Has Online Technology Changed Small Business Marketing and Advertising?,” Torian Group.com, accessed December 1, 2011, www.toriangroup.com/Portals/0/Documents/How%20Has%20Online%20Technology%20Changed%20Small %20Business%20Marketing%20and%20Advertising.pdf.
• SurveyMonkey, a do-it-yourself survey program, can be used to find out customer likes, dislikes, and demographic profiles.“How Has Online Technology Changed Small Business Marketing and Advertising?,” Torian Group.com, accessed December 1, 2011, www.toriangroup.com/Portals/0/Documents/How%20Has%20Online%20Technology%20Changed%20Small %20Business%20Marketing%20and%20Advertising.pdf.
• A multitude of online tools are available to measure online and onground marketing activities. This includes the all-important measurement of website activity. Examples include free web analytics tools, such as Google Analytics and HubSpot, and free marketing calculators.
KEY TAKEAWAYS
• The marketing plan should be an embodiment of the customer value proposition of a business.
• The marketing plan should represent a commitment to keeping costs as low as possible without sacrificing quality. This will help the company’s cash flow.
• Both digital technology and the e-environment can make important contributions to the development, implementation, evaluation, and control of the marketing plan.
EXERCISE
1. Your boss is struggling with the company’s marketing plan. He knows that a plan is needed, but he is really crunched for time—as usual. You have suggested to him that there is a much easier and cost-effective way to develop the plan by using digital technology and the Internet. He agrees but does not have the time to check into the options. He has asked you to do it for him. Prepare a list of options that includes an explanation of each option and a discussion of how each option will contribute to customer value and keep costs down. Be as specific as possible but do not overwhelm him with paper. He will not have the time to read it.
Disaster Watch
What Now?
MaryAnn has always wanted her own real estate office. She earned her real estate license as soon as she was eligible and was able to land a position with the top realtor in the area. As she gained sales experience, she studied for her broker’s license and obtained it on the “fast track.” Her plan was to open her own office as soon as she felt confident that she had enough experience under her belt.
Her office, Power Real Estate, is now open, and MaryAnn has done well in building a business and establishing a good reputation for results. One of the things she noticed in her years of real estate experience was that many people were wary of letting real estate agents sell their homes because they did not believe the agents would aggressively try to sell them fast enough.David Frey, “6 Deadly Small Business Marketing Mistakes,” accessed June 21, 2012, www.onyxwebsolutions.com.au/r...g_Mistakes.pdf. In response to this reluctance, MaryAnn developed and aggressively marketed a “Twenty-Point Power Marketing Plan” that would result in a client’s house being sold in thirty days or less.David Frey, “6 Deadly Small Business Marketing Mistakes,” accessed June 21, 2012, www.onyxwebsolutions.com.au/r...g_Mistakes.pdf. She knew it was risky, but so far things have worked out well.
Then the housing collapse occurred. MaryAnn found herself swamped with homeowners anxious to sell before being hit with foreclosure. She quickly found out that she could no longer sell homes in thirty days or less because there was a housing glut. She now sees her reputation at risk because of the housing glut. Her marketing plan is down the drain. What should she do? She does not see closing her office as an option she wants to consider. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/08%3A_The_Marketing_Plan/8.04%3A_The_Three_Threads.txt |
Simione Consultants LLC
Health care is the largest single industry in the US economy. Currently, health care represents nearly 17 percent of the gross domestic product, encompassing nearly 600,000 establishments and employing more than 14 million people. The health-care industry covers an extraordinary wide range of businesses and operations. It includes large hospitals, diagnostic laboratories, nursing care facilities, and the offices of doctors and dentists. Each establishment has individuals that possess considerable expertise in their respective disciplines. However, they may not possess the knowledge or the expertise that would enable them to manage their establishments in the most efficient manner. That is where firms like Simione Consultants LLC play a vital role.
Simione Consultants LLC represents the evolution of consulting companies that have spun off from many accounting firms. Accountants are no longer merely reconciling accounts or preparing tax returns for their clients. They are now offering a broad range of consulting services. Simione Consultants LLC provides expert assistance to hospital-based and hospital-affiliated home health and hospice agencies, visiting nurse associations, small proprietary agencies, and large national chains. They provide services that one might expect from a firm whose origins were in a standard accounting practice—such as assisting in accounts receivables and cash-flow management. Other accounting services that they provide include financial analysis reports and the preparation of cost reports for the federal government. They can conduct in-depth cost analyses at a detailed and a granular level so that clients can improve their operational efficiencies. The compliance division consulting services include working with health-care attorneys, corporate compliance and audit departments, and government agencies such as the Office of the Inspector General. Its clinical operations division works closely with financial consultants to improve the financial health of its clients.
What makes Simione Consultants LLC distinct is its ability to go beyond these basic accounting tasks and provide vital ancillary support for its clients in this niche market. They are in a position to conduct the valuation of businesses or assist in mergers and acquisitions. They help clients with preparing a prospectus or assisting with negotiations. Their consulting services can advise on how a client can maximize its return on an information management system by identifying system requirements and specifying possible solutions. In addition, the company has developed a software product—“The Financial Monitor”—that provides quarterly home health and hospice reports with multiple valuable benchmarks, including national, state, and profit-status norms, to help their clients and the industry make informed financial decisions.
A measure of how firms such as Simione Consultants LLC have moved beyond balance accounts is the company’s ability to support a client’s marketing function. The firm can help build comprehensive marketing plans and assist clients in developing and improving sales materials and training.
Simione Consultants LLC began its work in the home health-care industry more than forty years ago with an agency in Hamden, Connecticut. It was the vision of William J. Simione Jr., the founding member, who saw an opportunity. With his brother Robert J. Simione, the managing principal, and a dedicated team of principals, management, and staff, William Simione has helped Simione Consulting LLC become one of the leading home health and hospice consulting companies in the United States with over a thousand clients. Robert Simione says that a company is only as good as the people who work for it, and Simione Consultants LLC has the best home health and hospice consultants in the country. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/09%3A_Accounting_and_Cash_Flow/9.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Understand why a basic knowledge of accounting is important for a small business.
2. Understand the importance of selecting an accountant to enhance the overall operation of a business.
3. Define the two major approaches to accounting systems: cash versus accruals.
The older I get, the more interesting I find lawyers and accountants.Independent (London), April 21, 2010, quoted in “Accounting Quotes,” Qfinance, accessed February 14, 2012, www.qfinance.com/finance-and-business-quotes/accounting.
Alex James
Imagine that you invite a friend from China, who is visiting the United States for the first time, to a baseball game. Your friend has never been to a baseball game before and knows nothing of the game’s rules. He might notice on the scoreboard listings for runs, hits, and errors. Your friend might also see notations on the number of strikes and balls. He does not know exactly what any of those terms mean, but he notices that some people in the stands applaud when the number of runs increases. Your friend might be amused by seeing individuals periodically running from one base to another; however, without knowing the basic rules of baseball, he cannot possibly understand what is actually occurring. He certainly could not comment on how well the game is going or provide suggestions about what one of the teams should do next. Most Americans would be in the same position if they were watching a cricket match. In both cases, you and your friend are in the same position of someone who wishes to run a business without having a fundamental understanding of accounting systems.
Warren Buffett has said that accounting is, to put it simply, the language of business. Without a fundamental understanding of this language of accounting and its set of rules, you are in the same position as your Chinese friend—you really do not know what is going on with a business. If someone is considering starting a business, he or she should possess some degree of fluency in this language. One does not expect this businessperson to be as knowledgeable as a certified public accountant (CPA) or an expert in tax issues. However, such businesspeople should have a clear expectation that they will be able to look at the key elements of an accounting system and interpret how well their businesses are doing. They should be able to track some of the key tasks and elements associated with a comprehensive accounting system. As we will see in Section 9.4 "The Three Threads", computerized accounting programs for small businesses have greatly simplified this responsibility.
Accounting is defined by the American Institute of Certified Public Accountants (AICPA) as “the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.”Ramnik Singh Wahla, Accounting Terminology Bulletin No. 1: Review and Résumé, 1953, accessed February 14, 2012, c0403731.cdn.cloudfiles.rackspacecloud.com/collection/papers/1950/1953_0101_AccountingReview.pdf. Put more simply, it is essentially an information system. Accounting provides critical information to potential investors and businesses managers. Accounting may, in fact, be one of the oldest information systems known to humans. Some have argued that accounting systems were the impetus for the development of writing systems in Mesopotamia.Denise Schmandt-Besseart, “An Ancient Token System: The Precursor to Numerals and Writing,” Archaeology 39 (1986): 32–39; Richard Mattessich, “Prehistoric Accounting and the Problem of Representation: On Recent Archeological Evidence of Middle East from 8000 B.C. to 3000 B.C.,” Accounting Historians Journal 14, no. 2 (1987): 71–91. Archaeologists have discovered clay tokens, dating back 10,000 years ago, which functioned as part of the inventory system measuring agricultural goods, such as grains and domesticated animals. By 3500 BC, these tokens were being stored in containers—known as bullae. Notations on the surface of these containers indicated the type and quantity of the tokens held within; for many, this system was the basis of an abstract system of written communication. Salvador Carmona and Mahmoud Ezzamel, “Accounting and Forms of Accountability in Major Civilizations: Mesopotamia and Ancient Egypt” (working paper, Instituto de Empresa Business School, Madrid, Spain, and Cardiff University, Cardiff, UK, 2005), accessed December 2, 2011, latienda.ie.edu/working_papers_economia/WP05-21.pdf.
Other ancient societies recognized the importance of carefully monitoring and recording economic transactions. The Roman Empire needed to finance its operations and employed the familiar concept of an annual budget to coordinate expenditures and taxation. It had treasury managers, known as questors, who were subject to periodic audits. John R. Alexander, History of Accounting (Princeville, HI: Association of Chartered Accountants in the United States, 2002), 4. The most famous monograph on accounting dates to Renaissance Italy. Luca Pacioli, a Franciscan friar and polymath, wrote Summa de Arithmetica, Geometria, Proportioni et Proportionalita in 1494. Essentially this was a math textbook, but it included a section on double-entry bookkeeping. This approach to accounting had been covered by Beredetto Cotrugli a century earlier. John R. Alexander, History of Accounting (Princeville, HI: Association of Chartered Accountants in the United States, 2002), 9. The text was immediately recognized as an important contribution and was one of the first books produced by Gutenberg. On a first reading, Pacioli’s coverage appears to be remarkably “modern.” It described how merchants should identify their assets and liabilities, note transitions as they occur, and identify them as either debits or credits. He pointed out that the total of debits and credits must be equal, thus his model became the basis of the balance sheet. In the intervening five hundred years, business has essentially adapted Pacioli’s approach. Obvious, over the last five centuries, businesses have grown both in size and in complexity, and accounting systems have grown with them. Therefore, it is important for any business regardless of size to be able to “count” on solid accounting information.
The exact nature of accounting support will be greatly determined by the type and size of the small business. The level of accounting support required by the nonemployer business will obviously differ significantly from the level required by a business generating tens of millions of dollars of revenue and employing hundreds of workers. The level of support will also be influenced by the business owner’s familiarity with accounting and the type of accounting information systems that have been determined as appropriate. Regardless of size or type, small businesses should plan on eventually acquiring the talents of an accountant. Preferably, the decision to use an accountant should occur with the creation of the business.
Hiring an accountant or an accounting firm is an important decision for a small business. Employing an accountant does not translate into this individual being a full-time employee of the business. At the start, most small businesses will use the accountant as a consultant or a contract employee. As they grow, some small businesses might benefit from acquiring the services of full-service accounting firm. Although some start-ups, particularly those that might be cash-strapped, use the services of the bookkeeper only, but this is ill-advised. Most small businesses will need the services of a CPA. Another type of accountant a small business might employ is known as an enrolled agent. These are accountants who have passed a tax test from the Internal Revenue Service (IRS).
When looking for an accountant, there are some issues that you should consider. Try to find an accountant who has some working familiarity with a particular type of business or industry. Hopefully, you will be able to find an accountant with whom you have some rapport. This is important because a good accountant is more than simply someone who balances the books. You should consult an accountant before determining what type of accounting system you intend to employ—cash versus accrual (see Section 9.1 "Understanding the Need for Accounting Systems"). Remember that an accountant will play an important role in assisting you in the creation, purchase, and development of an accounting information system for the business. This system is important in providing the appropriate information to the external community (for this audience the term financial accounting is often used)—bankers, angel investors, venture capitalists, and/or the government. The same accounting information system will also be an important component of internal controls (in this case the term managerial accounting is used)—the systems and policies by which you make a firm more efficient. In this role, an accountant can help develop appropriate policies with respect to cash control and inventory control. An accountant can play a critical role in developing business plans, particularly with respect to budgets and financial statements. As highlighted in Section 9.3 "Financial Ratio Analysis", you should consult an accountant before selecting an accounting software package. Quite often, an accountant can be extremely useful in training people to use such a software package.Jean Murray, “Finding Help with Bookkeeping and Accounting Tasks,” About.com, accessed December 2, 2011, biztaxlaw.about.com/od/businessaccountingrecords/a/findacpa.htm.
Video Clip \(1\):
Why Warren Buffett Said Accounting Is the Language of Business
This video introduces the importance of accounting.
Video Clip \(2\):
Why You Need an Accountant
This video explains why a small business needs the services of a professional accountant.
Video Clip \(3\):
What CPAs Wish Every Small Business Knew
This video approaches small business’s need for accounting from the accountant’s perspective.
Alternative Approaches to Accounting Systems
The system of double-entry bookkeeping is, perhaps, the most beautiful one in the wide domain of literature or science. If it were less known, it would be the admiration of the learned world.“Edwin T. Freedley,” Cyber Nation, accessed February 14, 2012, www.cybernation.com/victory/quotations/authors/quotes_freedley_edwint.html.
Edwin T. Freedley
The evolution of accounting has led to two major systems: the cash basis model and the accrual basis model. Before describing the two systems, we must identify a very important term—accounting transactions. When in business, we either receive money from a sale or spend money, such as in buying a piece of equipment. We can define these as transactions. The manner in which we record transactions defines the difference between a cash basis accounting system or an accrual accounting system.
In most cases, either system can be used by a business (there are situations under which a cash-based accounting system cannot be used, the details of which are discussed later), but regardless of the system used, a business must clearly specify which method is being employed.
In the cash-based accounting system, a transaction is recorded when money is either received or spent. As an example, a business has three sales on June 29 of a particular year. The first sale is for \$500, the second is for \$1,000, and the third is for \$300. However, the three customers use different methods of payment. The first customer pays for the product in cash, the second customer writes a personal check, and the third customer pays by credit card. The second customer’s personal check clears on July 5, while the credit card company transfers the \$300 into the business’s account on July 3. Under the cash basis accounting system, the business would list the first sale of \$500 as a June transaction, but it would list the second and third sales (totaling \$1,300) as July transactions. The same logic is used with respect to expenditures. If the same firm purchased a laptop computer in July but did not have to pay for two months, then the transaction would be recorded in September.
Under the accrual accounting system, transactions are recorded when they occur. If the aforementioned business was functioning under the accrual basis accounting system, then all three sales (totaling \$1,800) would be recorded as June transactions, and the purchase of the laptop would be designated as a July transaction.
Generally, though, with some few exceptions, businesses must use the accrual basis accounting method if they have inventory of any component of items that they sell to the public and if the sales are more than \$5 million per year. Other conditions under which the cash basis accounting system may not be used include C corporations, partnerships with at least one C corporation partner, and tax shelters.“Comparison of Cash and Accrual Methods of Accounting,” Wikipedia, accessed December 2, 2011, en.Wikipedia.org/wiki/comparison_of_cash_method _and_accrual method of accounting. The major benefit of cash basis accounting is its simplicity. It greatly reduces the demand on bookkeeping. The cash basis system also provides a much more accurate indication of a company’s current cash position. This approach may be used to affect taxable income, which can be done by deferring billing so that payments are received in the next year.Melissa Bushman, “Cash Basis versus Accrual Accounting,” Yahoo! Voices, accessed December 2, 2011, voices.yahoo.com/cash-basis-versus-accrual-basis -accounting-147864.html?cat=3. However, there are drawbacks to the cash basis approach—the most serious being that it may provide a distorted or an inaccurate indication of profitability. The reality is that cash basis accounting systems are really only appropriate for businesses with sales under \$1 million and that function basically on a cash basis.
Accrual basis accounting is in conformance with IRS and generally accepted accounting principles (GAAP) regulations. Although more complex and generally requiring greater bookkeeping with a more sophisticated approach to accounting, the accrual basis provides a more accurate indication of the profitability of a business. The major drawback of the accrual basis system comes with respect to understanding the business’s cash position. A firm may look profitable under this system, but if customers have not paid for the goods and services, the cash position might be dire.“Cash vs. Accrual Accounting,” Nolo.com, accessed December 2, 2011, www.nolo.com/legal-encyclopedia/cash-vs-accrual-accounting-29513.html. A summary of the pros and cons of the two systems is provided in Figure \(1\).
Video Clip \(4\):
Accrual versus Cash-Basis Accounting Video Presentation
A lecture on the two accounting systems.
Video Clip \(5\):
Accrual Basis versus Cash Basis Accounting Power
A video with voice-over of a PowerPoint presentation.
KEY TAKEAWAYS
• Accounting is one of the oldest activities of human civilizations and dates back over five thousand years.
• Small businesses require accounting capabilities, which must be done either in-house or through an external service.
• The selection process for an accounting service should be carefully considered. The evaluation process should consider the following: expertise in a particular type of business or industry, rapport, availability of additional consulting services, and the ability to support computerized accounting systems.
• Accounting systems may be divided into two major types: cash basis and accrual basis.
• Cash basis systems count a transaction when the cash is received. Such systems are used by smaller businesses that have no appreciable inventory.
• Accrual basis systems count transactions when they occur. Although this system may require additional analysis to determine a business’s actual cash position, it provides a more accurate measure of profitability.
EXERCISES
1. Identify five local businesses and talk to their owners. Ask them about how they handle their accounting needs. Do they do it all themselves or do they use an accountant or an accounting service? If they use an accountant or an accounting service, ask them in what way—merely to prepare taxes or do they draw on them for other advice?
2. Identify five local accountants or accounting firms. Ask them about the services that they provide to small businesses. If possible, try to determine the cost of these services.
3. Ask the five local businesses which system they use—cash or accrual—and why they use it. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/09%3A_Accounting_and_Cash_Flow/9.02%3A_Understanding_the_Need_for_Accounting_Systems.txt |
Learning Objectives
1. Understand what is measured on a balance sheet.
2. Understand the term depreciation.
3. Understand what goes on an income statement.
4. Understand what is measured in a cash-flow statement.
5. Appreciate the importance of forecasting when developing a cash-flow projection statement.
It sounds extraordinary, but it’s a fact that balance sheets can make fascinating reading.“Accounting Quotes,” Qfinance, accessed February 14, 2012, www.qfinance.com/finance-and-business-quotes/accounting.
Mary, Lady Archer of Weston
As discussed in "The Business Plan", all business plans should contain sets of financial statements. However, even after the initial business plan is created, these financial statements provide critical information that will be required for the successful operation of the business. They not only are necessary for tax purposes but also provide critical insights for managing the firm and addressing issues such as the following:
• Are we profitable?
• Are we operating efficiently?
• Are we too heavily in debt or could we acquire more debt?
• Do we have enough cash to continue operations?
• What is this business worth?
There are three key financial statements: the balance sheet, the income statement, and the cash-flow statement. Every business owner or manager needs to be able to correctly interpret these statements if he or she expects to continue successful operations. It should be pointed out that all three financial statements follow general formats. The degree of detail or in some cases terminology may differ slightly from one business to another; as an example, some firms may wish to have an extensive list of operational expenses on their income statements, while others would group them under broad categories. Likewise, privately held businesses would not use the term shareholders’ equity but rather use owner’s equity in their balance sheet, and they would not list dividends. This aim of this chapter is to provide the reader with a broad overview of accounting concepts as they apply to managing small and mid-sized businesses.
The Balance Sheet Statement
One should think of the balance sheet statement as a photograph, taken at a particular point in time, which images the financial position of a firm. The balance sheet is dominated by what is known as the accounting equation. Put simply, the accounting equation separates what is owned from who owns it. Formally, the accounting equation states the following:
assets = liabilities + owner’s equity.
Assets are “economic resources that are expected to produce a benefit in the future.”Walter Harrison, Charles Lungren, and Bill Thomas, Financial Accounting, 8th ed. (Boston, MA: Prentice Hall, 2010), 63. Liabilities are the amount of money owed to outside claims (i.e., money owed to people outside the business). Owner’s equity—also known as stockholders’ equity—represents the claims on the business by those who own the business. As specified in the accounting equation, the dollar value of assets must equal the dollar value of the business’s liabilities plus the owner’s equity. Before proceeding with any numerical example, let us define some important terms.
Current assets are assets that will be held for less than one year. They include cash, marketable securities, accounts receivables, notes receivable, prepaid expenses, and inventory. These are listed in a specific order. The order is based on the degree of liquidity of each asset. Liquidity measures the ease in which an asset can be converted into cash. Naturally, cash is the most liquid of all assets. All firms should have cash readily available. The exact amount of the desirable amount of cash to be held at hand will be determined by the sales level of the anticipated cash receipts and the cash needs of the business.
Marketable securities are stocks and bonds that a business may hold in the hope that they would provide a greater return to the business rather than just letting cash “sit” in a bank account. Most of these securities can be easily turned into cash—should the need arise.
Accounts receivables represent the amount of money due to a business from prior credit sales. Not all firms operate on a strictly cash sales basis. Many firms will offer customers the opportunity to purchase on a credit basis. As an example, a furniture store sells a bedroom set worth \$6,000 to a newlywed couple. The couple puts down \$2,500 to fix the sale and then signs a contract to pay the remaining \$3,500 within the next year. That \$3,500 would be listed as accounts receivable for the furniture firm.
Prepaid expense is an accrual accounting term that represents a payment that is made in advance of their actual occurrence. Insurance would be an example of a prepaid expense because a company is paying premiums to cover damages that might occur in the near future. If a year’s worth of rent were paid at one time, it too would be viewed as a prepaid expense.
Inventory is the tangible goods held by a business for the production of goods and services. Inventory can fall into three categories: raw materials, work-in-process (WIP), and finished goods. Raw materials inventory represents items or commodities purchased by a firm to create products and services. WIP inventory represents “partially completed goods, part or subassemblies that are no longer part of the raw materials inventory and not yet finished goods.”“Work in Process,” BusinessDictionary.com, accessed December 2, 2011, www.businessdictionary.com/definition/work-in-process.html. The valuation of WIP should include the cost of direct material, direct labor, and overhead put into the WIP inventory. Finished inventory represents products that are ready for sale. Generally accepted accounting principles (GAAP) require that a business value its inventory on either the cost price or the market price—whichever is lowest. This inherent conservative approach to valuation is due to the desire to prevent the overestimation of inventory during inflationary periods.
Total current assets are the summation of the aforementioned items and are defined as follows:
total current assets = cash + marketable securities + accounts receivable + prepaid expenses + inventory.
The next set of items in the asset section of the balance sheet is long-term assets. Long-term assets are those assets that will not be turned into cash within the next year. Long-term assets may include a category known as investments. These are items that management holds for investment purposes, and they do not intend to “cash in” within the upcoming year. They might consist of other companies’ stock, notes, or bonds. In some cases, they may represent specialized forms—money put away for pension funds. The next major category of long-term assets is fixed assets. Fixed assets include plant, equipment, and land. Generally, these are valued at their original cost. The value of these assets will decline over time. As an example, you purchase a new car for \$25,000. If you were to sell the same car one, two, or five years later, its value would be less than the original purchase price. This recognition is known as depreciation, which is a noncash expense that specifically recognizes that assets decline in value over time. Accumulated depreciation is a running total of all depreciation on assets. Depreciation is also found on the income statement. Its presence in that financial statement enables a business to reduce its taxable income. There are many methods by which you can compute the depreciation value on fixed assets. These methods can be split into two broad categories: straight-line depreciation and accelerated depreciation. Straight-line depreciation is fairly easy to illustrate. In the example of the car, assume you purchased this car for company use. You intend to use it for five years, and at the end of the five years, you plan on scrapping the car and expect that its salvage value will be zero. This is illustrated in Table \(1\).
Table \(1\): Depreciation Calculations
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Depreciation \$0 \$5,000 \$5,000 \$5,000 \$5,000 \$5,000
Accumulated depreciation \$0 \$5,000 \$10,000 \$15,000 \$20,000 \$25,000
Net asset value \$25,000 \$20,000 \$15,000 \$10,000 \$5,000 \$0
Because the useful lifetime of the vehicle was five years, the original value of the vehicle was divided by five; therefore, the annual depreciation would equal \$5,000 (\$25,000/5 = \$5,000 per year). The accumulated depreciation simply sums up the prior years’ depreciation for that particular asset.
Accelerated depreciation methods attempt to recapture a major portion of the depreciation earlier in the life of an asset. Accelerated depreciation yields tax-saving benefits earlier in the life of any particular fixed asset. The appropriate method of depreciating an asset for tax purposes is dictated by the Internal Revenue Service (IRS). One should look at the IRS publication 946—How to Depreciate Property—to get a better understanding of the concept of depreciation and how to properly compute it.
The last category of long-term assets is intangible assets—assets that provide economic value to a business but do not have a tangible, physical presence. Intangible assets include items such as patents, franchises, copyrights, and goodwill. Thus the value of long-term assets can be calculated as follows:
long-term assets = investments + fixed assets − accumulated depreciation + intangible assets.
The last element on the asset side of the balance sheet is the total assets. This is the summation of current assets and long-term assets.
On the other side of the balance sheet, we have liabilities plus owner’s equity. The elements of liabilities consist of current liabilities and long-term liabilities. These represent what a business owes to others. Current liabilities are debts and obligations that are to be paid within a year. These include notes payable, accounts payable, other items payable (e.g., taxes, wages, and rents), dividends payable, and the current portion of long-term debt. In equation form,
current liabilities = notes payable + accounts payable + other items payable + dividends payable + the current portion of long-term debt.
Notes payable represents money that is owed and which must be repaid within a year. It is fairly inclusive because it may include lines of credit from banks that have been used, short-term bank loans, mortgage obligations, or payments on specific assets that are due within a year.
Accounts payable are short-term obligations that a business owes to suppliers, vendors, and other creditors. It may consist of all the supplies and materials that were purchased on credit.
Other items payable can include items such as the payroll and tax withholdings owed to employees or the government but which have not as of yet been paid.
Dividends payable is a term that is appropriate for businesses structured as corporations. This category represents the amount that a business plans to pay its shareholders.
The current portion of long-term debt represents how much of the long-term debt must be repaid within the upcoming fiscal year. This would include the portion of the principal that is due in this fiscal year.
The other portion of liabilities is represented by long-term liabilities. These are debts payable over a period greater than one year and include long-term debt, pension fund liability, and long-term lease obligations. In equation form,
long-term liabilities = long-term debt + pension fund liabilities + long-term lease obligations.
Total liabilities is the sum of current liabilities and long-term liabilities.
The other major component of the right-side of the balance sheet is owner’s (or stockholders’) equity. Owner’s equity represents the value of the shareholders’ ownership in a business. It is sometimes referred to as net worth. It may be composed of items such as paid in capital and retained earnings. Paid in capital is the amount of money provided by investors through the issuance of common or preferred stock.“Paid in Capital,” Investopedia, accessed December 2, 2011, www.investopedia.com/terms/p/paidincapital.asp. Retained earnings is the cumulative net income that has been reinvested in a business and which has not been paid out to shareholders as dividends.“Retained Earnings,” The Free Dictionary, accessed December 2, 2011, financial-dictionary.thefreedictionary.com/Retained+Earnings.
The entire balance sheet and its calculations are summarized in Figure \(1\).
In Table \(2\), we provide six years’ worth of balance sheet statements for a hypothetical small business—Acme Enterprises. It is obviously important to have such information, but what exactly might this tell us in terms of the overall success and operation of the business? We will return to these statements in Section 9.3 "Financial Ratio Analysis" to show how those questions can be addressed with ratio analysis.
Table \(2\) Acme Enterprises’ Balance Sheet, 2005–2010 (\$ Thousands)
December 31
Assets 2005 2006 2007 2008 2009 2010
Cash and marketable securities \$30.0 \$32.3 \$34.7 \$37.3 \$40.1 \$43.1
Accounts receivable \$100.0 \$107.5 \$115.6 \$124.2 \$133.5 \$143.6
Inventories \$70.0 \$75.3 \$80.9 \$87.0 \$93.5 \$100.5
Other current assets \$90.0 \$96.8 \$104.0 \$111.8 \$120.2 \$129.2
Total current assets \$290.0 \$311.8 \$335.1 \$360.3 \$387.3 \$416.3
Property, plant, and equipment—gross \$950.0 \$1,154.5 \$1,387.2 \$1,654.6 \$1,958.1 \$2,306.2
Accumulated depreciation \$600.0 \$695.0 \$810.5 \$949.2 \$1,114.6 \$1,310.4
Property, plant, and equipment—net \$350.0 \$459.5 \$576.7 \$705.4 \$843.5 \$995.7
Other noncurrent assets \$160.0 \$176.0 \$193.6 \$213.0 \$234.3 \$257.7
Total assets \$800.0 \$947.3 \$1,105.5 \$1,278.6 \$1,465.1 \$1,669.7
Liabilities
Accounts payable \$91.0 \$97.8 \$105.2 \$113.0 \$121.5 \$130.6
Short-term debt \$150.0 \$177.5 \$216.3 \$264.2 \$328.1 \$406.0
Other current liabilities \$110.0 \$118.3 \$127.1 \$136.7 \$146.9 \$157.9
Total current liabilities \$351.0 \$393.6 \$448.6 \$513.9 \$596.5 \$694.6
Long-term debt \$211.0 \$211.0 \$211.0 \$211.0 \$211.0 \$211.0
Deferred income taxes \$50.0 \$53.8 \$57.8 \$62.1 \$66.8 \$71.8
Other noncurrent liabilities \$76.0 \$81.7 \$87.8 \$94.4 \$101.5 \$109.1
Total liabilities \$688.0 \$740.0 \$805.2 \$881.4 \$975.8 \$1,086.5
Paid in capital \$— \$— \$— \$— \$— \$—
Retained earnings \$112.0 \$207.3 \$300.3 \$397.2 \$489.3 \$583.3
Total owner’s equity \$112.0 \$207.3 \$300.3 \$397.2 \$489.3 \$583.3
Total liabilities + owner’s equity \$800.0 \$947.3 \$1,105.5 \$1,278.6 \$1,465.1 \$1,669.7
Video Clip \(1\):
Beginner’s Guide to Financial Statements: Balance Sheets
An introduction to the balance sheet.
Video Clip \(1\):
What Is the Balance Sheet?
A voice-over PowerPoint presentation describing the balance sheet. Be aware that this is seven minutes long.
Video Clip \(1\):
Balance Sheet: How to Explain How a Balance Sheet Works
Another description of the balance sheet.
The Income Statement
Whereas the balance sheet looks at a firm at a particular point (date) in time, the income statement examines the overall profitability of a firm over a particular length or period of time. Normally, there are several time periods that may be used: fiscal year, fiscal quarter, or monthly. The income statement is also known as a profit and loss statement. It identifies all sources of revenues generated by a business and all the expenses incurred. The income statement provides the best insight into whether a business is profitable.
The income statement begins by identifying the sales or income for the designated period of time. Sales would be all the revenues derived from all the products and services sold during that time. The term income is sometimes used and represents all revenues and additional incomes produced by a business during the designated period. The next item in the income statement is the cost of goods sold (COGS), which is composed of all costs associated with the direct production of goods and services that were sold during the time period. It would include the costs of the raw materials used to produce the goods and those costs associated with production, such as direct labor. With these two values, the first measure of profit—gross profit—can be calculated:
gross profit = income − COGS.
The next element in the income statement is operating expenses—expenses that are incurred during the normal operation of a business. Operating expenses can be broken down into four broad categories: selling expenses, general and administrative expenses, depreciation, and other overhead expenses. Selling expenses would include all salaries and commissions paid to the business’s sales staff. It would also include the cost of promotions, advertising expenses, and other sales expenditures. Promotion costs might consist of costs associated with samples or giveaways. Advertising expenses would include all expenditures for print, radio, television, or Internet ads. Other sales expenditures would include money spent on meals, travel, meetings, or presentations by the sales staff. General and administrative expenses are those associated with the operation of a business beyond COGS and direct-selling expenses. Expenditures in this category would include salaries of office personnel, rent, and utilities. Depreciation was covered in the previous subsection. The balance sheet has a component designated accumulated depreciation. This is the summation of several years’ worth of depreciation on assets. In the income statement, depreciation is the value for a particular time period. If you look back in Table 9.1 "Depreciation Calculations", the annual depreciation on the vehicle was \$5,000. If a business was developing an income statement for one particular year, then the depreciation would be listed as \$5,000. It is a noncash expenditure expense. The last component of operating expenses would be other overhead costs—a fairly generic category that may include items such as office supplies, insurance, or a variety of services a business might use. Having identified all the components of operating expenses, one is now in a position to compute a second measure of profitability—operating profit, which is sometimes referred to as earnings before interest and taxes (EBIT):
operating profit (EBIT) = gross profit − operating expenses.
The next section of the income statement is designated other revenues and expenses. This segment would include other nonoperational revenues (such as interest on cash or investments) and interest payments on loans and other debt instruments. When the other revenues and expenses are subtracted from the operating profit, one is left with earnings before taxes (EBT):
EBT = operating profit − other revenues and expenses.
Taxes are then computed on the EBT and then subtracted. This includes all federal, state, and local tax payments that a business is obligated to pay. This brings us to our last measure of profitability—net profit:
net profit = EBT − taxes.
If a business does not pay out dividends, the net profit becomes an addition to retained earnings. The format of the income statement is summarized in \(3\):.The income statement is the item that most individuals look at to determine the success of business operations. In Table \(3\). Table 9.3, the income statements for Acme Enterprises are given for the period 2005 to 2010.
Table \(3\): Acme Enterprises’ Income Statement, 2005–10 (\$ Thousands)
2005 2006 2007 2008 2009 2010
Sales \$1,000.0 \$1,075.0 \$1,155.6 \$1,242.3 \$1,335.5 \$1,435.6
COGS \$500.0 \$537.5 \$566.3 \$608.7 \$641.0 \$689.1
Gross operating profit \$500.0 \$537.5 \$589.4 \$633.6 \$694.4 \$746.5
Selling and general administrative expenses \$250.0 \$268.8 \$288.9 \$310.6 \$333.9 \$358.9
Depreciation \$95.0 \$115.5 \$138.7 \$165.5 \$195.8 \$230.6
Other net (income)/expenses \$0.0 \$0.0 \$0.0 \$0.0 \$0.0 \$0.0
EBIT \$155.0 \$153.3 \$161.7 \$157.5 \$164.8 \$157.0
Interest income \$2.1 \$2.3 \$2.4 \$2.6 \$2.8 \$3.0
Interest expense \$10.5 \$12.4 \$15.1 \$18.5 \$23.0 \$28.4
Pretax income \$146.6 \$143.1 \$149.0 \$141.7 \$144.6 \$131.6
Income taxes \$51.31 \$50.10 \$52.16 \$49.58 \$50.61 \$46.06
Net income \$95.29 \$93.04 \$96.87 \$92.08 \$93.99 \$85.54
Dividends \$— \$— \$— \$— \$— \$—
Addition to retained earnings \$95.29 \$93.04 \$96.87 \$92.08 \$93.99 \$85.54
Video Clip \(1\):
What Is the Income Statement?
A basic introduction to income statements.
Video Clip \(1\):
Income Statement
https://youtu.be/Bpcn7QYOTx0
A further description of an income statement.
The Cash-Flow Statement
Customer satisfaction, employee satisfaction and cash flow the three most important indicators for business.Jack Welch, “A Healthy Company?,” Business Week, May 3, 2006.
Jack Welch
The third component of financial statements is the cash-flow statement. There are two types of cash-flow statements—one examines cash flows for a given period (historic), and the other is a projection of future cash flows. The historic cash-flow statement is similar to the income statement in that it looks at cash inflows and cash outflows for a business during a specified period of time. Like the income statement, these periods of time can be the fiscal year, the fiscal quarter, or a month. The cash-flow projections statement attempts to identify cash flows into a firm and cash flows from a firm for some future period. This projection is extremely important because it may identify future subperiods in which a firm is producing a negative cash flow—where cash outflows exceed cash inflows.
From the standpoint of a small business owner, cash-flow statements provide insight into where cash flows are coming and going. The cash-flow projections statement may be the most important component of all the financial statements. Its importance stems from the fact that the flow of cash into a firm may not be synchronized with its cash outflows. Should there be a significant mismatch with cash outflows being significantly higher than cash inflows, a business may be in great difficulty with respect to meeting its current obligations, such as payroll, paying suppliers, and meeting short-term creditors. As we will see, cash-flow projection statements require several forecasts. These are discussed later in this section.
At some point, many businesses will experience negative cash flow. In fact, a negative cash flow is quite common in start-up operations and high-growth businesses where there is a pressing need for capital expenditures, research and development expenditures, and other significant cash outflows. One can also see the recurring presence of negative cash flows in businesses with seasonal sales. Negative cash flows can be covered by short-term borrowing. However, this type of borrowing brings up two important issues. First, any type of borrowing raises the overall debt level of a business, which might have an impact on the interest rate on the debt. Second, when a negative cash flow exists either because of an unforeseen exigency or because a business owner has failed to properly conduct a cash-flow projection analysis, a lender might look at a business in a jaundiced manner, which could have long-term consequences for a business.
A careful examination of the cash-flow statement could illustrate a point that has been mentioned several times in this book: there can be a significant difference between positive cash flow and profit. In looking at the income statement, one could find a positive net income (profit) and then examine the cash-flow statement and discover that a business has a significant negative cash flow. The cash-flow statement specifically maps out where cash is flowing into a firm and where it flows out. A properly developed cash-flow statement will show if a business will be generating enough cash to continue operations, whether it has sufficient cash for new investments, and whether it can pay its obligations. As previously stated, many of the uninitiated will look singularly at profits, while those who have greater expertise in business will always believe that cash is king.
As a way of visualization, the cash-flow statement bears some similarity to the bank statement you may receive at the end of the month. A bank statement shows the beginning cash balance, deposits (cash inflows), and checks you have written (cash outflows) for that month. Hopefully, you have a positive cash flow—cash inflows are greater than cash outflows—and you have not bounced any checks. Unlike the bank statement, the cash-flow statement is broken into three major categories: operations, financing, and investing. Cash flow from operations examines the cash inflows from all revenues, plus interest and dividend payments from investments held by a business. It then identifies the cash outflows for paying suppliers, employees, taxes, and other expenses. Cash flow from investing examines the impact of selling or acquiring current and fixed assets. Cash flow from financing examines the impact on the cash position from the changes in the number of shares and changes in the short and long-term debt position of a firm.
Cash inflows from operating activities consist of the following:
• Cash derived from the sale of goods or services
• Cash derived from accounts receivable
• Any cash derived from interest or dividends
• Any other cash derived that is not identified with financing or investments
The cash outflows from operating activities consist of the following:
• Cash outlays for goods purchased in the creation of goods and services
• Cash outlays for payment to suppliers
• Cash outlays to employees
• Cash paid for taxes or interest paid to creditors
Financing focuses on the cash flows associated with debt or equity. Some of the cash inflows associated with financing activities consist of the following:
• Cash from the sale of a company’s stock
• Cash received from borrowing (debt)
Cash outflows associated with financing consist of the following:
• Cash outlays to repay principal on long- and short-term debt
• Cash outlays to repurchase preferred stocks
• Cash outlays to pay for dividends on either common or preferred stock
The third category is investing. The sources of cash flow from investing activities consist of the following:
• Cash received from the sale of assets
• Cash received from the sale of equity investments
• Cash received from collections on a debt instrument
Cash outflows associated with investing activities consist of the following:
• Cash outlays to acquire a debt instrument of another business
• Cash payments to buy equity interest in other businesses
• Cash outlays to purchase a productive asset
A schematic of the cash-flow statement’s three areas of analysis is presented in Figure \(4\).
Cash-flow projection statements are about the state of future cash flows, which means they require forecasts. This translates into multiple forecasts—sales forecasts, forecasts of expenses, forecasts for necessary investments, and forecasts for a business’s financing requirements. The importance of forecasts for planning is discussed in Chapter 5 "The Business Plan".
The most common approach for cash-flow forecasting in small businesses centers on projections of cash receipts and disbursements. These projections are often based on recent past data. We will demonstrate—shortly—this approach through an extensive example. This approach is generally limited to short and midterm forecasts (i.e., three to twelve months). There are other approaches to cash-flow forecasting; however, given the relative complexity of these approaches, they are often used only by larger and more sophisticated businesses. These other approaches include the adjusted net income method, the pro forma balance sheet method, and the accrual reversal method.Richard Bort, “Medium-Term Funds Flow Forecasting,” in Corporate Cash Management Handbook, ed. Richard Bort (New York: Warren Gorham & Lamont, 1990), 125.
The concept of cash-flow projection forecasting can be illustrated by using an example. Alex McLellan runs Soft Serve Services—a business that repairs and services soft-serve ice cream machines. His clients include ice cream parlors, resorts, and outlets at malls. Alex is a former engineer and somewhat methodical in developing his calculations for future budgets. He will be operating on the assumption that his business will be limited to his current locale. Alex has followed the same pattern for forecasting cash flows for years. First, he gathers together from his records his monthly and annual sales for the last five years, which are provided in Table \(4\).
Table \(4\): Sales Data for Soft Serve Services
2006 2007 2008 2009 2010
January \$20,135 \$20,562 \$21,131 \$22,657 \$23,602
February \$19,545 \$19,739 \$19,852 \$22,154 \$22,307
March \$24,451 \$24,360 \$24,594 \$26,361 \$27,590
April \$22,789 \$23,374 \$24,000 \$26,220 \$32,968
May \$25,986 \$28,531 \$27,099 \$30,057 \$34,834
June \$28,357 \$30,468 \$32,893 \$34,168 \$37,078
July \$32,650 \$35,307 \$36,830 \$40,321 \$46,899
August \$34,488 \$37,480 \$40,202 \$44,890 \$52,042
September \$26,356 \$27,909 \$29,317 \$32,917 \$33,309
October \$24,211 \$22,795 \$23,719 \$24,339 \$25,691
November \$21,722 \$22,272 \$22,147 \$23,080 \$23,466
December \$22,017 \$22,454 \$28,321 \$30,468 \$33,583
Annual sales \$302,706 \$315,252 \$330,105 \$357,631 \$393,368
Using these data, Alex was able to calculate the growth rate in sales for the last four of the five years. As an example:
growth rate 2007 = (sales 2007 − sales 2006) / (sales 2006) = (\$315,252 − \$302,706) / (\$302,706) = (\$12,546) / (\$302,706) = 4.14 percent.
Although the average of the four annual growth rates was 6.8 percent (the annual growth rates were 4.14 percent in 2007, 4.71 percent in 2008, 8.34 percent in 2009, and 9.99 percent in 2010, thus having an average of 6.8 percent), Alex believes that the last two years were unusually good, and the growth rate for 2011 would be slightly lower at a rate of 6.5 percent. This rate of growth would mean that his estimate for sales in 2011 would be \$418,937, which comes from the following:
annual sales 2011 = annual sales 2010 × (1 + growth rate 2011) = \$393,368 × (1.065).
He knows from experience that his sales are quite seasonal, as illustrated in Figure 9.5 "Seasonality in Sales". Alex believes that there is a high degree of consistency in this seasonality of sales across the years. So he computes (using a spreadsheet program) what percentage of annual sales occurs in each month. This calculation for January 2006 would be given as follows:
percentage of annual sales for January 2006 = (January 2006 sales) / (annual sales 2006) = (\$20,135) / (\$302,706) = 6.65 percent.
His analysis for each month in each of the five years is provided in Table \(5\), as are the averages for each month.
Figure 9.5 Seasonality in Sales
Table \(5\): Monthly Sales as a Percentage of Annual Sales
2006 (%) 2007 (%) 2008 (%) 2009 (%) 2010 (%) Average (%)
January 6.65 6.52 6.40 6.34 6.00 6.38
February 6.46 6.26 6.01 6.19 5.67 6.12
March 8.08 7.73 7.45 7.37 7.01 7.53
April 7.53 7.41 7.27 7.33 8.38 7.59
May 8.58 9.05 8.21 8.40 8.86 8.62
June 9.37 9.66 9.96 9.55 9.43 9.60
July 10.79 11.20 11.16 11.27 11.92 11.27
August 11.39 11.89 12.18 12.55 13.23 12.25
September 8.71 8.85 8.88 9.20 8.47 8.82
October 8.00 7.23 7.19 6.81 6.53 7.15
November 7.18 7.06 6.71 6.45 5.97 6.67
December 7.27 7.12 8.58 8.52 8.54 8.01
Alex was the able to estimate sales for January 2011 in the following manner:Because Alex was using spreadsheet software, the monthly averages were computed out to more than two decimal places. This explains why the calculations are not exact. As in the case of January, the actual monthly percentage was closer to 6.3821 percent, which provides the monthly forecast of \$26,737.
January 2011 sales = annual sales 2011 × January percentage = (\$418,937) × (6.38 percent) = \$26,737.
Using the same approach, he was able to compute forecasted sales for February and March. To maintain sales, Alex offers his customers a rather generous credit policy. He asks them to pay 50 percent of the bill in the month in which the work is done; another 35 percent of the bill in the following month, and the remaining 15 percent of the bill two months after the work has been completed. For Alex to project cash inflows for January, he would need to consider sales from the two prior months—December and November. His projected cash inflows for January would be determined as follows:These calculations have been rounded to the nearest dollar. This is also true for the values in Table 9.6 "Cash-Flow Projections for the First Quarter of 2011".
November 2010 sales = \$23,466December 2010 sales = \$33,583January 2011 sales = \$26,737cash inflow from November 2010 sales = (\$23,466) × 15 percent = \$3,520cash inflow from December 2010 sales = (\$33,583) × 35 percent = \$11,754cash inflow from January 2011 sales = (\$26,737) × 50 percent = \$13,368total cash inflows from operations = sum of cash inflows for three months = \$28,642.
Alex then estimates his cash outflows from operations. From past experience, he knows that the purchases of parts and materials run approximately 50 percent of the dollar value of his sales. However, because of delays in acquiring parts and materials, he must order them in advance. He has to anticipate what sales would be the following month and has to place a purchase order predicated on that value. Further, 60 percent of that dollar value is in that month and the remaining 40 percent is in the following month. This can be illustrated for January 2011. To determine the purchases of parts and materials in January, he begins with his forecast for sales in February 2011.
February 2011 sales = \$25,637parts and materials purchases in January 2011 = 50 percent of February 2011 sales = 50 percent × \$25,637 = \$12,819.
He is obligated to pay 60 percent of this amount in January 2011 and the remaining 40 percent in February 2011. This also means that his cash outlay in January 2011 must include a payment for 40 percent of December’s purchases.
parts and materials purchases in December 2011 = 50 percent of January 2011 sales = 50 percent × \$26,737 = \$13,369parts and materials cash outlay in January 2011 = 60 percent of purchases January 2011 + 40 percent of purchases December 2010parts and materials cash outlay in January 2011 = (60 percent × \$12,819) + (40 percent × \$13,369) = \$13,038.
In addition to purchasing parts and materials, Alex has to consider his operational expenses, which include wages, payroll taxes, office supplies, repairs, advertising, and expenses related to automobiles, phone bills, rent, utilities, expenses associated with accounting services, and taxes. These are itemized in Table 9.6 "Cash-Flow Projections for the First Quarter of 2011". Adding in these expenses brings his total cash outflow \$19,864.
For January 2001, he has no cash inflows or cash outflows with respect to either investment activities or financing activities. This means that his total cash flow for January 2011 represents the difference between cash inflows and outflows for operational activities. His cash flow for January 2011 was a positive value of \$8,778. Because he ended December 2010 with a cash position of \$3,177, the addition of this \$8,778 brings his cash position at the end of January 2011 to \$11,955. His bank, with which he has an open line of credit, requires that he maintain a minimum of \$2,500 in his cash account each month. Should Alex drop below this amount, his bank will lend him—automatically—up to \$5,000.
It is useful to examine the rest of his projections (see Table \(6\). February 2011 follows much as January 2011. Alex was able to produce a positive net cash flow in February of \$5,669, which brought his ending cash position at the end of February 2011 to \$17,624.
Unlike the other months of 2011, Alex planned on producing cash flows with respect to investment activities in March 2011. He planned on selling an asset to a friend and anticipated a positive cash flow of \$500 from this sale. He also planned on purchasing a used van in March 2011 and estimated that the price would be \$21,000. His intention was to pay for the van from his cash account and not take out a car loan. His cash outflows for March 2011 were a negative \$16,075. With the bank’s requirement of maintaining a \$2,500 minimum balance, this meant that Alex activated the automatic borrowing option from his bank to the amount of \$950. It required some effort on Alex’s part to build the cash-flow spreadsheet, but it enabled him to examine various options, such as the impact of deferring the purchase of the van until May 2011. Although any cash-flow spreadsheet is dependent on the accuracy of forecasts, it is a mechanism by which a small business owner can examine various scenarios and determine the possible impact of those scenarios on his or her overall cash flow.
Table \(6\): Cash-Flow Projections for the First Quarter of 2011
November December January February March
Cash Flow from Operating Activities
Cash on hand at end of month \$3,177 \$11,955 \$17,624 \$1,550
Cash Inflow from Operations
Sales \$23,466 \$33,583 \$26,737 \$25,637 \$31,537
Cash flow from month of sales \$13,369 \$12,818 \$15,769
Cash flow from prior month’s sales \$11,754 \$9,358 \$8,973
Cash flow from two month’s prior sales \$3,520 \$5,037 \$4,011
Total cash inflow from operations \$28,642 \$27,214 \$28,752
Parts Purchases
Cash outflow for this month’s purchases \$7,691 \$9,461 \$9,533
Cash outflow for prior month’s purchases \$5,347 \$5,127 \$6,307
Gross wages (excludes withdrawals) \$4,000 \$4,000 \$4,000
Payroll expenses (taxes, etc.) \$150 \$150 \$150
Outside services \$— \$— \$—
Supplies (office and operating) \$50 \$50 \$50
Repairs and maintenance \$— \$— \$450
Advertising \$100 \$200 \$250
Auto, delivery, and travel \$120 \$150 \$180
Accounting and legal \$200 \$200 \$200
Rent \$1,650 \$1,650 \$1,650
Telephone \$65 \$65 \$65
Utilities \$325 \$325 \$325
Insurance \$166 \$166 \$166
Taxes (real estate, etc.) \$— \$— \$1,000
Interest \$—
Other expenses \$— \$— \$—
Total cash outflows from operations \$19,864 \$21,544 \$24,327
Sale of asset \$— \$— \$500
Sale of debt or equity \$— \$— \$—
Collection of principal on a loan \$— \$— \$—
Total cash flow from investing activities \$— \$— \$500
Purchase of plant, property, and equipment \$— \$— \$21,000
Purchase of debt \$— \$— \$—
Total cash outflows from investing \$— \$— \$21,000
Sales of securities or equity \$— \$— \$—
Issue of debt instruments \$— \$— \$—
Total cash inflow from financing activities \$— \$— \$—
Payment of dividends \$— \$— \$—
Redemption of long-term debt \$— \$— \$—
Total cash outflows from financing \$— \$— \$—
Net cash flow \$8,778 \$5,669 \$(16,075)
Required cash balance \$2,500 \$2,500 \$2,500 \$2,500 \$2,500
Required borrowing \$— \$— \$(950)
Video Clip \(1\):
Cash-Flow Analysis
A discussion of cash flow.
KEY TAKEAWAYS
• To truly understand how well a business is doing requires an ability to understand the financial statements of the business.
• The balance sheet shows what a business owns and what claims are on the business.
• The income statement shows how profitable a business is and identifies the expenses of the business.
• Cash flow is the lifeblood of a business’s operation.
• Cash-flow projections are vital for any business.
EXERCISES
Edwina Haskell was an accomplished high school student who looked forward to attending Southern New England University (SNEU). SNEU was unique in that it operated on a trimester basis, its policy was to actively foster independent development among the students. Edwina’s mother and father each own their own small businesses. Soon after freshman orientation at SNEU, Edwina recognized a need among the students that could be the basis for developing a small business. Freshman students could not bring their cars on the campus. In effect, they were confined to the dorm; if they wished to travel, they had to take school-provided buses that operated on a fixed schedule. Further, the university’s cafeteria closed at eight in the evening. Students who wanted to have some food or snacks after 8:00 p.m. had to call local restaurants that delivered. The few restaurants in the neighborhood around SNEU that had delivery services often were late in their deliveries, and hot food, such as pizza, was frequently delivered cold.
Edwina felt that there was a niche market on the campus. She believed that students would be interested in ordering sandwiches, snacks, and sodas from a fellow student provided that the food could be delivered in a timely fashion. After talking with several students in her dorm complex, she believed that offering a package of a sandwich, a soda, and a small snack, such as potato chips, for \$5 and a guaranteed delivery of 15 minutes or less would be a winner. Because her dorm complex consisted of four large adjoining buildings that house nearly 1,600 students, she felt that there would be sufficient demand to make the concept profitable. She talked about this concept with her roommates and with her parents. Her roommates were willing to help prepare the sandwiches and deliver them. She planned on paying each of them \$250 per trimester for taking orders, making sandwiches, and delivering them. All three roommates, whom she knew from high school, were willing to be paid at the end of the trimester.
Edwina recognized that for this business plan to work, she would have to have a sufficient inventory of cold cuts, lettuce, tomatoes, soda, chips, and condiments to be able to meet student demands. The small refrigerators in the dorm rooms would not be sufficient. After talking to her parents, they were willing to help her set up her business. They would lend her \$1,000 to buy a larger refrigerator to place in her dorm room. She did not have to repay this loan until she graduated in four years, but her parents wanted her to appreciate the challenges of operating a small business. They set up several conditions. First, although she did not have to pay back the \$1,000 for the refrigerator for four years, she had to pay interest on this “loan.” She had to repay 3 percent of this loan each trimester. Further, they reminded her that although she could pay her friends at the end of the semester, she would need funds to buy the cold cuts, bread, rolls, soda, snacks, condiments, and supplies such as foil to wrap the sandwiches, plus plates and paper bags. Although Edwina was putting \$500 of her own money into her business, her parents felt that she might need an infusion of cash during the first year (i.e., the first three trimesters). They were willing to operate as her bank—lending her money, if needed, during the trimesters. However, she had to pay the loan(s) back by the end of the year. They also agreed that the loan(s) would be at a rate of 2 percent per trimester.
Within the first three weeks of her first trimester at SNEU, Edwina purchased the \$1,000 refrigerator with the money provided by her parents and installed it in her dorm. She also went out and purchased \$180 worth of supplies consisting of paper bags; paper plates; and plastic knives, spoons, and forks. She paid for these supplies out of her original \$500 personal investment. She and her roommates would go out once or twice a week, using the SNEU bus system to buy what they thought would be the required amount of cold cuts, bread, rolls, and condiments. The first few weeks’ worth of supplies were purchased out of the remainder of the \$500. Students paid in cash for the sandwiches. After the first two weeks, Edwina would pay for the food supplies out of the cash from sales.
In the first trimester, Edwina and her roommates sold 640 sandwich packages, generating revenue of \$3,200. During this first trimester, she purchased \$1,710 worth of food supplies. She used \$1,660 to make the 640 sandwich packages. Fortunately, the \$50 of supplies were condiments and therefore would last during the two-week break between the trimesters. Only \$80 worth of the paper products were used for the 640 sandwich packages. Edwina spent \$75 putting up posters and flyers around the campus promoting her new business. She anticipated that the tax rate would be approximately 35 percent of her earnings before taxes. She estimated this number at the end of the first trimester and put that money away so as to be able to pay her tax bill.
During the two weeks off between the first and second trimester, Edwina and her roommates talked about how they could improve business operations. Several students had asked about the possibility of having warm sandwiches. Edwina decided that she would purchase two Panini makers. So at the beginning of the second trimester, she tapped into her parents’ line of credit for two Panini grills, which in total cost \$150. To make sure that the sandwiches would be delivered warm, she and her roommates spent \$100 on insulated wrappings. The \$100 came from cash. The second trimester proved to be even more successful. The business sold 808 sandwiches, generating revenue of \$4,040. During this second trimester, the business purchased \$2,100 worth of food supplies, using \$2,020 of that to actually create the 808 sandwich packages. They estimated that during the second trimester, they used \$101 worth of supplies in creating the sandwich packages.
There was only a one-week break between the second and third trimesters, and the young women were quite busy in developing ideas on how to further expand the business. One of the first decisions was to raise the semester salary of each roommate to \$300 apiece. More and more students had been asking for a greater selection of warm sandwiches. Edwina and her roommates decided to do some cooking in the dorms so as to be able to provide meatball and sausage sandwiches. Edwina once again tapped into her parents’ line of credit to purchase \$275 worth of cooking supplies. One of the problems they noticed was that sometimes students would place calls to order a sandwich package, but the phones were busy. Edwina hired a fellow student to develop a website where students could place an order and select the time that they would like a sandwich package to be delivered. The cost of creating and operating this website for this third trimester was \$300.
This last semester of Edwina’s freshman year proved to be the most successful in terms of sales. They were able to fulfill orders for 1,105 sandwich packages, generating revenue of \$5,525. Edwina determined that the direct cost of food for these sandwich packages came out to be \$2,928.25. The direct cost of paper supplies was \$165.75. At the end of her freshman year, Edwina repaid her parents the \$425 that came from her credit line that was used to purchase the Panini makers and the cooking utensils.
1. Prepare a beginning balance sheet for the first day of Edwina’s business.
2. Prepare income statements for the end of each trimester.
3. Prepare balance sheets for the end of each semester | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/09%3A_Accounting_and_Cash_Flow/9.03%3A_Financial_Accouting_Statements.txt |
Learning Objectives
1. Understand why the numbers found on a balance sheet and an income statement may not be enough to properly evaluate the performance of a business.
2. Understand the concept of financial ratios and the different categories of financial ratios.
3. Acquire the ability to calculate financial ratios and interpret their meaning.
One can say that figures lie. But figures, when used in financial arguments, seem to have the bad habit of expressing a small part of the truth forcibly, and neglecting the other, as do some people we know.“Accounting Quotes,” Qfinance, accessed February 14, 2012, www.qfinance.com/finance-and-business-quotes/accounting.
Fred Schwed
Section 9.1 "Understanding the Need for Accounting Systems" discusses the differences between managerial accounting and financial accounting. Managerial accounting focuses on providing information that is useful for the managers of a firm. Financial accounting provides information to interested external constituencies. Both use information derived from financial statements. These numbers, however, may not provide a singular insight into the overall economic effectiveness of any particular business. These numbers must be placed in some form of context. As an example, suppose you are told that a particular business earned \$2 million worth of profit last year. Obviously, earning a \$2 million profit is better than a \$1 million profit and certainly better than a \$2 million loss. However, you are still left with the question of exactly how good that \$2 million profit is. After all, if you were told that Walmart made only \$2 million profit last year, you would likely be concerned with respect to the management capability and performance of Walmart. Making only \$2 million profit on revenues in excess of \$400 billion worth of sales would not be at all impressive. However, if you were told that a mom-and-pop grocery store made \$2 million profit last year based on \$4 million of sales, you would be amazed at that mom-and-pop store and hold them in considerable esteem for their management capability.
One way of putting financial data into a comparative context is known as financial ratio analysis. From a financial accounting standpoint, ratio analysis enables external constituencies to evaluate the performance of a firm with respect to other firms in that particular industry. This is sometimes referred to as comparative ratio analysis. From a managerial accounting standpoint, ratio analysis can assist a management team to identify areas that might be of concern. The management team can track the performance on these ratios across time to determine whether the indicators are improving or declining. This is referred to as trend ratio analysis. There are literally scores of financial ratios that can be calculated to evaluate a firm’s performance.
Financial ratios can be grouped into five categories: liquidity ratios, financial leverage ratios, profitability ratios, asset management or efficiency ratios, and market value ratios. Because many small businesses are not publicly held and have no publicly traded stock, market ratios play no role in analyzing a small firm’s performance. This section will review some of the most commonly used ratios in each category.
Liquidity ratios provide insight into a firm’s ability to meet its short-term debt obligations. It draws information from a business’s current assets and current liabilities that are found on the balance sheet. The most commonly used liquidity ratio is the current ratio given by the formula
current assets / current liabilities.
The normal rule of thumb is that the current ratio should be greater than one if a firm is to remain solvent. The greater this ratio is above one, the greater its ability to meet short-term obligations. As with all ratios, any value needs to be placed in context. This is often done by looking at standard ratio values for the same industry. These ratios are provided by Dun and Bradstreet; these data are also available on websites, such as Bizstats.com.
Another ratio used to evaluate a business’s ability to meet in short-term debt obligations is the quick ratio—also known as the acid test. It is a more stringent version of the current ratio that recognizes that inventory is the least liquid of all current assets. A firm might find it impossible to immediately transfer the dollar value of inventory into cash to meet short-term obligations. Thus the quick ratio, in effect, values the inventory dollar value at zero. The quick ratio is given by the following formula:
current assets − inventory / current liabilities.
Using the data provided in the balance sheet for Acme Enterprises ("Acme Enterprises’ Balance Sheet, 2005–2010 (\$ Thousands)" ) we can compute the current ratio and the quick ratio. The results for Acme Enterprises and its industry’s means are provided in Table \(1\).
Table \(1\): Liquidity Ratio Results
2005 (%) 2006 (%) 2007 (%) 2008 (%) 2009(%) 2010 (%)
Acme’s current ratio 0.83 0.79 0.75 0.70 0.65 0.60
Industry’s current ratio 1.15 1.08 1.04 1.02 1.03 1.01
Acme’s quick ratio 0.63 0.60 0.57 0.53 0.49 0.45
Industry’s quick ratio 1.04 1.02 0.98 0.95 0.94 0.91
One should immediately notice that this business appears to be in serious trouble. None of the current ratios are above of value of 1.0, which indicates that the business would be unable to meet short-term obligations to its creditors should they have to be paid. Acme’s current ratios are below the industry’s average values; however, it should be noted that the industry’s values are quite close to one. Further, the current ratio values for Acme and the industry are declining, but Acme’s are declining quite significantly. This indicates the financially precarious position of the firm is growing steadily worse. The quick ratio shows an even direr situation should the firm not be able to sell off its inventory at market value. Acme’s quick ratio values are well below the industry’s average. Without these two ratios, a quick perusal of the total current assets of Acme Enterprises would result in a false impression that the firm is growing in a healthy fashion and current assets are rising.
Financial leverage ratios provide information on a firm’s ability to meet its total and long-term debt obligations. It draws on information from both the balance sheet and the income statement. The first of these ratios—the debt ratio—illustrates the extent to which a business’s assets are financed with debt. The formula for the debt ratio is as follows:
total debt / total assets.
A variation on the debt ratio is the ratio of debt to the total owner’s equity (the debt-to-equity ratio). As with the other ratios, one cannot target a specific, desirable value for the debt-to-equity ratio. Median values will vary significantly across different industries. The automobile industry, which is rather capital intensive, has debt-to-equity ratios above two. Other industries, such as personal computers, may have debt-to-equity ratios under 0.5.“Debt/Equity Ratio,” Investopedia, accessed December 2, 2011, www.investopedia.com/terms/D/debtequityratio.asp. The formula for the debt-to-equity ratio is as follows:
total debt / total owner’s equity.
One can refine this ratio by examining only the long-term portion of total debt to the owner’s equity. Comparing these two debt-to-equity ratios gives insight into the extent to which a firm is using long-term debt versus short-term debt. The formula for the long-term debt-to-owner’s equity ratio is as follows:
long-term debt / total owner’s equity.
The interest coverage ratio examines the ability of a firm to cover or meet the interest payments that are due in a designated period. The formula for the interest coverage ratio is as follows:
EBIT / total interest charges.
The financial leverage ratios for Acme and its industry are provided in Table \(2\). Interestingly, Acme’s debt-to-total-assets ratio has declined over the last six years. Further, its ratio has always been lower than the industry average in every year. This stands in contrast to the liquidity ratios. The business’s debt-to-equity ratio has declined precipitously over the last six years and was significantly lower than the industry averages. The same is true for the long-term debt-to-equity ratios. These ratios have declined for several reasons. The total assets of the firm have doubled over the last six years, and equity has grown by a factor of five while the long-term debt has remained constant. It would appear that the firm has been financing its growth with short-term debt and its own profits. However, one should note that the times interest earned ratio has declined dramatically, falling to approximately half the level of the industry average in 2010. This indicates that the firm has less ability to meet its debt obligations. In conjunction with the results of the other ratios, one would say that Acme has relied, excessively, on its short-term debt and should take actions to return to a firmer financial footing.
Table \(2\): Financial Leverage Ratios Results
2005 (%) 2006 (%) 2007 (%) 2008 (%) 2009 (%) 2010 (%)
Acme’s debt-to-total assets ratio 0.86 0.78 0.73 0.69 0.67 0.65
Industry’s debt-to-total assets ratio 1.01 0.97 0.95 0.92 0.89 0.86
Acme’s debt-to-equity ratio 6.14 3.57 2.68 2.22 1.99 1.86
Industry’s debt-to-equity ratio 3.31 3.25 3.67 3.11 2.96 2.65
Acme’s long-term debt-to-equity ratio 1.88 1.02 0.70 0.53 0.43 0.36
Industry’s long-term debt-to-equity ratio 1.52 1.54 1.42 1.32 1.27 1.12
Acme’s times interest earned ratio 14.76 12.34 10.68 8.52 7.17 5.52
Industry’s times interest earned ratio 11.55 11.61 10.95 10.65 10.43 10.01
The next grouping of ratios is the profitability ratios. Essentially, these ratios look at the amount of profit that is being generated by each dollar of sales (revenue). Remember, from the review of the income statement, we can identify three different measures of profit: gross profit, operating profit, and net profit. Each measure of profit can be examined with respect to the net sales of a business, and each can give us a different insight into the overall efficiency of a firm in generating profit.
The first profitability ratio examines how much gross profit is generated by each dollar of revenue and is given by the following formula:
gross profit margin = gross profit / revenue.
The next examines operating profit per dollar of sales and is calculated in the following manner:
operating profit margin = operating profit / revenue.
Lastly, the net profit margin is the one that is mostly used to evaluate the overall profitability of a business. It is determined as follows:
net profit margin = net profit / revenue.
The profitability ratios for Acme and its industry are provided in Table \(3\). Acme has seen a slight increase in its gross profit margin over the last six years, which indicates a reduction in either direct labor or direct materials costs. Acme’s gross profit margin is slightly lower, across the six years, than the industry’s mean values. Acme’s operating profit margins have declined, particularly since 2008. This would indicate, in light of an increasing gross profit margin, that its operating expenses have increased proportionately. Acme’s operating profit margins had parity with its industry until 2008. The most troublesome results may be the net profit margins, which experienced a one-third decline over the last six years. Although the industry’s net profit margins have declined, they have not done so at the same rate as those for Acme. These results indicate that Acme needs to carefully review its operational expenses with a clear intention to reduce them.
Table \(3\): Profitability Ratios Results
2005 (%) 2006 (%) 2007 (%) 2008 (%) 2009 (%) 2010 (%)
Acme’s gross profit margin 50.0 50.0 51.0 51.0 52.0 52.0
Industry’s gross profit margin 51.2 51.3 51.6 51.5 53.2 53.1
Acme’s operating profit margin 15.5 14.3 14.0 12.7 12.3 10.9
Industry’s operating profit margin 14.7 14.1 14.2 13.2 13.0 13.2
Acme’s net profit margin 9.5 8.7 8.4 7.4 7.0 6.0
Industry’s net profit margin 9.2 8.9 8.5 8.4 8.1 7.9
The last category of financial ratios is the asset management or efficiency ratios. These ratios are designed to show how well a business is using its assets. These ratios are extremely important for management to determine its own efficiency. There are many different activity or efficiency ratios. Here we will examine just a few. The sales-to-inventory ratio computes the number of dollars of sales generated by each dollar of inventory. Firms that are able to generate greater sales volume for a given level of inventory are perceived as being more efficient. This ratio is determined as follows:
sales to inventory = sales / inventory.
There are other efficiency ratios that look at how well a business is managing its inventory. Some look at the number of days of inventory on hand; others look at the number of times inventory is turned over during the year. Both can be used to measure the overall efficiency of the inventory policy of a firm. For simplicity’s sake, these ratios will not be reviewed in this text.
The sales-to-fixed-asset ratio is another efficiency measure that looks at the number of dollars of sales generated by a business’s fixed assets. Again, one is looking for a larger value than the industry average because this would indicate that a business is more efficient in using its fixed assets. This ratio is determined as follows:
sales to fixed assets = sales / fixed assets.
Another commonly used efficiency ratio is the days-in-receivables ratio. This ratio shows the average number of days it takes to collect accounts receivables. The desired trend for this ratio is a reduction, indicating that a firm is being paid more quickly by its customers. This ratio is determined as follows:
days in receivables = accounts receivable / (sales / 365).
The 365 in the denominator represents the number of days in a year. A summary of the activity ratios for Acme and the industry is provided in Table \(4\).
Table \(4\): Efficiency Ratios Results
2005 (%) 2006 (%) 2007 (%) 2008 (%) 2009 (%) 2010 (%)
Acme’s sales to inventory 14.3 14.3 14.3 14.3 14.3 14.3
Industry’s sales to inventory 16.2 15.7 15.3 14.9 14.3 13.7
Acme’s sales to fixed assets 8.57 7.02 6.01 5.28 4.75 4.33
Industry’s sales to fixed assets 7.64 7.12 6.78 6.55 6.71 6.34
Acme’s days in receivables 36.5 36.5 36.5 36.5 36.5 36.5
Industry’s days in receivables 33.2 34.6 38.2 37.4 33.9 35.1
Almost immediately one should notice several interesting sets of value. Acme’s sales-to-inventory ratios for the period 2005 to 2010 and its days in receivables for the same time frame are constant. This is not true for the industry values. This might indicate that Acme has a rigorous policy of tying its inventory level to sales. Likewise, it would appear that Acme has some formal policy to explicitly link accounts receivable to sales volume. Industry values for both ratios fluctuated across the time span; however, it should be noted that the industry’s days in receivables fluctuated across a rather narrow band. Acme’s sales to fixed assets have been declining from 2005 to 2010. In fact, it has dropped almost in half. This is a sign that Acme’s ability to manage its assets vis-à-vis sales has declined significantly and should be a source of considerable worry for the management team.
Financial ratios serve an extremely useful purpose for small business owners who are attempting to identify trends in their own operations and see how well their business’s stand up against its competitors. As such, owners should periodically review their financial ratios to get a better understanding of the current position of their firms.
Video Clip \(1\):
Financial Ratios: Debt Management
Basic coverage for calculating debt ratios.
Video Clip \(1\):
Financial Ratios: Profitability
Basic coverage for calculating profitability ratios.
Video Clip \(1\):
Financial Ratios: Asset Management
Basic coverage for calculating asset management ratios.
Key Takeaways
• Financial ratios enable external constituencies to evaluate the performance of a firm with respect to other firms in a particular industry.
• Ratio analysis can help a management team identify areas that might be of concern.
• The management team can track the performance on these ratios across time to determine whether the indicators are improving or declining.
• Financial ratios can be grouped into five categories: liquidity ratios, financial leverage ratios, asset management or efficiency ratios, profitability ratios, and market value ratios.
EXERCISES
1. In the Appendix (Chapter 16 "Appendix: A Sample Business Plan"), you will find the income statements and balance sheets for Frank’s All-American BarBeQue for the years 2006 to 2010. Compute some of the key financial ratios for this business and discuss the meanings of any trends.
2. Locate the average values of these values for the restaurant industry and comment on how well or poorly Frank’s All-American BarBeQue appears to be doing with respect to the industry.
3. Frank’s business plan in the Appendix (Chapter 16 "Appendix: A Sample Business Plan") provides projected income statements and balance sheets for a five-year forecast horizon. Compute the same ratios as in Exercise 1 and comment on your results. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/09%3A_Accounting_and_Cash_Flow/9.04%3A_Financial_Ratio_Analysis.txt |
Learning Objectives
1. To understand that a functioning accounting system can provide customer value through accurate billings and records.
2. To understand that there are several techniques that can help a small business maintain a positive cash flow.
3. To appreciate that small businesses can use sophisticated, low-cost computer accounting systems to manage their accounting and operational operations.
Customer Value
One might find at first consideration a tenuous link between a business’s accounting system and the concept of customer value. However, if looked at from the customer’s perspective, a business that provides accurate and prompt billings is a business that can control its costs, which can result in lower prices. A business that improves its overall efficiency because it can accurately monitor and track its operations provides far greater value than a business with a haphazard approach to accounting controls.
The ability to tailor a business’s operations to better meet customer needs is the key to providing value. As a business acquires a better appreciation of its capabilities, it can then make improvements that will better meet customer needs and outperform competitors.“Customer Value Analysis,” Quality Solutions, Inc., accessed December 2, 2011, www.qualitysolutions.com/customer_value_analysis.htm.
As a business grows more confident in its ability to handle accounting issues, it may wish to look at more sophisticated techniques that can better serve the business and the customer. As Andrew Hereth puts it, “An accounting process needs to be established that accounts for the cost of each customer, for each market and for each channel.”Andrew Hereth, “Accounting for Superior Customer Service,” Andrew M. Hereth Blog, accessed December 2, 2011, andrewmhereth.com/blog/accounting-for -superior-customer-service.
Cash-Flow Implications
Like good health, positive cash flow is something you’re most aware of when you haven’t got it. That’s one of the most profound truths in life.“The Importance of Cash Flow Management—Entrepreneur University,” Young Entrepreneur Blog, February 9, 2009, accessed February 14, 2012, www.youngentrepreneur.com/blog/entrepreneur-university/the-importance-of -cash-flow-management-entrepreneur-university.
Robert Heller
Creating a positive cash flow or at least reducing a negative cash flow should be of central interest to all small businesses. Unlike the example of Alex’s Soft Serve Services, not all small businesses can anticipate that they will be able to cover a negative cash flow simply by borrowing. That means that businesses must be much more proactive in attempting to eliminate or reduce negative cash flows. Therefore it is important to examine some ways in which a small business can increase its cash inflows.
• Restrict credit and credit terms. Many small businesses, but not all, offer credit terms and policies for current and potential customers. The easier the credit, the more likely a business will be able to generate a sale; however, easy credit terms generally mean that it will take a longer period of time for the business to receive the total cash payment from a sale. Thus many businesses accept only cash or debit and credit cards. Restricting the credit terms may simply mean that credit is provided only to particular customers or the terms of the credit are tightened—for example, 60 percent of the sale price is due the day of the sale, and the remaining 40 percent would be due in thirty days.
• Conduct credit checks. Businesses that plan to offer credit to customers, particularly customers who will be making large purchases, may find that it pays to spend money to conduct a credit check on these customers. Again, the use of credit checks is very much a function of the type and size of the business and the potential sales that may be involved.
• Make credit terms explicit. For businesses that provide credit to their customers, it is critical to make sure the customer has an explicit idea of what the exact credit terms are. In the long run, it will pay to clearly indicate on the invoice the exact payment schedule.
• Provide incentives to expedite customer payment. It is often worth to knock off several percentage points on a sale to speed up a customer’s payment. The exact size of the discount will have to be determined by the business owner.
• Request partial payment in advance. When providing credit terms, small businesses should consider the requirement of a deposit or a retainer up front. Hopefully, this should not deter many customers from purchasing particularly high-priced items. The request for payment in advance assures that a business will receive some cash inflow even if the customer defaults.
One of the best ways to maintain a positive cash flow is to reduce the size of the negative cash flow, which can be done by conducting cash-flow analyses on a regular basis. Throughout this chapter, the time frame most commonly used has been the fiscal year or a fiscal month. In the case of rigorously monitoring cash flow, it is strongly suggested that one consider using even smaller time units, namely a weekly analysis or even a daily analysis.
Digital Technology and E-Environment Implications
Computer-based accounting systems have much to offer the owner of a small business. Most small businesses would find that a computerized accounting system has the following advantages over a manual system:
• Accuracy. In computerized systems, data entry can be structured so as to preclude the input of wrong information. Further, transactions are entered only once in computerized systems, whereas they may require several entries in a manual system.
• Speed. Data entry and data retrieval can occur on a real-time basis. Calculations are done instantly in a computerized system. For businesses with multiple locations, data can be instantly coordinated rather than waiting for the collection of data from diverse locations as would occur with manual systems.
• Report generation. Computerized systems can provide real-time generation of a variety of reports that can enable owners or operators to improve their decision making.
• Cost reduction. Although small businesses may be required to expend money on the initial purchase (and maintenance) of computerized accounting system, these systems often provide significant savings in terms of reducing the amount of time required for bookkeepers and accountants to track businesses records.“The Advantages of Using a Computerized Accounting Package such as MYOB Accounting Software,” ITS Tutorial School, accessed December 2, 2011, www.tuition.com.hk/computerized-accounting.htm.
• Backup. The records in a computerized system can be backed up at a variety of locations. This minimizes the chance that all records would be destroyed in some form of accident, such as a fire or a flood, as might be the case with paper records in a manual system.Sheila Shanker, “Differences between Manual and Computerized Accounting Systems, Chron.com, accessed January 31, 2012, smallbusiness.chron.com/differences-between-manual-computerized-accounting-systems-3764.html.
Computer-based accounting packages that have been designed for small to midsize businesses have been available for more than a quarter of a century. Many of the packages that existed twenty-five years ago are no longer available. Some have argued that a natural selection process exists for computerized accounting system so that today’s survivors represent the best qualities required of such systems.John Hedtke, “Natural Selection of Low-Cost Accounting,” Accounting Technology 22, no. 5 (2006): 34–38. In recent years, a whole new category of accounting software has been developed—cloud-based software. This software resides on the web and does not require a software package to be downloaded on small business owner’s computer. Such programs are accessible from any computer.
Selecting a new computer accounting system or changing from a manual system to a computer-based system is a major step for any small business. It should be conducted with careful consideration and treated as a major project. Prior to starting the project, it is highly advisable to sit down with one’s accountant and consider the options. Some of the first steps in starting this project involve specifying the budget and the required attributes of the software package. In developing the budget, one should consider the initial acquisition price of the software, training costs, and maintenance costs. If one is planning to move from one computerized accounting system to another, the cost of transferring operations should also be considered in the overall budgeting process. With regard to the initial purchase price, these packages can range from being free to costing thousands of dollars depending on the number of modules required. Some systems use a fee structure that is based on the number of users. This would allow a business owner to get some sense of the look and the feel of the software package.
The second initial phase of the acquisition process centers on identifying what is needed in the accounting package. This relates to the elements (support services) or modules that are absolutely required. One should also identify what modules might be of benefit at some point in the future. To assist an owner in identifying what modules are required or may be required in the future, the information that flows into the accounting system must be specified. In "Understanding the Need for Accounting Systems", we refer to the idea of accounting transactions, which fall into several categories. A business needs to identify all the required categories, particularly if it is transitioning from a manual system to a computerized system. A business also needs to identify the accounting reports that are required throughout the business. It is important to consider if the software is compatible with e-business, e-commerce, and Internet capabilities.
Another issue is to consider how many people will have to access the system throughout the entire business. This number will have a dramatic impact on the training requirements. Recognize that the business will have to provide manuals that must be accessible to all who will be using the accounting system. This also brings up the issue of the necessity of employee training programs. Consider the relative ease of use of any computerized accounting system—not only for yourself but also for the employees. This is where an understanding of the learning curve of using the system will be extremely important. Again, a business’s accountant can play a critical role not only in determining the selection of the system but also in developing training programs for the employees and showing them how to use the system. Having generated this list of the required components of the accounting system, one should identify competing software products (along with their costs) and prioritize them, as shown in Figure \(1\). In addition to consulting with an accountant, a business owner should review the various accounting software packages by talking to other business owners, reading evaluations in the business and computer press, and exploring software packages on a trial basis.“Accounting Software A to Z,” Business-Software.com, accessed March 11, 2021. Many accounting software packages allow users to try out the system with no initial charge. After a fixed period of time, usually thirty days, the program becomes inoperative. This allows you to become familiar with the look and the feel of the software.
The third preliminary step is the creation of a timeline that would determine when you must successfully implement the accounting package into the actual operations of the business. This timeline should consider the time required to conduct test runs of the software. Tests should be conducted with only one or two modules. They should be operated for a sufficient period of time (at least a month) to examine if the system works as well as the manual system or the current computerized system. A timeline should also be created for training the personnel who will be using the software.
Moving to a computerized accounting system or a new system means that you should be ready for any disaster. To prepare for such disasters, there should be a formal policy of backing up all data on a regular basis. The backed up data should be at another locale other than the main storage site. Portable hard drives for off-site data storage site serve this purpose well. Some software packages perform their own backup procedures.
Several factors may need to be considered when examining accounting software for small businesses, including the following: will the software run on computers that a business currently uses, how often should the company provide updates of the software, and are there specific versions of the accounting software for the industry in which a business operates. Small businesses should also consider cloud computing options with regard to accounting software. Cloud computing refers to the fact that programs and data are stored off-site at another location. This means that accounting transactions can be entered from any computer, in some cases from smartphones, and are accessible anywhere in the world. Although for start-up businesses and the very smallest of businesses the adoption of a computerized accounting system appears to be a daunting task, in the long run, it is a key element for the long-term survival of the business.
Video Link 9.1
Evaluating Accounting Software
Video that discusses ways to determine what software is best.
www.ehow.com/video_5103398_evaluating-accounting-software.html
KEY TAKEAWAYS
• Good accounting systems can help a firm provide value to its customers through better billing and increased efficiency.
• Small businesses can be proactive in preserving cash flow through a variety of simple actions.
• Small businesses today can acquire very powerful computer accounting software packages. These packages are affordable and relatively easy to use.
EXERCISES
1. Besides the suggestions provided, what other approaches might a small business use to preserve cash flow?
2. Select five or six computerized accounting packages (including one of the cloud variety) that might be used by a start-up restaurant, and prepare a rigorous analysis of which should be selected and why.
Disaster Watch
Sales and cash-flow forecasting can often prove to be a significant challenge to small business owners. Assumptions have to be made, forecasting models must be selected, and calculations have to be made. In many cases, the forecasts will not be exact. This can be profoundly frustrating. Yet one of the great benefits of forecasting is that it may force a small business owner to think about what the future may hold. However, neither small businesses nor large businesses can predict or plan for all events. Certain events just happen. Given this element of unpredictable chance, businesses should think about how they might protect and conserve their cash flow should the “unthinkable” occur.
Yankee Gas had a project that involved installing a pipeline from Waterbury, Connecticut, to Wallingford, Connecticut.Josh Morgan, “Yankee Gas Work Upsets Local Businessowners,” The Cheshire Herald (Cheshire, Connecticut), October 21, 2010. The original intent according to Yankee Gas was that all work on the pipeline would occur during the night to minimize customer disruptions. Or at least, this was what the storeowners along the line of the work were told. During one phase of the project, the company altered the schedule and began working during daytime hours. Installation involved digging a trench into which the pipeline was laid. This produced a major disruption that required that traffic be diverted away from several businesses’ main entrances and their parking lots. Multiple businesses found their customers had to be “forceful” with the local police to enter areas near the businesses. One of the businesses was a deli that focused on preparing fresh food on a daily basis. Food that was not sold during the day had to be discarded that night. This occurred during the summer months, which were the best times for this deli. A local gas station saw sales drop so precipitously that the owner was unable to meet the rent.
One of the responses on the part of many of the business owners was to seek compensation. Unfortunately, they found that no one was willing to accept responsibility for the detour policy. As an owner of a travel agency put it, “The Town said it was the State, the State said it was the (local) police and the police said it was Yankee Gas.”Josh Morgan, “Yankee Gas Work Upsets Local Businessowners,” The Cheshire Herald (Cheshire, Connecticut), October 21, 2010. While the owners await the resolution of responsibility, they have to consider the possibility of more street work during the following summer. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/09%3A_Accounting_and_Cash_Flow/9.05%3A_The_Three_Threads.txt |
The Notch Store
No small business, or for that matter no large business, becomes a landmark and community-gathering place overnight. It takes time along with some very sharp management skills. In the case of the Notch Store, a local legend in Cheshire, Connecticut, it took ninety years and three generations of family members.
The business began in 1921 when Pauline Salvatore recognized a business opportunity. Her husband Mike worked in the nearby quarry, and she recognized that the employees needed a location where they could buy groceries for their lunch or to bring home for dinner. She began to sell them from her living room. Soon the business located to a facility next to her home. The name Notch Store came from its use in the quarry.
A few years later, Mike left the quarry and began to work with Pauline. Over the years, the Notch Store evolved as customer needs changed. They began to expand their offerings. The physical store was enlarged. A gasoline pump was installed, and for several years, one wall of the store carried auto parts.
In 1967, Mike and Pauline’s son Frank and his wife Josephine took over the operation of the business. In the 1970s, the Notch Store extended its offerings to include deli items and lunches. It even offered a homemade cider every fall. The business grew and included its third generation of Salvatores—Frank Jr.
In the early 1990s, Frank Jr. was in charge of operations. Like any business man, he was open to suggestions from others, including his employees. One woman who worked for Frank Jr. suggested that he add breakfast sandwiches to the menu. To make these sandwiches, Frank Jr. needed a restaurant-quality stove. In one of those strange twists of life, Frank Jr. had a friend who knew Joe Namath and his wife. The Namaths were building a new home, and Joe’s wife did not like the stove in the home. Frank Jr. acquired it, and since then, the breakfast sandwich offerings have become a major staple in the Notch Store.
No business develops without encountering problems, and the Notch Store was no exception. Several years ago, a number of customers complained that they had become ill from the Notch’s cider. This was followed by several lawsuits. For most businesses, this might have been a fatal crisis and financial ruin. Fortunately, years before, Frank Jr. had listened to his brother Robert’s advice (Robert was in the insurance industry). The Notch Store had \$2.3 million in insurance coverage, which was more than enough to ensure its survival. For several reasons, including recognition of the risk of serving food to the public, the Notch Store has adopted a limited liability corporation format. Even with the best of financial planning and risk reduction strategies, many businesses have to deal with factors beyond their control. The recent economic downturn has meant that there is a significant reduction in new homes being built in Cheshire. This means that there are far fewer builders buying breakfasts and lunches, but Frank Jr. is coping with a small line of credit at a local bank. The future is still bright for the Notch Store and so is the possibility of it continuing into a fourth generation. Frank Salvatore (owner), in discussion with the authors. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/10%3A_Financial_Management/10.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Understand the difference between accounting and finance for small businesses.
2. Understand the major activities of finance.
3. Understand how finance can affect the selection of a business form.
4. Understand the various sources that can be used to finance the start-up operations of a business.
5. Understand what factors might affect the extent to which a firm is financed by either debt or equity.
"Accounting and Cash Flow" discusses the critical importance of a small business owner understanding the fundamentals of accounting—“the language of business.” This chapter examines finance and argues that the small business owner should acquire a basic understanding of some key principles in this discipline. One question that might come to someone’s mind immediately is as follows: “What is the difference between accounting and finance?” As an academic discipline, finance began in the early decades of the twentieth century. We have already seen that accounting predates the formal study of finance by millennia.“Difference between Accounting and Finance,” DifferenceBetween.net, accessed February 1, 2012. Yet some have argued that accounting should be seen as a subset of finance.“Difference between Accounting and Finance,DifferenceBetween.net, accessed February 1, 2012. Others have argued that both accounting and finance should be seen as subdisciplines of economics. Not surprisingly, others have argued in favor of the primacy of accounting. If we get beyond this debate, we can see that accounting is involved with the precise reporting of the financial position of a firm through the financial statements, which is presented in "Accounting and Cash Flow". The accounting function is expected to collect, organize, and present financial information in a systematic fashion. Finance can be seen as “the science of money management” and consists of three major activities: financial planning, financial control, and financial decision making. Financial planning deals with the acquisition of adequate funds to maintain the operations of a business and making sure that funds are available when needed. Control seeks to assure that assets are being efficiently used. Decision making is associated with determining how to acquire funds, where to acquire funds, and how those funds should be used and within the context of the risk assessment of the aforementioned decisions. As an academic discipline, finance has grown tremendously over the last four decades.
Much of the work produced during this period possessed both an esoteric analytical quality and profound practical consequences. One only has to look at newspapers and the business press, during the last few years, to see how financial theory (efficient market hypothesis) and financial models (options pricing, derivatives, and arbitrage models) have played a dominant role in the global economy. Fortunately, most small businesses have no need to directly involve themselves with these analytical abstractions. But this does not mean that small business owners do not need to concern themselves with fundamental issues of financing their firms.
Impact of Organization Type on Finance Decisions
Selecting the form of business organization that is adopted by a business depends on many factors. One could begin by anticipating the eventual size and nature of the business.“Types of Business Organizations,” BusinessFinance.com, accessed December 2, 2011. The complexity of a business may dictate the type of business organization that is adopted. However, many of the factors that go into this determination are either directly or indirectly financial in nature. The indirect factors are as follows: the extent to which a business owner wishes to attain control of the business, the relationship that the owner would have with partners or investors, and the perceived risk associated with the business. This last factor is tied to the question of the extent to which the owner will invest his or her own money and assets. The direct financial factors that go into selecting the type of the business organization include the following: expected profits or losses, tax issues, the vulnerability and threat from lawsuits, and the ability to extract profits from the business for the owner’s use. The federal government recognizes six forms of business organizations for tax purposes: sole proprietorship, partnership, C-corporation, S-corporation, trust, and nonprofit. The last two are unlikely to be adopted by small businesses. It is useful to examine the financial implications of organizing along the remaining four basic formats.
Sole Proprietorship
Many small businesses operated by a single individual adopt sole proprietorship format of business organization. It is the most basic type of business organization. It is also the least expensive to create and the easiest to operate and dissolve. Sole proprietorships can be incorporated if the owner so desires. Not being a legal entity, single scratch sole proprietorships disappear after the death of the owner. This type of business is essentially a format for a single-person business (although many have between one and ten employees), where the owner makes all the decisions related to the business’s operations. The owner can extract all profits from the business for his or her personal use, or the owner can decide to reinvest any portion of the profits back into the business. It is interesting to know that 70 percent of all businesses in the United States are sole proprietorships yet they only produce 20 percent of all the nation’s profits.“Business Finance—by Category,” About.com, accessed December 2, 2011. Because a single proprietorship is not a legal entity, any income generated by the business goes directly on the owner’s personal tax return. However, the single owner is also personally responsible for any debts that the business acquires. This means that the owner may put his or her own personal assets at risk. In addition, this business organization means unlimited liability for its owner. The format means that there is very little opportunity to raise funds from sources other than the owner’s own capital or consumer loans.
Partnerships
Partnerships generally are unincorporated businesses. From a financial standpoint, partnerships offer a few advantages over sole proprietorship. By having more than one owner (investor), it is often easier to raise additional capital. In some businesses, such as law firms and accounting firms, the prospect of becoming a partner may be an attractive inducement to gain employees. There are several versions of partnerships.
The general partnership is composed of two or more owners who contribute the initial capital of the business and share in the profits and any losses. It is similar to a sole proprietorship in that all partners are personally responsible for all the debts and the liabilities of the business. A general partnership is comparable to a sole proprietorship in that neither is a taxable entity; therefore, the partners’ profits are taxed as personal income. They can deduct any business losses from their personal income taxes. The exact proportion of ownership of the firm is generally found in a written document known as the partnership agreement.
A limited partnership is a business that may have several general partners and several more limited partners. The major difference with a general partnership is that the limited partners do not have unlimited liability. Their losses are limited to their original investment in the business. Common practice means that these limited partners do not play a major decision-making role in the life of the business.
C-Corporations
Selecting a C-corporation form of business entails more effort and expense in creating this format. Corporations must be chartered by the state in which they are headquartered. Corporations are viewed as legal entities, meaning that they can enter into legal agreements with individuals and other corporations. They are also subject to numerous local and state regulations. This often results in extensive paperwork that can be costly. Corporations are owned by their shareholders. The shareholders are liable only for their original investment in the business. They cannot be sued for more than that amount. One of the major advantages of adopting a corporate format is that in this type of business, it is sometimes much easier to raise capital through either debt or the issuance of stock. Profits derived from this type of business are taxed at the corporate rate. It is important to note that dividends paid to shareholders, unlike interest expenses, are not deductible. So in a real sense, this form of income is doubly taxed.
S-Corporations
The S-corporation is a special format designed to eliminate the problem of double taxation that one might find with a C-corporation format. It first differs from a C-corporation in that it is limited to a hundred shareholders, although it can be created with just one shareholder. If a shareholder is an employee of the business and contributes any service to the business, then the corporation is required to pay that individual a salary. The term that is used is “reasonable” salary. This definition may vary under several conditions. A failure to comply with this ambiguous definition of “reasonable” salary means that the IRS can reclassify the profits as wages and tax the amount at the personal income rate.
Limited Liability Company
A limited liability company is an organizational form that can be limited to a single individual or several other owners or shareholders. Like a general partnership, there is a requirement for documents that define the distribution of responsibilities, profits, or losses. Generally, the members of a limited liability company are liable for the debts of the company. This format may provide tax and financial benefits for the participants. This format cannot be used in the banking or insurance industries.
Acquisition of Funds
Capital is the lifeblood of all businesses. It is needed to start, operate, and expand a business. Capital comes from several sources: equity, debt, internally generated funds, and trade credits (see Figure \(1\) ).
Equity financing raises money by selling a certain share of the ownership of the business. It involves no explicit obligation or expectation, on the part of the investors, to be repaid their investment. The value of equity financing lies in the partial ownership of the business.
Perhaps the major source of equity financing for most small start-up businesses comes from personal savings. The term bootstrapping refers to using personal, family, or friends’ money to start a business.“Financing,” Small Business Notes, accessed December 2, 2011, www.smallbusinessnotes.com/business-finances/financing. The use of one’s own money (or that of family and friends) is a strong indicator that a business owner has a strong commitment to and belief in the success of the business. If a business is financed totally from one’s personal savings, that means the owner or the operator has total control of the business.
If a business is structured as a corporation, it may issue stock. Generally, two major types of stock may be issued: common stock and preferred stock. It should be noted that in most cases, owners of common stock have what are known as voting rights. They have a proportional vote (directly related to the number of shares they own) for members of the board of directors. Preferred stock does not carry with it voting rights, but it has a form of guaranteed dividend.
Corporations that issue stock must comply with several steps to meet both federal and state statutes, including the following: outlines to issue stock to shareholders, determining the price and number of shares to be issued, creating stock certificates; developing a record to record all stock transactions; and meeting all federal and state securities requirements.“Checklist: Issuing Stock,” San Francisco Chronicle, accessed December 2, 2011, allbusiness.sfgate.com/10809-1.html. Smaller businesses may choose to issue stock only to those who were involved in the initial investment of the business. In such cases, one generally does not have to register these securities with state or federal agencies. However, one may be required to fill out all the forms.“How to Form a Corporation,” Yahoo! Small Business Advisor, April 26, 2011, accessed February 1, 2012, smallbusiness.yahoo.com/advisor/how-to-form-a-corporation -201616320.html.
"The Business Plan" discusses two sources of capital investment: venture capitalist and angel investors. Venture capitalists are looking for substantial returns on their initial investment—five, ten, sometimes even twenty-five times their original investment. They will be looking for firms that can rapidly generate significant profits or significant growth in sales. Angel investors may be more attracted to their interest in the small business concept than in reaping significant returns. This is not to say that they are not interested in recouping their original investment with some type of significant return. It is much more likely that angel investors, as compared to venture capitalists, will play a much more active role in the decision-making process of the small business.
One area for possible capital infusion into a small business may come from a surprising source. Many students (and some adults) may find funding to start up a business through business plan competitions. These competitions are often hosted by colleges and universities or small business associations. The capital investment may not be large, but it might be enough to start very small businesses.
Debt financing represents a legal obligation to repay the original debt plus interest. Most debt financing involves a fixed payment schedule to repay both principal and interest. A failure to meet the schedule has serious consequences, which might include the bankruptcy of the business. Those who provide debt financing expect that the principal will be repaid with interest, but they are not formal investors in the business.
There are numerous sources for debt financing. Some small businesses begin with financing by borrowing from friends and family. Some firms may choose to finance business operations by using either personal or corporate credit cards. This approach to financing can be extraordinarily expensive given the interest rates charged on credit cards and the possibility that the credit card companies may change (by a significant amount) the credit limit associated with the credit card.
The largest source of debt financing for small businesses in the United States comes from commercial banks.“How Will a Credit Crunch Affect Small Business Finance?,” Federal Reserve Bank of San Francisco, March 6, 2009, accessed December 2, 2011. Bank lending can take many forms. The most common loan specifies the amount of money to be repaid within a specific time frame for a specific interest rate. These loans can be either secured or unsecured. Secured loans involve pledging some assets—such as a home, real estate, machinery, and plant—as collateral. Unsecured loans provide no such collateral. Because they are riskier for the bank, they generally have higher interest rates. For a more comprehensive discussion of bank loans, see "Relationships with Bank and Bankers".
The Small Business Administration (SBA) has a large number of programs designed to help small businesses. These include the business loan programs, investment programs, and bonding programs. The SBA operates three different loan programs. It should be understood that the SBA does not make the loan itself to a small business but rather guarantees a portion of the loan to its partners that include private lenders, microlending institutions, and community development organizations. To secure one of these loans, the borrower must meet criteria set forth by the SBA. It should be recognized that these SBA loan rules and guidelines can be altered by the US Congress and are dependent on prevailing economic and political conditions. The following subsections briefly describe some of the loan programs used by the SBA.
(a) Loan Programs
This class of loans may be used for a variety of reasons, including the purchase of land, buildings, equipment, machinery, supplies, or materials. It may also be used for long-term working capital (paying accounts payable or the purchase of inventory). It may even be used to purchase an existing business. This class of loans cannot, however, be used to refinance existing debt, to pay delinquent taxes, or to change business ownership.
• Special-purpose loans program. These loans are designed to assist small businesses for specific purposes. They have been used to help small businesses purchase and incorporate pollution control systems, develop employee stock ownership plans, and aid companies negatively impacted by the North American Free Trade Agreement (NAFTA). It includes programs such as the CAPLines, which provide assistance to businesses for meeting their short-term working capital needs. There is also the Community Adjustment and Investment Program. This program is designed to assist businesses that might have been adversely impacted by NAFTA.
• Express and pilot programs. These loan programs are designed to accelerate the process of providing loans. SBA Express can respond to a loan application within thirty-six hours while also providing lower interest rates.
• Community express programs. These programs are designed to assist borrowers whose businesses are located in economically depressed regions of the country.
• Patriot express loans. These loans are designed to assist members of the US military who wish to create or expand a small business. These loans have lower interest rates and can be used for starting a business, real estate purchases, working capital, expansions, and helping the business if the owner should be deployed.
• Export loan programs. Given the remarkable fact that 70 percent of American exporters have less than twenty employees, it is not surprising that the SBA makes a special effort to support these businesses by providing specialized loan programs. These programs include the following:
• Export Express Program. This program has a rapid turnaround time to support export-based activities. It can provide for funds up to \$500,000 worth of financing. Financing can be either a term loan or a line of credit.
• Export Working Capital Program. A major challenge that small exporters face is the fact that many American banks will not provide working capital advances on orders, receivables, or even letters of credit. This SBA program assures up to the 90 percent of a loan so as to enhance a business’s export working capital.
• SBA and Ex-Im Bank Coguarantee Program. This is an extension of the Export Working Capital Program and deals with expanding a business’s export working capital lines up to \$2 million.
• International Trade Loan Program. This program, with a maximum guarantee of \$1.75 million, enables small businesses to start an exporting program, enlarge an exporting program, or deal with the consequences of competition from overseas imports.
Another source of debt financing is the issuance of bonds. Bonds are promissory notes. There are many forms of bonds, and here we discuss only the most basic type. The fundamental format of the bond is that it is a debt instrument that promises to repay a fixed amount of money within a given time frame while providing interest payments on a regular basis. The issuance of bonds is generally an option available to businesses with a corporation format. It also requires extensive legal and financial preparations.
Another source of capital is the generation of internal funding. This simply means that a business plows its retained earnings back into the business. This is a viable source of capital when a business is highly profitable.
The last source of capital is trade credit. Trade credit involves purchasing supplies or equipment through financing made available by vendors. This approach may allow someone to acquire inventory of materials and supplies without having the full price at the time of purchase. Some analysts say that trade credit is the second largest source of financing for small businesses after borrowing from banks.Anita Campbell, “Trade Credit: What It Is and Why You Should Pay Attention,” Small Business Trends, May 11, 2009, accessed December 2, 2011, smallbiztrends.com/2009/05/trade-credit-what-it-is-and-why-you-should-pay-attention.html. Trade credit is often a vital way of securing supplies.
Trade credit is often expressed in terms of three important numbers—a discount rate, the number of days for one to pay to qualify for the discount, and the number of days on which the bill must be paid. As an example, a trade credit offered by a supplier might be listed as 5/5/30. This translates into a 5 percent discount if the bill is paid within five days of the issuance. The third number means that the bill must be paid in full within thirty days.
Video Clip \(1\):
How to Raise Capital: The #1 Skill of an Entrepreneur
Describes what an entrepreneur needs to do in order to acquire capital for the firm.
Video Clip \(2\):
Pat Gage: Getting Business Financing for a Small Business
Voice-over PowerPoint identifies where a small business owner can acquire funding.
Video Clip \(3\):
How to Finance a Business: How to Get Start-Up Business Financing
Examines the use of bank financing for the small business.
Video Clip \(4\):
Financing a New Business: How to Find Government Small Business Grants
Locate places to find small business grants through search engines with ideas from a certified public accountant in this free video on new business financing.
Video Clip \(5\):
The Role of Credit Cards in Small Business Financing
Congressional testimony that warns of the use of using credit cards to finance small businesses.
Video Clip \(6\):
Financial Analysis for Small-Business Owners
This excerpt from the popular video learning series at BusinessBuffet.com introduces the core concepts behind financial analysis for small business.
Web Resources
Credit Loans for Small Businesses
The Chase portal—one provider of loans for small businesses.
https://www.chase.com/business/loans
Five Ways to Finance a Business in Difficult Financial Times
Alternative ways of financing when banks are not lending.
biztaxlaw.about.com/od/financingyourstartup/tp/financingsmallbiz.htm
Capital Structure: Debt versus Equity
A critical component of financial planning for any business is determining the extent to which a firm will be financed by debt and by equity. This decision determines the financial leverage of a business. Many factors enter into this decision, particularly for the small business. From the classic economic and finance perspective, one should evaluate the cost of both debt and equity. Debt’s cost centers largely on the interest rate associated with a specific debt. Equity’s cost includes ceding control to other equity partners, the cost of issuing stock, and dividend payments. One should also consider the fact that the interest payment on debt is deductible and therefore will lower a business’s tax bill.Gavin Cassar, “The Financing of Business Startups,” Journal of Business Venturing 19 (2004): 261–83. Neither the cost of issuing stock nor dividend payments is tax deductible.
Larger businesses have many more options available to them than smaller enterprises. Although this is not always true, larger businesses can often arrange for larger loans at more favorable rates than smaller businesses.Lola Fabowale, Barbara Orse, and Alan Riding, “Gender, Structural Factors, and Credit Terms between Canadian Small Businesses and Financial Institutions,” Entrepreneurship Theory and Practice 19 (1995): 41–65. Larger businesses often find it easier to raise capital through the issuance of stock (equity).
By increasing a business’s proportion of debt, its financial leverage can be increased. There are many reasons for attempting to increase a business’s financial leverage. First, one is growing the business with someone else’s money. Second, there is the deductible nature of interest on debt. Third, as more clearly shown in "Capital Structure Issues in Practice", increasing one’s financial leverage can have a positive impact on the business’s return on equity. For all these benefits, however, there is the inescapable fact that increasing a business’s debt level also increases a business’s overall risk. The term financial leverage can be seen as being comparable to the base word—lever. Levers are tools that can amplify an individual’s power. A certain level of debt can amplify the “lifting” power of a business (see the upper portion of Figure \(2\) ). However, beyond a certain point, the debt may be out of reach, and therefore the entire lifting power of financial leverage may be lost (see the lower portion of Figure \(2\)). Beyond the loss of lifting power, the assumption of too much debt may lead to an inability to pay the interest on the debt. This situation becomes the classic case of filing for bankruptcy.
This major issue for small businesses—determining how to raise funds through either debt or equity—often transcends economic or financial decisions. For many small business owners, the ideal way of financing business growth is through generating internal funds. This means that a business does not have to acquire debt but has generated sufficient profits from its operations. Unfortunately, many small businesses, particularly at the beginning, cannot generate sufficient internal funds to finance areas such as product development, the acquisition of new machinery, or market expansions. These businesses have to rely on securing additional capital debt, equity, or some combination of both.
Many individuals start small businesses with the express purpose of finding independence and control over their own economic and business lives. This desire for independence may make many small business owners averse to the idea of equity financing because that might mean ceding business control to equity partners.Harry Sapienza, M. Audrey Korsgaard, and Daniel Forbes, “The Self-Determination Mode of an Entrepreneur’s Choice of Financing,” in Advances in Entrepreneurship, Firm Emergence, and Growth: Cognitive Approaches to Entrepreneurship Research, ed. Jerome A. Katz and Dean Shepherd (Oxford: Elsevier JAI, 2003) 6:105–38. Another issue that makes some small business owners averse to acquiring additional equity partners is the simple fact that the acquisition of these partners means less profit to the business owner. This factor in the control issue must be considered when the small business owner is looking to raise additional capital through venture capitalist and angel investors.Allen N. Berger and Gregory F. Udell, “The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle,” Journal of Banking and Finance 22, no. 6–8 (1998): 613–73.
A recent research paperRowena Ortiz-Walters and Mark Gius, “Performance of Newly Formed Micro Firms: The Role of Capital Financing Structure and Entrepreneurs’ Personal Characteristics” (unpublished manuscript), 2011. examined the relationship between profitability and sources of financing for firms that had fewer than twenty-five employees. It found several rather interesting results:
• Firms that use only equity have a low probability of being profitable compared to firms that use only business or personal debt.
• Firms owned by females and minority members relied less on personal debt than male and minority owners.
• Female owners will be more likely to rely on equity from friends and family than their male counterparts.
• Firms that rely exclusively on personal savings to finance business operations will more likely be profitable than firms using equity forms of debt.
Web Resources
Capital Structure
Definition and explanation of capital structure.
www.enotes.com/capital-structure-reference/capital-structure-178334
Capital Structure from an Investor’s Perspective
This reviews how an investor would interpret a business’s capital structure.
Links available
KEY TAKEAWAYS
• Business owner must be aware of the implications of financing their firms.
• Owners should be aware of the financial and tax implications of the various forms of business organizations.
• Business owners should be aware of the impact of financing their firms through equity, debt, internally generated funds, and trade credit.
• Small-business owners should be aware of the various loans, grants, and bond opportunities offered by the SBA. They should also be aware of the restrictions associated with these programs.
EXERCISES
1. Interview the owners of five local businesses and ask them what business organizational format they use and why they adopted that form.
2. Ask them how they initially financed the start-up of their businesses.
3. Ask these same owners how they prefer to finance the firm. (Note that most owners will probably not want to go into any detail about the financial operations of their businesses.)
4. Ask them if they have had any experience with any SBA loan program and if they have any reactions to these programs. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/10%3A_Financial_Management/10.02%3A_The_Importance_of_Financial_Management_in_Small_Business.txt |
Learning Objectives
1. Learn about the importance of cultivating a relationship with a banker.
2. Understand the elements of the CAMPARI approach to evaluating a loan.
Relationships with Bank and Bankers
One often hears the following standard complaint of small businesses: bankers lend money only to those businesses that do not need the money. The inverse of this complaint from the bank’s standpoint might be that small businesses request money only when they are least likely to be able to repay it. The conflict between small businesses and bankers may stem from a misunderstanding of the respective roles of both groups. At face value, it might appear—particularly to small businesses—that bankers are investing in their companies.
Under normal conditions, bankers are extremely risk averse. This means they are not investors anticipating a substantial return predicated on the risks associated with a particular business. Bankers lend money with the clear expectation that they will be repaid both principal and interest. It is in the interest of both parties to transcend these two conflicting perceptions of the role of bankers in the life of a small business. The key way is for the small business owner to try to foster improved communications with a banker. This communication promoted by the small business owner should become the basis of a solid working relationship with the bank. Most often, this means developing a personal relationship with the loan officer of the bank, which is sometimes a problematic proposition. Bank loan officers are often moved to different branches, or they may change jobs and work for different banks. It should be the responsibility of the small business owner to maintain frequent contact with whoever is representing the bank. This should involve more than just providing quarterly statements. It should include face-to-face discussions and even asking the officer to tour a business’s facilities. The point is to personalize the working relationship between the two parties. “Ideally, it’s a human relationship as well as a business relationship,” says Bill Byne, an entrepreneur and author of Habits of Wealth.“The Benefits of Making Your Banker Your Friend,Small Business Administration, accessed December 2, 2011.
Although bankers and loan officers will rely heavily on data related to the creditworthiness of a small business, they will also consider the trustworthiness and integrity of the business owner. This intangible sense that a business owner is a worthy credit risk may play a determinant role in whether a loan is approved with the extension of a credit line. This notion of integrity has to be built over time. It is predicated on projecting an image that you can be counted on to honor what you say, know the right thing to do to make the business a success, and be able to execute the correct decisions.
It is sometimes said that bankers, when reviewing a perspective loan applicant, think of the drink “CAMPARI,” which stands for the following:
• Character. As previously stated, bankers will consider the issue of personal integrity. Part of that definition of integrity will include a sense of professionalism, which can be reflected in one’s attitude and dress. Bankers will also review one’s history as a business leader, namely one’s track record of success. This notion of character may also be extended to the upper echelon of the management team of a small business.
• Ability. The bank’s prime concern is with repayment of the principal and the interest of a loan. The loan application should clearly demonstrate a business’s ability to repay the loan. All support materials should be brought to bear to prove to the banker that the loan will not be defaulted on and will be paid in a timely fashion.
• Means. This refers to a business’s ability to function in a way so that it can repay the loan. Bankers must be convinced of this crucial point. The best way to do this is by providing a comprehensive business plan with detailed numbers that indicate the business’s ability to repay the loan. The business plan should also include the business strategy and the business model that will be employed to convince the banker of the validity of the overall plan.
• Purpose. Bankers want to know for what purpose the borrowed money will be used. You should never request a loan with the argument that having more money is better for the business than having less money. You should clearly identify how the money will be used, such as purchasing a piece of capital equipment. Having done that, you should also indicate how the acquisition of the capital equipment will positively affect the bottom line of the business.
• Amount. It would be extraordinarily inadvisable to begin a request for a business loan by saying “I need some money.” It is very important that you specify the exact amount of the loan and also justify how you determined this amount of money. As an example, you might want to identify a particular piece of capital equipment that you plan to acquire. How did you determine its price? You should be able to address what additional expenditures might be required—such as training on the use of the equipment. The greater the degree of precision that is brought to this proposal, the greater the confidence the bank might have in granting the loan.
• Repayment. This refers to demonstrating an ability to repay both the interest and the principal. Again, detailed documentation, such as sales projections, profit margins, and projected cash flows, is essential if you wish to secure the loan. It is important when generating these data that you try to be as honest as possible. Extremely positive projections may be misleading. Worse still, if they are misleading and inaccurate, it may result in the business defaulting on the loan and perhaps losing the business.
• Insurance. Even the most scrupulously developed sales and profit projections might not pan out. It would be extraordinarily useful to show contingency plans to the bank that would indicate how you would repay the loan in the event that the scenarios that you have identified do not come to fruition.
One should recognize that a good relationship with the bank can yield benefits above and beyond credit lines and business loans. Bankers can serve as interlocutors, connecting you to potential customers, suppliers, and other investors. A good working relationship with a bank can be the best reference a business could have. This is particularly true in the current business climate where bankers have significantly restricted lending to small businesses.
KEY TAKEAWAYS
• Any business owner must be aware that bankers consider several factors when considering a loan decision.
• Business owners should be aware of their own and their business’s creditworthiness.
• Business owners should be aware that bankers appreciate precision, particularly when it comes to the exact size of the loan, its purpose, and how it will be repaid.
EXERCISES
1. Arrange an interview with a loan officer at a local bank. Ask him or her what factors are considered when evaluating a small business loan for
1. a start-up business
2. a line-of-credit
3. an equipment purchase
4. a real estate purchase
2. Ask him or her how the bank evaluates the risk associated with these loans.
3. Ask the loan officer what might constitute a “red flag” that would mean that the loan would not be approved. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/10%3A_Financial_Management/10.03%3A_Financial_Control.txt |
Learning Objectives
1. Learn the importance of a breakeven analysis.
2. Understand how to conduct a breakeven analysis.
3. Understand the potential power and danger of financial leverage.
4. Learn how changing financial leverage can affect measures of profitability, such as ROA and ROE.
5. Learn how to use scenarios to evaluate the impact of various levels of financial leverage.
Breakeven Analysis
A breakeven analysis is remarkably useful to someone considering starting up a business. It examines a business’s potential costs—both fixed and variable—and then determines the sales volume necessary to produce a profit for given selling price.“Breakeven Analysis: Know When You Can Expect a Profit,” Small Business Administration, accessed December 2, 2011, www.sba.gov/content/breakeven-analysis -know-when-you-can-expect-profit. This information enables one to determine if the entire concept is feasible. After all, if one has to sell five million shoes in a small town to turn a profit, one would immediately recognize that there may be a severe problem with the proposed business model.
A breakeven analysis begins with several simplifying assumptions. In its most basic form, it assumes that you are selling only one product at a particular price, and the production cost per unit is constant over a wide range of values. The purpose of a breakeven analysis is to determine the sales volume that is required so that you neither lose money nor make a profit. This translates into a situation in which the profit level is zero. Put in equation form, this simply means
total revenue − total costs = \$0.
By moving terms, we can see that the break-even point occurs when total revenues equal total costs:
total revenue = total costs.
We can define total revenue as the selling price of the product times the number of units sold, which can be represented as follows:
total revenue (TR) = selling price (SP) × sales volume (Q)TR = SP × Q.
Total costs are seen as being composed of two parts: fixed costs and total variable costs. Fixed costs exist whether or not a firm produces any product or has any sales and consist of rent, insurance, property taxes, administrative salaries, and depreciation. Total variable costs are those costs that change across the volume of production. As part of the simplifying assumptions of the breakeven analysis, it is assumed that there is a constant unit cost of production. This would be based on the labor input and the amount of materials required to make one unit of product. As production increases, the total variable cost will likewise increase, which can be represented as follows:
total variable costs (TVC) = variable cost per unit (VC) × sales quantity (Q)TVC = VC × Q.
Total costs are simply the summation of fixed costs plus the total variable costs:
total costs (TC) = [fixed costs (FC) + total variable cost (TVC)]TC = FC + TVC.
The original equation for the break-even point can now be rewritten as follows:
[selling price (SP) × sales volume (Q)] − total costs (TC) = \$0(SP × Q) − TC = \$0.
At the break-even point, revenues equal total costs, so this equation can be rewritten as
SP × Q = TC.
Given that the total costs equal the fixed costs plus the total variable costs, this equation can now be extended as follows:
selling price (SP) × sales volume (Q) = [fixed costs (FC) + total variable costs (TVC)]SP × Q = FC + TVC.
This equation can be expanded by incorporating the definition of total variable costs as a function of sales volume:
SP × Q = FC + (VC × Q).
This equation can now be rewritten to solve for the sales value:
(SP × Q) − (VC × Q) = FC.
Because the term sales volume is present in both terms on the left-hand side of the equation, it can be factored to produce
Q × (SP − VC) = FC.
The sales value to produce the break-even point can now be solved for in the following equation:
Q = FC / (SP − VC).
The utility of the concept of break-even point can be illustrated with the following example.
Carl Jacobs, a retired engineer, was a lifelong enthusiast of making plastic aircraft models. Over thirty years, he entered many regional and national competitions and received many awards for the quality of his model building. Part of this success was due to his ability to cast precision resin parts to enhance the look of his aircraft models. During the last ten years, he acquired a reputation as being an expert in this field of creating these resin parts. A friend of his, who started several businesses, suggested that Carl look at turning this hobby into a small business opportunity in his retirement. This opportunity stemmed from the fact that Carl had created a mold into which he could cast the resin part for a particular aircraft model; this same mold could be used to produce several hundred or several thousand copies of the part, all at relatively low cost.
Carl had experience only with sculpturing and casting parts in extremely low volumes—one to five parts at a time. If he were to create a business format for this hobby, he would have to have a significant investment in equipment. There would be a need to create multiple metal molds of the same part so that they could be cast in volume. In addition, there would be a need for equipment for mixing and melting the chemicals that are required to produce the resin. After researching, he could buy top-of-the-line equipment for a total of \$33,000. He also found secondhand but somewhat less efficient equipment. Carl estimated that the total cost of acquiring all the necessary secondhand equipment would be close to \$15,000. After reviewing the equipment specifications, he concluded that with new equipment, the unit cost of producing a set of resin parts for a model would run \$9.25, whereas the unit cost for using the secondhand equipment would be \$11.00. After doing some market research, Carl determined that the maximum price he could set for his resin sets would be \$23.00. This would be true whether the resin sets were produced with new or secondhand equipment.
Carl wanted to determine how many resin sets would have to be sold to break even with each set of equipment. For simplicity’s sake, he assumed that the initial purchase price of both options would be his fixed cost. His analysis is presented in Table \(1\).
Table \(1\): break-even point Analysis
Option Fixed Costs Variable Cost Selling Price break-even point
New equipment \$33,000 \$9.25/unit \$23.00
Q = \$33,000 / (\$23.00 − \$9.25)
Q = \$33,000 / \$13.75
Q = 2,400 units
Secondhand equipment \$15.000 \$11.00/unit \$23.00
Q = \$15,000 / (\$23.00 − \$11.00)
Q = \$15,000 / \$12.00
Q = 1,250 units
From this analysis, he could see that although the secondhand equipment is not as efficient (hence the higher variable cost per unit), it will break even at a significantly lower level of sales than the new equipment. Carl was still curious about the profitability of the two sets of equipment at different levels of sales. So he ran the numbers to calculate the profitability for both sets of equipment at sales levels of 1,000 units, 3,000 units, 5,000 units, 7,500 units, and 10,000 units. The results are presented in Table \(2\).
Table \(2\): Sales Level versus Profit Breakdown
Secondhand Equipment New Equipment
Sales Level Revenue Fixed Cost Total Variable Costs Profit Revenue Fixed Cost Total Variable Costs Profit
1,000 \$23,000 \$15,000 \$11,000 \$(3,000) \$23,000 \$33,000 \$9,250 \$(19,250)
3,000 \$69,000 \$15,000 \$33,000 \$21,000 \$69,000 \$33,000 \$27,750 \$8,250
5,000 \$115,000 \$15,000 \$55,000 \$45,000 \$115,000 \$33,000 \$46,250 \$35,750
7,500 \$172,500 \$15,000 \$82,500 \$75,000 \$172,500 \$33,000 \$69,375 \$70,125
10,000 \$230,000 \$15,000 \$110,000 \$105,000 \$230,000 \$33,000 \$92,500 \$104,500
From these results, it is clear that the secondhand equipment is preferable to the new equipment. At 10,000 units, the highest annual sales that Carl anticipated, the overall profits would be greater with secondhand equipment.
Video Clip \(1\):
Breakeven Analysis: Economics for Managers
A slide show showing breakeven calculations.
Video Clip \(2\):
Breakeven Analysis
A breakeven tutorial with voice-over.
Video Clip \(3\):
Perform a Breakeven Analysis with Excel’s Goal Seek Tool
Shows how Excel can be used to conduct sophisticated breakeven analyses.
Breakeven Analysis
This site provides a straightforward description of breakeven analysis with an example.
Capital Structure Issues in Practice
In "Financial Control", the need to balance debt and equity, with respect to financing a firm’s operations, is briefly discussed. A critical financial decision for any business owner is determining the extent of financial leverage a firm should acquire. Building a firm using debt amplifies a return of equity to the owners; however, the acquisition of too much debt, which cannot be repaid, may lead to a "Foundations for Small Business" bankruptcy, which represents a complete failure of the firm.
In the early 1950s, the field of finance tried to describe the effect of financial leverage on the valuation of a firm and its cost of capital.David Durand, “Cost of Debt and Equity Funds for Business: Trends and Problems of Measurement,” Conference on Research in Business Finance (New York: National Bureau of Economic Research, 1952), 220. A major breakthrough occurred with the works of Franco Modigliani and Merton Miller.Franco Modigliani and Merton Miller, “The Cost of Capital, Corporation Finance and the Theory of Investment,” American Economic Review 48, no. 3 (1958): 261–97; Franco Modigliani and Merton Miller, “Taxes and the Cost of Capital: A Correction,” American Economic Review 53 (1963): 433–43. Reduced to simplest form, their works hypothesized that the valuation of a firm increases as the financial leverage increases. This is true but only up to a point. When a firm exceeds a particular value of financial leverage—namely, it has assumed too much debt—the overall value of the firm begins to decline. The point at which the valuation of a firm is maximized determines the optimal capital structure of the business. The model defined valuation as a firm’s earnings before interest and taxes (EBIT) divided by its cost of capital. Cost of capital is a weighted average of a firm’s debt and equity, where equity directly relates to a firm’s stock. The reality is that this model is far more closely attuned, from a mathematical standpoint, to the corporate entity. It cannot be directly applied to most small businesses. However, the basic notion that there is some desired level of debt to equity, a level that yields maximum economic benefit, is germane, as we will now illustrate.
Let us envision a small family-based manufacturing firm that until now has been able to grow through the generation of internal funds and the equity that has been invested by the original owners. Presently, the firm has no long-term debt. It has a revolving line of credit, but in the last few years, it has not had to tap into this line of credit to any great extent. The income statement for the year 2010 and the projected income statement for 2011 are given in Table \(3\):. In preparing the projected income statement for 2011, the firm assumed that sales would grow by 7.5 percent due to a rapidly rising market. In fact, the sales force indicated that sales could grow at a much higher rate if the firm can significantly increase its productive capacity. The projected income statement estimates the cost of goods sold to be 65 percent of the firm’s revenue. This estimate is predicated on the past five years’ worth of data. Table \(4\) shows an abbreviated balance sheet for 2010 and a projection for 2011. The return on assets (ROA) and the return on equity (ROE) for 2010 and the projected values for 2011 are provided in Table \(5\):.
Table \(3\): Income Statement for 2010 and Projections for 2011
2010 2011
Revenue \$475,000 \$510,625
Cost of goods sold \$308,750 \$331,906
Gross profit \$166,250 \$178,719
General sales and administrative \$95,000 \$102,125
EBIT \$71,250 \$76,594
Interest \$— \$—
Taxes \$21,375 \$22,978
Net profit \$49,875 \$53,616
Table \(4\): Abbreviated Balance Sheet
2010 2011
Total assets \$750,000 \$765,000
Long-term debt \$— \$—
Owners’ equity \$750,000 \$765,000
Total debt and equity \$750,000 \$765,000
Table \(5\): ROA and ROE Values for 2010 and Projections for 2011
2010 (%) 2011 (%)
Return on assets 6.65 7.01
Return on equity 6.65 7.01
After preparing these projections, the owners were approached by a company that manufactures computer-controlled machinery. The owners were presented with a series of machines that will not significantly raise the productive capacity of their business while also reducing the unit cost of production. The owners examined in detail the productive increase in improved efficiency that this computer-controlled machinery would provide. They estimated that demand in the market would increase if they had this new equipment, and sales could increase by 25 percent in 2011, rather than 7.5 percent as they had originally estimated. Further, the efficiencies brought about by the computer-controlled equipment would significantly reduce their operating costs. A rough estimate indicated that with this new equipment the cost of goods sold would decrease from 65 percent of revenue to 55 percent of revenue. These were remarkably attractive figures. The only reservation that the owners had was the cost of this new equipment. The sales price was \$200,000, but the business did not have this amount of cash available. To raise this amount of money, they would either have to bring in a new equity partner who would supply the entire amount, borrow the \$200,000 as a long-term loan, or have some combination of equity partnership and debt. They first approached a distant relative who has successfully invested in several businesses. This individual was willing to invest \$50,000, \$100,000, \$150,000, or the entire \$200,000 for taking an equity position in the firm. The owners also went to the bank where they had line of credit and asked about their lending options. The bank was impressed with the improved productivity and efficiency of the proposed new machinery. The bank was also willing to lend the business \$50,000, \$100,000, \$150,000, or the entire \$200,000 to purchase the computer-controlled equipment. The bank, however, stipulated that the lending rate would depend on the amount that was borrowed. If the firm borrowed \$50,000, the interest rate would be 7.5 percent; if the amount borrowed was \$100,000, the interest rate would increase to 10 percent; if \$150,000 was the amount of the loan, the interest rate would be 12.5 percent; and if the firm borrowed the entire \$200,000, the bank would charge an interest rate of 15 percent.
To correctly analyze this investment opportunity, the owners could employ several financial tools and methods, such as net present value (NPV). This approach examines a lifetime stream of additional earnings and cost savings for an investment. The cash flow that might exist is then discounted by the cost of borrowing that money. If the NPV is positive, then the firm should undertake the investment; if it is negative, the firm should not undertake the investment. This approach is too complex—for the needs of this text—to be examined in any detail. For the purpose of illustration, it will be assumed that the owners began by looking at the impact of alternative investment schemes on the projected results for 2011. Obviously, any in-depth analysis of this investment would have to entail multiyear projections.
They examined five scenarios:
1. Their relative provides the entire \$200,000 for an equity position in the business.
2. They borrow \$50,000 from the bank at an interest rate of 7.5 percent, and their relative provides the remaining \$150,000 for a smaller equity position in the business.
3. They borrow \$100,000 from the bank at an interest rate of 10 percent, and their relative provides the remaining \$100,000 for a smaller equity position in the business.
4. They borrow \$150,000 from the bank at an interest rate of 12.5 percent, and their relative provides the remaining \$50,000 for an even smaller equity position in the business.
5. They borrow the entire \$200,000 from the bank at an interest rate of 15 percent.
Table \(6\): presents the income statement for these five scenarios. (An abbreviated balance sheet for the five scenarios is given in Table \(7\).) All five scenarios begin with the assumption that the new equipment would improve productive capacity and allow sales to increase, in 2011, by 25 percent, rather than the 7.5 percent that had been previously forecasted. Likewise, all five scenarios have the same cost of goods sold, which in this case is 55 percent of the revenues rather than the anticipated 65 percent if the new equipment is not purchased. All five scenarios have the same EBIT. The scenarios differ, however, in the interest payments. The first scenario assumes that all \$200,000 would be provided by a relative who is taking an equity position in the firm. This is not a loan, so there are no interest payments. In the remaining four scenarios, the interest payments are a function of the amount borrowed and the corresponding interest rate. The payment of interest obviously impacts the earnings before taxes (EBT) and the amount of taxes that have to be paid. Although the tax bill for those scenarios where money has been borrowed is less than the scenario where the \$200,000 is provided by equity, the net profit also declines as the amount borrowed increases.
Table \(6\): Income Statement for the Five Scenarios
Borrow \$0 Borrow \$50,000 Borrow \$100,000 Borrow \$150,000 Borrow \$200,000
Revenue \$593,750 \$593,750 \$593,750 \$593,750 \$593,750
Cost of goods sold \$326,563 \$326,563 \$326,563 \$326,563 \$326,563
Gross profit \$267,188 \$267,188 \$267,188 \$267,188 \$267,188
General sales and administrative \$118,750 \$118,750 \$118,750 \$118,750 \$118,750
EBIT \$148,438 \$148,438 \$148,438 \$148,438 \$148,438
Interest \$— \$3,750 \$10,000 \$18,750 \$30,000
Taxes \$44,531 \$43,406 \$41,531 \$38,906 \$35,531
Net profit \$103,906 \$101,281 \$96,906 \$90,781 \$82,906
Table \(7\): Abbreviated Balance Sheet for the Five Scenarios
Borrow \$0 Borrow \$50,000 Borrow \$100,000 Borrow \$150,000 Borrow \$200,000
Total assets \$965,000 \$965,000 \$965,000 \$965,000 \$965,000
Long-term debt \$— \$50,000 \$100,000 \$150,000 \$200,000
Owners’ equity \$965,000 \$915,000 \$865,000 \$815,000 \$765,000
Total debt and equity \$965,000 \$965,000 \$965,000 \$965,000 \$965,000
The owners then calculated the ROA and the ROE for the five scenarios (see Table \(8\) ). When they examined these results, they noticed that the greatest ROA occurred when the new machinery was financed exclusively by equity capital. The ROA declined as they began to fund new machinery with debt: the greater the debt, the lower the ROA. However, they saw a different situation when they looked at the ROE for each scenario. The ROE was greater in each scenario where the machinery was financed either exclusively or to some extent by debt. In fact, the lowest ROE (the firm borrowed the entire \$200,000) was 50 percent higher than if the firm did not acquire the new equipment. A further examination of the ROE results provides a very interesting insight. The ROE increases as the firm borrows up to \$100,000 of debt. When the firm borrows more money (\$150,000 or \$200,000), the ROE declines (see Figure 10.3 "ROE for the Five Scenarios"). This is a highly simplified example of optimal capital structure. There is a level of debt beyond which the benefits measured by ROE begins to decline. Small businesses must be able to identify their “ideal” debt-to-equity ratio.
Table \(8\): ROA and ROE for the Five Scenarios
Borrow \$0 Borrow \$50,000 Borrow \$100,000 Borrow \$150,000 Borrow \$200,000
ROA 10.77% 10.50% 10.04% 9.41% 8.59%
ROE 10.77% 11.07% 11.20% 11.14% 10.84%
The owners decided to carry their analysis one step further; they wondered if the sales projections were too enthusiastic. They were concerned about the firm’s ability to repay any loan should there be a drop in sales. Therefore, they decided to examine a worst-case scenario. Such analyses are absolutely critical if one is to fully evaluate the risk of undertaking debt. They ran the numbers to see what the results would be if there was a 25 percent decrease in sales in 2011 rather than a 25 percent increase in sales compared to 2010. The results of this set of analyses are in Table \(9\). Even with a heavy debt burden for the five scenarios, the firm is able to generate a profit, although it is a substantially lower profit compared to if sales increased by 25 percent. They examined the impact of this proposed declining sales on ROA and ROE. These results are found in Table \(10\).
Table \(9\):Income Statement for the Five Scenarios Assuming a 25 Percent Decrease in Sales
Borrow \$0 Borrow \$50,000 Borrow \$100,000 Borrow \$150,000 Borrow \$200,000
Revenue \$356,250 \$356,250 \$356,250 \$356,250 \$356,250
Cost of goods sold \$195,938 \$195,938 \$195,938 \$195,938 \$195,938
Gross profit \$160,313 \$160,313 \$160,313 \$160,313 \$160,313
General sales and administrative \$71,250 \$71,250 \$71,250 \$71,250 \$71,250
EBIT \$89,063 \$89,063 \$89,063 \$89,063 \$89,063
Interest \$— \$3,750 \$10,000 \$18,750 \$30,000
Taxes \$26,719 \$25,594 \$23,719 \$21,094 \$17,719
Net profit \$62,344 \$59,719 \$55,344 \$49,219 \$41,344
Table 10.10 ROA and ROE for the Five Scenarios under the Condition of Declining Sales
Borrow \$0 Borrow \$50,000 Borrow \$100,000 Borrow \$150,000 Borrow \$200,000
ROA 6.46% 6.19% 5.74% 5.10% 4.28%
ROE 6.46% 6.53% 6.40% 6.04% 5.40%
Video Clip \(4\):
Debt Financing versus Equity Financing: Which Is Best for Us?
Overview of the benefits and dangers associated with debt financing and equity financing.
Video Clip \(5\):
Capital Structure
Compares capital structure to a commercial aircraft.
Video Clip \(6\):
Lecture in Capital Structure
Explains why capital structure matters.
Video Clip \(7\):
The Capital Structure of a Company
Discusses the issue of long-term and short-term debt in capital structure.
KEY TAKEAWAYS
• A relatively simply model—breakeven analysis—can indicate what sales level is required to start making a profit.
• Financial leverage—the ratio of debt to equity—can improve the economic performance of a business as measured by ROE.
• Excessive financial leverage—too much debt—can begin to reduce the economic performance of a business.
• There is an ideal level of debt for a firm, which is its optimal capital structure.
EXERCISES
1. A new start-up business will have fixed costs of \$750,000 per year. It plans on selling one product that will have a variable cost of \$20 per unit. What is the product’s selling price to break even?
2. Using data from the business in Exercise 1, in its second year of operation, it adds a second selling facility, which increases the fixed cost by \$250,000. The variable cost has now decreased by \$2.50 per unit. What is the new selling price to break even?
3. Using the example in "Capital Structure Issues in Practice", how would the ROA and the ROE change if economic conditions made borrowing money more expensive? Specifically, what would be the impact if the interest rate on \$50,000 was 10 percent; \$100,000, 15 percent; \$150,000, 17.5 percent; and \$200,000, 20 percent?
4. Again using the example in "Capital Structure Issues in Practice", how much would sales have to decrease to threaten the business’s ability to repay its interest on a \$100,000 loan? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/10%3A_Financial_Management/10.04%3A_Financial_Decision_Making.txt |
Learning Objectives
1. Understand that effective and efficient financial management can enhance value provided to customers.
2. Appreciate that effective financial management can improve the firm’s cash-flow position.
3. Understand that the use of technologies can significantly reduce cost of operations and improve profitability.
Customer Value
In "Your Business Idea: The Quest for Value", "Marketing Basics", and "Marketing Strategy", there has been extensive discussion of the notion of market segmentation. By segmenting the market, one improves the probability that a business will be able to better serve particular customers’ needs and thus provide better customer value. From a financial perspective, there may be an equivalent notion of segmentation. Earlier discussions on market segmentation were centered on how a business could provide value to particular sets of customers. A subsequent stage of this analysis would be to examine how and if these customers can provide value to a business. No one is served if the business provides significant value to its customers but the business goes broke in the process. The financial equivalent of customer segmentation examines the profitability of different groups of customers. Some customer groups may be extremely profitable to a firm, while others produce nothing but losses. Identifying these different groups requires a commitment to accounting and a financial analysis of each customer base. The first step is to determine the margin provided by each customer group. In many cases, this is a bit of a challenge. It may require more extensive record keeping. The business may have to use activity-based costing systems. (Activity-based costing systems were developed in the late 1970s and the early 1980s.) This approach to accounting “is a process where costs are assigned due to the cause and effect relationship between costs and the activity that drives the cost.”Tiffany Bradford, “Activity-Based Costing,” Accounting @ Suite 101, accessed December 2, 2011, tiffany-bradford.suite101.com/activitybased-costing-abc-a52148.
Done properly, activity-based accounting can help a business identify the true costs for serving particular customer groups and therefore identify their real profit margins. A business may discover that some customer groups are actually a source of losses for the firm.
It should be pointed out that activity-based accounting is complex, difficult to implement, and, in some instances, does not conform to the requirements of generally accepted accounting principles. This might mean that a business would have to have two coexisting accounting systems, which may be too much of a burden for the small business.
Cash-Flow Implications
It should not be too surprising to find that good financial management can benefit tremendously when a firm’s cash flow is improved. Two areas where good financial management can help would be e-procurement and factoring. E-procurement involves managing the timing of invoices to customers and from suppliers to improve the cash flow of the firm.Peter Robbins, “E-Procurement—Making Cash Flow King,” Credit Control 26, no. 2 (2005): 23–26. The electronic handling of orders and their associated invoices assures that customers will receive their orders in a more timely fashion. E-procurement means that fewer personnel are required to take and handle orders. This can be a tremendous source of cash saving in and of itself. E-procurement should be on any supply chain management program of a business. We discuss supply chain management in "People and Organization".
Another area where good financial management can improve cash flow is factoring. The most common form of factoring is associated with a business’s accounts receivable. Trade credits involve purchasing and taking delivery of supplies now while planning to pay for it later. (See "The Importance of Financial Management in Small Business" for a discussion of trade credits.) Three key numbers often identify trade credits: a discount rate for early payment, the time to pay to take advantage of the discount rate, and the date by which the entire bill must be paid. We underscore the kinds of the factoring with the following example.
A firm makes a large sale of supplies—\$200,000. The trade credit program is 2/10/60. This means that the firm will give a 2 percent discount if the customer pays the entire \$200,000 within 10 days and expects the payment of the entire \$200,000 within the next 60 days. The firm knows that its customer never exercises the discount opportunity and always pays on the last possible date. Further, let us assume that this firm is having a problem with its cash flow. It would like to expedite payment as quickly as possible but does not expect that the customer will obtain a 2 percent discount by paying within 10 days. This firm could exercise the factoring option. This business goes to another firm that would provide as much as 80 percent of the cash receivable invoice immediately for small fee. In other words, the firm would receive \$160,000 immediately rather than waiting 60 days. When its customer pays the bill, the firm would receive, in total, slightly less than the \$200,000 but would have expedited the payment and thus aided its cash flow. Factoring can be an important element in improving the overall cash flow of any firm.
Digital Technology and E-Environment Implications
We identify four sources of capital in "The Importance of Financial Management in Small Business", one of which is internally generated funds. Businesses can increase the supply of capital money by becoming more operationally efficient. Improved operational efficiency can save any organization considerable amounts of money. Many start-ups, particularly those with some technological savvy, use technology to produce significant cost savings. This recognition of the vital role of technology as a cost-saving tool came to the forefront at a recent GeeknRolla conference in London. This conference brings together new business start-ups and potential investors. There is a heavy emphasis on how new businesses (and established businesses) can successfully integrate a variety of technologies and improve their operational efficiencies. As one participant in the conference, Michael Jackson, an investor, said, “Companies that are cottoning on quickly to these tools are doing very well, and they are taking business away from those who are too slow to adapt.”Sharif Sakr, “GeeknRolla: Tech Start-Ups Reveal Cost-Cutting Tips,” BBC Business, accessed December 2, 2011.
The 2011 conference paid special attention to the concept of cloud computing. This term refers to having software programs and databases located on an outsourced site. As an example, rather than buying Microsoft’s Office Suite for every computer in a business, one could access a word-processing program, a spreadsheet program, or a database as needed. The firm would be charged for each use or a monthly fee rather than having to purchase an entire package. "The Three Threads" mentions that one can even access an entire accounting system as a part of a cloud computing option. As Sharif Sakr said, “In addition to being ‘pay-as-you-go,’ cloud computing has the advantage of reducing the number of computers, servers and network connections that a small business needs.”Sharif Sakr, “GeeknRolla: Tech Start-Ups Reveal Cost-Cutting Tips,” BBC Business, accessed December 2, 2011.
In addition to reducing a small business’s initial commitment to an information technology (IT) infrastructure—computers, software, network systems, and IT staff—cloud computing provides some of the following additional benefits:
• Scalability. Many cloud applications allow for the growth of a business. As an example, some cloud accounting packages charge on the basis of the number of users; therefore, a company could purchase as much capability as it needed.
• Updates. Businesses do not have to worry about purchasing the latest version of the software, uninstalling the old version, and installing the latest version. This is done automatically by the vendor.
• Access. Cloud programs can be accessed wherever one has a connection to the Internet. A business is not tied to its own computer or the network where the software resides. This results in tremendous flexibility; as an example, one can access the program and the data while on the road with a client.
• Integration. Having programs and databases on the cloud facilitates multiple members of an organization successfully working together. No one has to worry whether he or she is working with the latest version of the spreadsheet or the client list.
• Security. Cloud providers recognize that securing their client’s data is a core issue for business survival. They will bring into play the required technology to ensure that every one’s data are secure and safe. They have much greater capability of assuring this than almost any small business.
• Customization. Businesses can acquire the software that they need.
• Extensions into the world of social media. More and more businesses are using various forms of social media—Facebook, Twitter, LinkedIn, and so forth—yet many small businesses lack the technological savvy to fully exploit these new avenues of marketing. Cloud providers can assist these businesses in this vital area.Eilene Zimmerman, “A Small Business Made to Seem Bigger,” New York Times, March 2, 2011, accessed December 2, 2011, www.nytimes.com/2011/03/03/business/smallbusiness/03sbiz.html?_r=1.
So how can smaller businesses aspire to efficiencies that much larger organizations have achieved through the use of IT while achieving it at a fraction of the cost? Entire accounting systems can be placed on the cloud. FreshBooks, which is free for solo location businesses, provides an accounting system that can be extended to allow business operators to submit invoices via the iPhone. Shoeboxed, another cloud-based company, allows small businesses to take digitalized receipts and turn them into invoices.
Owners and employees can more productively manage their time by using a variety of scheduling programs. TimeTrade is an effective personal scheduling assistant. It can show prospective clients available times and assist in arranging a scheduled appointment. Major companies, such as Microsoft and Google, provide cloud-based applications that can be employed by both large corporations and the smallest of businesses. Microsoft has an e-mail system—Exchange—that can be used by smaller businesses for fees as low as \$50 per month. Google Voice can translate voice mail and e-mail messages and forward them anywhere in the world. Programs such as Mail-Chimp can send information packages to any or all of a business’s clients and then automatically post the same information on the company’s Facebook and Twitter sites.
KEY TAKEAWAYS
• Just as a business must identify what is of value to its customers, it should also determine how valuable its customers are to the business.
• It may not “pay” to attract and keep all customers.
• Techniques such as factoring accounts receivable may improve the cash flow of a firm.
• The use of cloud computing can significantly reduce costs and improve the financial position of a firm.
• Local, national, and international economic conditions can affect any firm. Businesses should plan on how to deal with major economic upheavals.
EXERCISES
1. Search the Internet to find out about the availability and price of activity-based accounting software.
2. Imagine your boss has asked you to prepare a small report on using factoring as an option in her auto parts business. Search the Internet to find out about the economics of factoring.
3. Prepare a report on accounting and finance software packages available through cloud computing. Discuss their pros, cons, and pricing structures.
Disaster Watch
At the beginning of "Financial Management", it was stated that a major cause of failure in small businesses is inadequate financial management. If one looks at that statement at face value, the only conclusion one can come to is that failure solely rests on the shoulders of the small business owner. This is far from the full story. Small businesses can face disastrous financial situations over which they have absolutely no control. This simple fact has been brought to the forefront in the last few years with the economic downturn.
For most small businesses, the major source of external financing comes from banks. Anything that affects the banks’ ability or desire to lend to small businesses can have a profound effect. One of the first responses on the part of commercial banks to the crisis of 2008 was a severe restriction of credit. At the height of the crisis in October 2008, nearly 72 percent of large banks and 78 percent of small banks stated that they were tightening their credit standards for small businesses.“How Will a Credit Crunch Affect Small Business Finance?,” Federal Reserve Bank of San Francisco, March 6, 2009, accessed December 2, 2011, . This slightly more restrictive approach on the part of smaller banks represented a change from some prior recessions. Berger and Udell (1994) found that during the credit crunch of 1990–92 smaller banks were more willing to lend than larger banks.Allen N. Berger and Gregory F. Udell, “Did Risk-Based Capital Allocate Bank Credit and Cause a Credit Crunch in the US?,” Journal of Money, Credit and Banking 26 (1994): 585–628.
The current credit crunch has even more significance for small businesses. The originator of current economic difficulties was in the US real estate industry. The result has been a significantly depressed real estate market. Many small businesses use either personal residences or business property (real estate) as the basis for collateral to secure loans. A depressed real estate market reduces the viability of this option. Other negative consequences for small businesses in this current economic environment revolve around its impact on alternatives of raising capital via commercial bank loans. In earlier credit crunches, many small businesses turned to commercial finance companies. These types of companies would lend money to small businesses that pledged assets as collateral.Gregory F. Udell, Asset-Based Finance: Proven Disciplines for Prudent Lending (New York: Commercial Finance Association, 2004), 16. Since the early 1990s, many of these firms either disappeared or have been absorbed by larger commercial banking institutions. Today, many of the largest firms in the United States are holding onto cash (some estimate it in the neighborhood of \$2 trillion to \$3 trillion). Their unwillingness to spend or invest is impacting smaller businesses that operate further down the supply chain. Another impact of the current economic crisis has been that many banks have changed their lending practices for credit cards. They have raised rates, raised fees, and lowered credit limits. Many small businesses are sometimes reduced to using credit cards as a basis for attaining short-term financing for purchases or meeting bills. This sudden change in the “rules of the game” for credit cards has presented many small businesses with an unexpected challenge.
None of these changes in the financial landscape were brought about by the decision making or the knowledge of entrepreneurs and small business operators. Only an extraordinarily small number of financial experts saw the crisis coming. Nonetheless, entrepreneurs and small business owners have found that they must learn to rapidly adapt to what is simply a disastrous situation. The financial lesson to be learned from the current crisis is that any business, particularly small businesses, must prepare to have alternative sources of financing available for the continued operations. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/10%3A_Financial_Management/10.05%3A_The_Three_Threads.txt |
R. W. Hine
Source: Used with permission from R. W. Hine.
No business—small, midsize, or large—survives for more than a century without successfully identifying changing customer needs and adapting its processes and technologies. The adoption of new technologies is not limited to advanced manufacturing or web-based business. New technologies can be crucial to any business, even a business as seemingly prosaic as the local hardware store. However, successfully running a business with an inventory between twenty-five thousand and thirty thousand different items is anything but prosaic.
R. W. Hine has been a central fixture in Cheshire, Connecticut, since it was established in 1910. For the last quarter century, it has been owned and managed by Pat Bowman.
It is obvious that any local hardware store, which must carry an extremely large number of different products, faces a considerable challenge when competing with big box stores such as Home Depot or Lowe’s. Hine is a relatively small enterprise with approximately twenty-five employees, many of whom are high school or college students working part time. Hine is able to effectively compete because of two main factors. The first is an edge seen in many small businesses—a clear focus on identifying and meeting what constitutes customer value and meeting it rapidly. A typical example is as follows: in anticipation of a major winter storm, Hine quickly stocked up on roof rakes—a tool that is used to remove heavy snow from roofs. Hine has had a tremendous success meeting the special needs of its customers. The second factor is Hine’s membership in the ACE Hardware Cooperative. ACE Hardware was founded in 1924 to centralize purchasing for member stores. In 1973, ACE Hardware became a cooperative. Today, it consists of nearly 4,500 member hardware stores. The cooperative centralizes purchasing for all members. It provides all members with the benefit of volume purchasing, which significantly reduces costs. The cooperative also simplifies inventory maintenance issues for its member stores. A member store can either order items directly from a participating supplier or have items shipped from an ACE Hardware warehouse. Shipments are generally done on a weekly or a semiweekly basis. Such rapid turnaround allows member stores, such as Hine, to respond to customer demand. Hine also uses Epicor enterprise resource planning (ERP) software. It enables Hine to monitor its historic sales information, set targeted inventory levels, and suggest reorder times. The juxtaposition of a commitment to giving customers value and the effective use of supply chain management techniques appear to prove that this local hardware store will succeed in its second century of operation.
11.02: The Supply Chain and a Firm's Role in It
Learning Objectives
1. Understand what is meant by the term supply chain management.
2. Understand the four components of supply chain management.
3. Understand the “bullwhip” phenomenon.
4. Recognize the benefits for a small business in adopting supply chain management.
No man is an island, entire of itself. John Donne, “XVII. Meditation,” The Literature Network, accessed February 4, 2012, www.online-literature.com/donne/409.
John Donne
Given the almost daily exposure and coverage of modern business theories or concepts in the popular press, one of the great challenges for both small business owners and corporate executives is the need to separate the wheat from the chaff. In the last four or five decades, businesspeople have heard and read about the next great idea that will revolutionize business as we know it. One almost feels obligated to run out and buy a book that lays out the general principles of concepts such as management by objectives, business process reengineering, transactional versus transformational leadership, management by walking around, the learning organization, matrix management, benchmarking, lean methodologies, and several quality systems—total quality management, the Deming method, and Six Sigma. Some of these have proven to be business fads and have run their course—sometimes with poisonous effects. John Mickletwait and Adrian Woodridge, Witch Doctors: Making Sense of the Management Gurus (New York: Time Books, 1996), 22. Others, such as lean methodologies and some quality systems, have proven to be solid bases on which to improve an organization’s efficiency and effectiveness.
A modern concept that has been popularized over the last two decades is that of supply chain management. In one sense, supply chain management is as old as business itself. One has to look only at the traffic along antiquity’s Silk Road trade route. This route was used to move goods across Asia’s vast steppes between China and the Middle East and as far west as ancient Rome. It possessed most of the fundamental elements of today’s supply chain: goods were produced (make), transported (move), deposited in warehouses (store), purchased by merchants (buy), and sold to customers (sell; see \(1\) ). As will be seen, these five activities are the core of any supply chain. Scott Webster, Principles and Tools for Supply Chain Management (Boston: McGraw-Hill, 2008), 62. If these activities have been universal dimensions of business, then what is different about supply chain management? That question will now be addressed.
What Is a Supply Chain?
The owners of many small businesses may pride themselves on knowing many—if not all—of their employees. Other small businesses may have some degree of familiarity with most of their customers. They may have professional contacts with someone at the office of their immediate suppliers. Beyond those contacts, the daily demands of operations may mean that they have failed to see their firm’s position in the larger context known as the supply chain. What precisely do we mean when we use the term supply chain management? Industrial organizations and academics provide several different definitions of supply chain management.
The Council of Supply Chain Management Professionals provides the following definition: “Supply chain management encompasses the planning and management of all activities involved in sourcing and procurement, conversion, and all logistics management activities. Importantly, it also includes coordination and collaboration with channel partners, which can be suppliers, intermediaries, third party service providers, and customers. In essence, supply chain management integrates supply and demand management within and across companies.” “CSCMP Supply Chain Management Definitions,” Council of Supply Chain Management Professionals, accessed February 1, 2012, cscmp.org/aboutcscmp/definitions.asp.
The Association for Operations Management (APICS) defines a supply chain as “a total systems approach to designing and managing the entire flow of information, materials, and services—from raw material suppliers, through factories and warehouses, and finally to the customer…The chain comprises many links, such as links between suppliers that provide inputs, links to manufacturing and service support operations that transform the input into products and services, and links to the distribution and local service providers that localized the product.”APICS—Operations Management Body of Knowledge Framework, 2nd ed. (Chicago: APICS, 2009).
In a seminal article on the subject, supply chain management was defined as follows: “Supply chain management is the systemic, strategic coordination of the traditional business functions and the tactics across these business functions within a particular company and across businesses within the supply chain, for the purposes of improving the long-term performance of the individual companies and the supply chain as a whole.”John Mentzer, William DeWitt, James Keebler, Soonhong Min, Nancy Nix, Carlo Smith, and Zach Zacharia, “Defining Supply Chain Management,” Journal of Business Logistics 22, no. 2 (2001): 7.
For our purpose, we define the supply chain as follows: “It is a systematic and integrated flow of materials, information, and money from the initial raw material supplier through fabricators, manufacturers, warehouses, distribution centers, retailers, and the final customer. Its ultimate objective is the improvement of the entire process, which means an increase of economic performance of all participants and an increase in value for the end customer.”
If we examine these definitions, several common themes stand out. Supply chain management is not limited to the flow of goods and materials. The successful supply chain requires a consideration of both financial flows and information flows across the entire chain (see Figure 11.2 "Additional Flows in a Supply Chain"). A second theme is that organizations must overcome myopia of just being concerned with their immediate suppliers and customers. They must take into consideration their suppliers’ suppliers and their customers’ customers. To be able to do this, organizations must expand the flow of communication and information.
One might easily pose the following question: How has the concept of supply chain management taken off in the last twenty years? The proliferation of supply chain management is a core concept for businesses that can be attributed to several major factors, including the following:
• The increasing importance of globalization. Global trade has seen a spectacular increase in the last half century. It is estimated that international trade has increased by 100 percent increase since 1955.Steve Schifferes, “Globalisation Shakes the World,” BBC News, January 21, 2007, accessed February 1, 2012, news.bbc.co.uk/2/hi/business/6279679.stm. The end of the Cold War in the early 1990s produced a political environment conducive to the promotion of the notion of free trade. Free trade advocates that nations lower or eliminate trade barriers and tariffs so that countries might develop some particular competencies so that they can participate in the global economy. Several trading blocs have been built during the last three decades that facilitate trade among their partners, including the European Union, which currently consists of twenty-seven countries with a total population in excess of five hundred million and a gross domestic product (GDP) greater than that of the United States. The European Union shares a common currency, and there are no trade barriers among its member states. NAFTA stands for the North American Free Trade Agreement and encompasses Canada, the United States, and Mexico. With respect to the combined GDP of these three countries, NAFTA represents the largest trading bloc in the world. Two other trading blocs in the Western Hemisphere are the Dominican Republic-Central American Free Trade Agreement and MERCOSUR (Common Southern Agreement), which promotes trade among Argentina, Brazil, Paraguay, and Uruguay. The spectacular growth of international finance should also be considered when examining the growth of globalism in recent history.
• Changes in consumer demands. Across the world, consumers are becoming progressively more demanding. They expect better quality products with more options and at a lower cost. One has to look only at the global market for cell phones for an example. Even in countries that might be classified as Third World countries, consumers expect to be able to buy cell phones with cutting-edge capability at reasonable prices. This results in a great need for new products, which in turn requires a reduction in life cycle development times. Normally, increasing the product development time would generally result in higher cost, something that is unacceptable today. To meet increasing and often conflicting demands, businesses find that they must work closely with members of their supply chain.
• Organizations that have recognized the need to change. Increasingly, more and more businesses recognize that old models may no longer function. In the past, many businesses strove to be vertically integrated. This meant that they wanted to control as many aspects of their operations as possible. Large oil companies exhibit vertical, industry-wide integration. A firm such as Exxon-Mobil has the capacity to carry out almost all the functions associated with the petroleum industry. Exxon-Mobil has units that can explore for oil, drill for oil, transport oil, refine oil into gasoline, and sell it directly to consumers. In this way, it has almost complete control over the entire supply chain. This approach—total vertical integration—may work in some industries where firms recognize that it is economically advantageous to outsource noncore activities. Firms are making the decision whether to make or buy, and they are finding it financially attractive to have other businesses make components or products for them. As outsourcing became more popular, there was immediate recognition that businesses had to pay careful attention to all the elements of their supply chains. They had to develop working relationships with their suppliers and their customers. As will be highlighted in Section 11.2.1 "Developing New Relationships", successful supply chain management requires new approaches for dealing with suppliers. Those businesses that have successfully made this transition can fully exploit the benefits of supply chain management.
Another area where businesses have learned to change, which has greatly impacted the acceptance of supply chain management, is the change from a push philosophy to a pull philosophy. A push philosophy means that a business produces goods and services and pushes it into the marketplace. A push-based system will forecast demand in the market, produce the required amount, push the product out the door, and hope that the forecast was correct. In contrast, a pull philosophy means that the production of goods and services is initiated only when the marketplace or the consumer demands it. Production is initiated by actual demand.
• Technical innovations. Today’s approach to supply chain management would be impossible without technological revolutions in the fields of communication and computer software. It would be impossible to operate in a global supply chain without the Internet. As will be discussed in Section 11.4 "The Three Threads", software packages for customer relationship management (CRM), warehousing control, inventory management, and supply chain relationship software are vital to the growth of supply chains.
Video Clip \(1\):
What Is a Supply Chain?
A brief explanation of the supply chain.
Video Clip \(2\):
Supply Chain: Three Key Things to Know
Rob O’Byrne of the Logistics Bureau talks about three key concepts for a supply chain.
Video Clip \(3\):
What Is Supply Chain Management?
The first of a series of twelve videos on supply chain management, providing an excellent overview of the subject.
Key Elements of a Supply Chain
What precisely makes up a supply chain management system? Various authors identify the different components or elements of such a system.Martin Murray, “Introduction to Supply Chain Management,” About.com, accessed February 1, 2012,; Phillip Edwards, “Supply Chain for Small Businesses and Its Benefit,” Small and Medium Business Corner, April 22, 2011, accessed February 1, 2012, ; Joel D. Wisner, G. Keong Leong, and Keah-Choon Tan, Principles of Supply Chain Management: A Balanced Approach (Mason, OH: South-Western, 2004), 13. The simple list would include four core elements: procurement, operations, distribution, and integration.
The first of the four elements—procurement—begins with the purchasing of parts, components, or services. However, it does not end with the purchase. Procurement must ensure that the right items are delivered in the exact quantities at the correct location on the specified time schedule at minimal cost. This means that procurement must concern itself with the determination of who should supply the parts, the components, or the services. It must address the question of assurance that these suppliers will deliver as promised. The opening phrase of this question is often as follows: should the business make or buy a particular part or service? The make-or-buy question can have both strategic significance and economic significance. Some businesses will choose not to have others make or provide services because they believe they may lose control over particular technologies or skill sets. Will it benefit a business to have lower cost in the short run yet lose its source of competitive advantage in the long run to another competitor? Overseas outsourcing may pose difficulties with respect to communication difficulties, extended transportation distances, and timelines. The inability to ensure the overall quality of the outsourced item may be a deciding factor in not having another business make the part or provide the service. Recent difficulties with the quality assurance of products made in China have given many American manufacturers second thoughts about outsourcing.
There are, however, reasons for businesses to outsource production or services. The most obvious reason is associated with lower costs. Read the business press and discover the phrase the China price. This refers to the low cost of products produced in China given its low wages. One should not think that outsourcing is associated only with overseas manufacturing. Many firms will domestically outsource certain in-house service activities. The firm ADP specializes in preparing businesses payrolls, employee benefits, and tax compliance. ADP has been successful because it is able to provide a high-quality product at lower cost than many firms could produce in-house. Another reason why a business may outsource production or other activities is that the business is currently unable to meet particular demand levels.
If one were to exclude strategic considerations and merely look at economic issues, many make-or-buy decisions could be fairly straightforward variations of breakeven analysis. Imagine a firm is thinking about outsourcing the manufacture of a particular part to a Chinese firm. The plot is not unique from a technical standpoint, so outsourcing would have no strategic significance. The firm has gathered the data in Table (1\): for its own operations and that of the Chinese firm.
Table \(1\): Data for Domestic Production versus Chinese Outsourcing Option
Costs Domestic Production (\$) Outsourcing to China (\$)
Fixed costs 40,000 4,000
Labor cost per unit 9.90 4.25
Material cost per unit 7.20 7.20
Transportation cost per unit 0.40 3.80
Tariff duty per unit 0.00 1.50
Total cost per unit 17.50 16.75
With these figures, there is no need to conduct a breakeven analysis. Outsourcing to China produces a lower total unit cost, and the fixed costs are significantly lower. The total cost reduction would dictate that China is the preferred location to produce the part. But now envision another scenario, one in which the transportation cost increases by \$2.55 (increasing the transportation cost per unit to \$6.35) and the tariff duty per unit increases by \$1 per unit. These results are presented in Table \(1\).
Table \(1\): Revised Data for Domestic Production versus Chinese Outsourcing Option
Costs Domestic Production (\$) Outsourcing to China (\$)
Fixed costs 40,000 4,000
Labor cost per unit 9.90 4.25
Material cost per unit 7.20 7.20
Transportation cost per unit 0.40 6.35
Tariff duty per unit 0.00 2.50
Total cost per unit 17.50 19.30
Given these changes, we can now conduct a breakeven analysis.
Domestic Production Total Costs Outsourced to China Total Costs
Fixed costs + total variable costs = Fixed costs + total variable costs
\$40,000 + \$17.50 * Q = \$4,000 + \$19.30 * Q
(\$40,000 − \$4,000) = (\$19.30 − \$17.50) * Q
\$36,000 = \$1.80 * Q
break-even point Q = 20,000 units
Q = Quantity
This simply means that if the demand for the part is fewer than 20,000 units, then it is cheaper to produce the part in China; however, if the demand is greater than 20,000 units, it is cheaper to produce the part domestically.
The key issue in procurement is how one goes about selecting and maintaining a supplier, which can be approached from two directions. The first centers on how a firm might evaluate a potential supplier. The second is how a firm evaluates those businesses that are already suppliers to an operation. When looking at the potential suppliers of a business, a firm may be aided by examining those suppliers with some form of certification. Perhaps the most globally recognized certification program is ISO 9000, a program designed to ensure that suppliers are certified and fully committed to quality production. A supplier that is ISO 9000 certified may mean that incoming goods need not be tested. In examining suppliers, one might also look at the number of employees of the potential supplier who have received certification in the area of supply chain management. The Association for Operations Management, formerly known as the American Production and Inventory Control Society (APICS), has a program to certify professionals in supply chain management. After selecting a supplier, one must have a program that continuously evaluates the capability of the supplier. Some of the capabilities that may be considered include on-time delivery, the accuracy of delivery (i.e., correct items in the correct quantities are shipped), the ability to handle fluctuations in demand, and the ability to hold inventory until needed by the customer. One needs a comprehensive set of metrics to perform such an analysis. One set of metrics will be discussed in "Managing Information in New Ways". In addition, one must think about developing a new type of relationship with suppliers, one that is not adversarial but develops a close working relationship bordering on being an alliance.
The second major element of supply chain management system is operations. Having received raw materials, parts, components, assemblies, or services from suppliers, the firm now must transform them and produce the products or the services that meet the needs of its consumers. It must conduct this transformation in an efficient and effective manner for the benefit of the supply chain management system. We will briefly overview those operational activities that most directly relate to supply chain management.
One element is demand management. This involves attempting to match demand with capacity. In a manufacturing environment, this may entail a better and more detailed production schedule. In a service environment, it may entail rescheduling customer appointments to better match service provider availability. A key element is improvements in inventory control, which may be done by using materials requirement planning software or instituting a just-in-time program. Just-in-time attempts to create an inventory system where the inventory arrives exactly when it is needed. Another way of achieving operational efficiency to improve the supply chain management system is by adopting lean methodologies. The essence of lean is attempting to eliminate all forms of waste from a production or service system.
The third element of the supply chain management system is distribution. Distribution involves several activities—transportation (logistics), warehousing, and customer relationship management (CRM). The first and most obvious is logistics—the transportation of goods across the entire supply chain. The need to efficiently transport goods has led to a hierarchy of logistics providers. Some argue that it now consists of a four-party hierarchy. First-party logistics providers are those who wish to ship goods to a particular location. Second-party logistics providers are those businesses that provide the means of transportation, including shipping freight by air, rail, or truck. Second-party logistics providers may also offer warehousing services to temporarily store goods. Third-party logistics providers specialize in offering an array of services to simplify transportation. They offer services that synthesize a variety of services, including the shipping of goods, warehousing, inventory management, and packaging. They also may offer services associated with facilitating customs operation and the resolution of problems associated with international transportation. The range of services can be so extensive that the literature segments third-party logistics providers into four groups.Susanne Hertz and Monica Alfredsson, “Strategic Development of Third-Party Logistics Providers,” Industrial Marketing Management 32, no. 2 (2003): 139. They range from those businesses that pick up and deliver goods to those businesses that essentially perform the entire logistics function for a customer. In the last fifteen years, a fourth level of logistics providers was added to this hierarchy. Although there is some argument as to what distinguishes sophisticated third-party logistics providers from fourth-party logistics providers, the essential distinction is that fourth-party logistics providers function as consultants for supply chain management logistics issues. They are non-asset-based integrators“Fourth-Party Logistics,” Business Dictionary.com, accessed February 27, 2012,.—firms do not own shipping assets or warehouses; they simply provide consulting services.
The CRM component of the distribution element represents an attempt to automate interactions with customers and facilitate the development of sales prospects through software packages. Most small businesses will start using CRM as a means of contacting current customers and future prospective customers. They then move on to software that automates the entire sales process. The ultimate goal of CRM is the greater connection with customers, thus providing them with greater value.
The last element of supply chain management is the need for integration. At the beginning of this chapter, we mentioned that many small businesses are unfamiliar with their immediate customers and their immediate suppliers; however, they may be part of a much larger chain. It is critical that all participants in the service chain recognize the entirety of the service chain. A failure to overcome the myopia of just being concerned with the immediate customer and the immediate supplier can produce significant disruptions in the entire chain. These disruptions can significantly increase costs and destroy value.
The impact of the failure to adopt a system-wide perspective—that is, examining the totality of the chain—is most clearly seen in what is known as the “bullwhip” effect. This effect illustrates how a narrow perspective can produce unexpected consequences. Envision a classic supply chain composed of a retailer—who is supplied by a wholesaler—who in turn is supplied by a distributor with a product coming from the manufacturer. Each element of this chain must forecast its anticipated demand and determine the appropriate levels of inventory. Because no element of this chain wishes to “stock out”—having insufficient inventory to meet a customer’s demand—each element will carry what is known as safety stock. In many cases, the more certain the demand, the greater the need for such safety stock. If demand at the retail level increases, then it follows that demand will also increase at each level further up the supply chain. If demand decreases at the retail level, the demand will likewise decrease further up the chain. The rate at which demand and inventory levels fluctuate is dependent on the lead time at each level in the chain. The delay between an increase for the retail level and the corresponding increase or decrease at the manufacturing level will be a function of this lead time. The bullwhip effect recognizes that the amplitude of inventory swings increases as one travels up the supply chain because each element of the supply chain is a relatively narrow focus of just trying to meet the needs of their customers. If the forecast for “shared” demand across the entire chain could be made simultaneously or if the lead time could be significantly reduced, then this phenomenon would not be quite as dramatic or problematic. The bullwhip effect calls for integrating information across the entire supply chain.
An enterprise resource planning (ERP) system can successfully integrate information across the entire supply chain. An ERP system is an integrated set of computer programs that brings information about a firm’s accounting, financial, sales, and operations into a common database.Cecil C. Bozarth and Robert B. Handfield, Introduction to Operations and Supply Chain Management, 2nd ed. (Upper Saddle River, NJ: Pearson Prentice Hall, 2007), 519. One also needs a series of metrics that would indicate the overall performance of the supply chain. This should also be part of the integration process. We discuss such metrics in Section 11.2.2 "Managing Information in New Ways".
Video Clip \(4\):
Module 2: Buy It: Managing Supply
An introduction to purchasing.
Video Clip \(5\):
Module 3: Make It: Manufacturing and Operations
Manufacturing and supply chain management in local firms operations.
Video Clip \(6\):
Module 4: Move It: Transportation and Logistics
Discussion of the difference between transportation and logistics.
Video Clip \(7\):
Module 5: Sell it and Service It: Retail Considerations
Discussion of supply chains in the retail environment.
Web Resources
Supply Chain Management Description
An introduction to the topic.
www.eil.utoronto.ca/profiles/rune/node5.html
About.com Introduction to Supply Chain Management
Brief coverage of supply chain management for small businesses with additional links.
logistics.about.com/od/forsmallbusinesses/For_the_Small_Business.htm
Big Business Supply Chain Management: A Small Business Option?
Looks at the benefits of supply chain management for smaller businesses.
smallbiztrends.com/2006/05/big-business-supply-chain-management-a-small-business-option.html
KEY TAKEAWAYS
• The supply chain involves the integration of goods, finances, and information from the initial supplier to the final customer.
• A revolution in supply chain management has been produced by globalization, changes in consumer demand, organizations that recognize the need for changing ways of doing business, and technical innovations.
• Supply chains are composed of four major elements: procurement, operations, distribution, and integration.
• Supply chain management should not be seen as appropriate only for large businesses.
EXERCISES
1. Interview the owners of five local businesses and ask them if they have a supply chain management system. If the answer is no, ask them if they intend to have such a system in the near future. If the answer is still no, ask them why not.
2. Ask the business owners how they handle their shipping needs.
3. The bullwhip effect is illustrated by a simulation known as the “BeerGame.” Go to the following website, which has an online version of the game: http://www.masystem.com/Ma-system-consulting/Spela-Beer-Game/Regler. Play the game as the retailer for a fifty-two-week period (it actually takes only a few minutes to play the game). Examine the results and write a short (two- to four-page) paper on what they signify.
4. Repeat Exercise 3 but assume the role of the manufacturer. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/11%3A_Supply_Chain_Management_-_You_Better_Get_It_Right/11.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Learn about the importance of developing new types of relationships with suppliers and customers.
2. Businesses need to strive toward win-win scenarios with their supplier partners.
3. Understand the need for accurate metrics to evaluate the performance of the supply chain management system.
Developing New Relationships
Game theory is a branch of mathematics. Broadly stated, game theory examines competitive situations in which one’s outcomes may be influenced or dictated by the decisions of other players. It has been applied to a variety of worldwide domains, including economics, military operations, political science, and business strategy. It has its own very large literature base, and work in this field has been recognized by several Nobel prizes in economics. To better understand some of the risk associated for small businesses participating in supply chain management, we will briefly look at two types of games: zero-sum games and non-zero-sum games.
Zero-sum games are those in which the total benefits for all participants total zero. Baseball can be seen as a zero-sum game. If one is told that the New York Yankees and the New York Mets played an exhibition game and the Yankees won, then one also knows that the New York Mets lost. Basketball and most games in professional football are also zero-sum games because there is a winner and a loser. Poker can also be seen as a zero-sum game. If your five friends have a Friday night game of poker and one player is up \$100, then you also know that the other four players have suffered a cumulative loss of \$100.
Non-zero-sum games, on the other hand, are those that potentially have net results other than zero. This simply means that the loss of one player does not directly correspond to the game of another player. In a non-zero-sum game, it is possible for all the players to win or for all the players to lose. The classic illustration of a non-zero-sum game is known as the prisoner’s dilemma. The prisoner’s dilemma hypothesizes that two criminals (prisoner A and prisoner B) are arrested and charged with the same crime. At the police station, they are separated, and each is given the following option: if you inform on the other prisoner, you will be set free, while the other prisoner will receive a five-year sentence. Both prisoners would instinctively recognize that if they both remained silent, the police would have insufficient evidence to convict both of the crime. At worst, they would be held in the jail for several months. If, however, both prisoners informed on each other, they would probably receive a two-year sentence. Assuming that both prisoners wish to serve the minimal amount of time, their individual decisions will be dictated by what they believe will be the other prisoner’s decision. There are four possible outcomes to this scenario:
1. Prisoner A informs on prisoner B while prisoner B remains silent. This is a win for prisoner A and a loss for prisoner B. This is a win-lose outcome.
2. Prisoner B informs on prisoner A while prisoner A remains silent. This is a win for prisoner B and a loss for prisoner A. This is a win-lose outcome.
3. Both prisoner A and prisoner B inform on each other. This situation essentially represents a loss for both prisoner A and prisoner B. This is a lose-lose outcome.
4. Both prisoner A and prisoner B trust each other and remain silent. This results in both prisoners doing a minimal amount of time. In effect, this is a win-win for both individuals.
The point of this brief introduction to game theory is to highlight the possibility of creating a win-win scenario. In the prisoner’s dilemma, the key to achieving a win-win outcome is that both parties must have complete trust in each other. This concept of mutual trust plays a critical role in successful supply chain management. Far too often, both the supplier and the customer perceive the relationship as a win-lose outcome only. Customers want suppliers to provide items at the lowest possible cost, with the highest quality, delivered exactly when needed. Customers often use multiple suppliers and play them off against each other to guarantee the lowest possible price. Suppliers want to provide customers with items of the highest possible price, with acceptable quality, and delivered when it is convenient for the supplier. These attitudes produce a “dance” between the customer and the supplier, where both are trying to win even if that means that the other loses. These attitudes often stem from the fact that there is no trust between the customer and the supplier.
W. Edwards Deming, the famous management guru who was most commonly associated with the quality movement, had several interesting insights into areas that would be associated with supply chain management. As one of the few management theorists whose ideas were comprehensive enough to be synthesized into a coherent business philosophy, Deming summarized his approach to management in fourteen points. One of these points is as follows: “End the practice of awarding business on the basis of price. Instead, minimize total cost. Move toward a single supplier for any one item, with a long-term relationship of loyalty and trust.”Ken Boyer and Rohit Verma, Operations and Supply Chain Management for the 21st Century (Mason, OH: South-Western, 2009), 38.
Deming argued that the move toward a single supplier for a particular part could yield significant advantages. Using a single supplier requires that a customer must sign a multiyear agreement with the supplier. This enables both the supplier and the customer to better understand each other’s needs and capabilities. As this knowledge grows, the supplier can better serve the customer by improving quality, design, and service.W. Edwards Deming, The New Economics for Industry, Government, Education, 2nd ed. (Cambridge, MA: MIT Press, 2000), 232. From these improvements, one can easily anticipate that there will be lower costs and higher profits. A multiyear contract with a supplier guaranteeing particular sales is invaluable to many suppliers because of the benefit of such a contract when that supplier must deal with its bank. Deming counters the argument for the need for multiple suppliers, in case a catastrophe or a disaster strikes that single supplier, by suggesting that a tight and trusting relationship will lead the supplier to develop sufficient contingency plans. Deming argues that a sense of joint responsibility comparable to a marriage comes from such trust.
Building such trust between two organizations is not easy. It will often require significant changes in one or both parties. Such change is best induced when it is clear to all participants that there is top-level management support for the new ways of doing business. Top management must articulate the shared vision between the two organizations. Top management must clearly identify the objectives and metrics to be used by both the supplier and the customer. People need to clearly understand the joint benefits from adopting the new way of business. In addition, even with electronic communication, it is highly advisable that members of both organizations meet on a regular basis and perhaps tour each other’s facilities.
The new relationships that are required for the success of any supply chain management program are not easy to implement, but they are vital. Every effort must be made to adopt this win-win perspective.
Video Clip \(1\):
Module 6: Supply Chain Integration
How elements of a supply chain must be brought together.
Video Clip \(2\):
Module 7: Global Supply Chain Management
An examination of global operations.
Video Clip \(3\):
Module 8: Socially Responsible Supply Chain Management
Social responsibility and sustainability are important concepts.
Video Clip \(4\):
Module 9: Business Processes
The moment a customer places an order through delivery.
Video Clip \(5\):
Module 11: Quality Management
Supply chains are tasked with producing high-quality products.
Managing Information in New Ways
Cost, profits, and financial ratios can provide useful insights into the overall efficiency and effectiveness of any business. However, they do not always tell the full story. A sudden spike in the price of oil, a flood that destroys a low-cost supplier, an increase in interest rates, the closing of a large plant in a small town, or a national banking crisis are all external factors that can cripple the financial viability of any business. These external factors lie beyond the control of even the best management team. Sometimes we need to be very careful about what we measure and how we should measure. Although it adds a layer of complexity to a basic accounting system, measurements that are useful for evaluating processes that serve customers can be provided.
When evaluating the supply chain of a business, there is a great need to carefully consider what metrics should be employed. Such a consideration should include at least some of the following factors:
• Total supply chain cost. All the operational expenditures of a cost associated with the requisite information systems.
• Cash-to-cash cycle time. The time between when an organization purchases raw materials and when they are paid by the customer.
• Delivery. The percentage of orders delivered on or before customer due dates.
• Flexibility. The amount of time required to handle a significant ramp up in production.Joel D. Wisner, G. Keong Leong, and Keah-Choon Tan, Principles of Supply Chain Management: A Balanced Approach (Mason, OH: South-Western, 2004), 442.
For those who are seriously committed to maximizing the benefits from successful supply chain management, study the supply chain operations reference (SCOR) model. This model enables businesses to benchmark their supply chain management systems. Developed in 1996 by the Supply Chain Council in conjunction with AMR Research and Pittiglio Rabin Todd and Rath,Scott Webster, Principles and Tools for Supply Chain Management (Boston: McGraw-Hill, 2008), 55. the purpose of the SCOR model is to provide methods to measure and benchmark the performance of the supply chain management system of a business. Currently, one thousand firms, universities, and government agencies participate in the continuing evolution of the SCOR model. It is predicated on three major components: process modeling, performance measurement, and the determination of best practices.
The process-modeling component begins with five essential elements that link together the supply chain: plan, source, make, deliver, and return. Plan refers to those processes associated with the design of the supply chain, planning activities associated with the other four processes, and the implementation of all these plans. These plans should enable management to identify any significant gaps and determine how these gaps will be closed. Source refers to the ordering and the acquisition of goods and services to meet anticipated demand, including purchase orders, scheduling, receipts, and storage. Make refers to those processes used to create the product or the service, including, for example, make to stock, make to order, or engineer to order. Deliver refers to those processes associated with the development and the fulfillment of customer orders, including scheduling, packaging, and shipping all orders. Lastly, return refers to those processes associated with the return of finished products by a customer. The SCOR model attempts to be as inclusive as possible with respect to these five major processes. Each process can be broken down into subcomponents. Currently, there are thirty subcomponents for the plan element, twenty-seven subcomponents for the source element, thirty-one subcomponents for the make element, sixty-one subcomponents for the deliver element, and thirty-six subcomponents for the return element. This program then goes on to identify specific metrics for nearly every subcomponent. It is the most comprehensive system of evaluation for supply chain management.
Video Clip \(6\):
Walmart Logistics
A Walmart logistics commercial.
Video Clip \(7\):
Ford Manufacturing Supply Chain
A Cisco promotional video on supply chain management.
Video Clip \(8\):
Module 10: Measuring Performance
Supply chains are tasked with being effective, efficient, and adaptable.
Web Resources
Game Theory
A comprehensive set of materials from a professor’s course on game theory.
www.agsm.edu.au/bobm/teaching/SGTM.html
Prisoner’s Dilemma
A computer application that allows individuals to play a game based on the prisoner’s dilemma.
www.gametheory.net/Mike/applets/PDilemma
SCOR Frameworks
An overview of SCOR from the Supply Chain Council.
supply-chain.org/resources/scor
The SCOR Model for Supply Chain Strategic Decisions
An article describing SCOR.
scm.ncsu.edu/scm-articles/article/the-scor-model-for-supply-chain-strategic-decisions
KEY TAKEAWAYS
• In game theory’s non-zero-sum model, it is possible to produce win-win scenarios for multiple players.
• Win-win scenarios require mutual trust.
• Supply chain management success needs new levels of trust and respect for it to function properly in the long run.
• Supply chain management needs metrics to evaluate its performance.
• Existing models of supply chain metrics (SCOR) can handle the most complicated of supply chains.
EXERCISES
1. Identify some examples in your life and in business of win-win scenarios.
2. How were these scenarios achieved?
3. What were the greatest threats to these scenarios?
4. Interview five small business owners and ask them if they have had any experiences with win-win scenarios and how were they achieved.
5. Ask the same five small business owners how they measure (if they do) the effectiveness of the performance of their supply chain.
6. Imagine a local bakery that produces goods for a regional supermarket chain. Examine the SCOR model and determine if it is appropriate for evaluating the bakery’s supply chain. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/11%3A_Supply_Chain_Management_-_You_Better_Get_It_Right/11.03%3A_Firm%27s_Role_in_the_Supply_Chain.txt |
Learning Objectives
1. Understand the major benefits to be derived from adopting a supply chain management system.
2. Understand the challenges of creating such a system.
3. Understand the technical and managerial risks associated with supply chain management.
4. Recognize the benefits for a small business in adopting supply chain management.
The Benefits of Successful Supply Chain Management
For any small business, a commitment to developing a supply chain management system is not a small undertaking. It involves the commitment of significant financial resources for the acquisition of appropriate software. Policies and procedures must be changed in accordance with the needs of the new system. Personnel must be trained in not only using the new software but also adapting to new ways of doing business. Small businesses accept these challenges of adopting supply chain management systems because such systems are viewed as being important for long-term survival and because businesses anticipate substantial management and economic benefits.
The management benefits of supply chain management system include the following:
• Silo busting. By their very nature, supply chain management systems improve communication across all functions within a business. This leads to employees having a better understanding of the entire operations of a business and how their work relates to the overall benefits of the business.
• Improve communications with suppliers and customers. Improved communications with customers enhances the overall value provided to those customers. The improvement in customer satisfaction leads to longtime relationships, which yields significant economic benefits. Improved communications with suppliers improve the overall operational efficiency of both participants, reduce costs, and improve profits.
• Supplier selection. Supply chain management systems can help businesses evaluate prospective suppliers and monitor the performance of current suppliers. This capability can lead to strategic sourcing and significant cost savings plus improvement of the when- and where-needed variables.
• Improvements in purchasing. The automation of purchasing reduces errors and improves the economic efficiency of the purchasing function. Disciplined purchasing can allow for the full exploitation of available discounts.
• Reduction of inventory costs. Supply chain management systems can produce significant cost savings across all levels of inventory. Improved forecasting and scheduling will lead to increases in inventory turns and a corresponding reduction of costs.
• Improvements in operations. Improved quality control reduces the scrap rate, which in turn can have significant cost savings. Better production scheduling translates into producing what is needed when it is needed. The business does not have to spend additional money trying to expedite the production of particular orders to customers. The cost of goods sold is reduced in this manner. An additional benefit of supply chain management systems is that they lead to better utilization of plant and equipment. Great utilization translates into less likelihood that unneeded assets will be acquired, which has major financial benefits.
• Error reduction. By automating processes, billing errors and errors associated with purchasing and shipping quantities can be reduced. This not only saves money but also improves satisfaction with both suppliers and customers.
• Improvements in transportation operations. Accurate deliveries reduce returns and their associated costs. Sophisticated shipping models can reduce the overall cost of transportation.
• Additional financial benefits. Such systems can improve the collections process, which impacts customer relations, reduces bad debts, and improves cash flow.
The Risks Associated with Supply Chain Management
The major risks associated with a supply chain management system fall into two categories: technical and managerial.
Michael Porter’s five forces model is a model of the major factors that contribute to an industry’s overall structure. It also points to factors that might affect the overall profitability of the particular business within that industry. The greater the strength of these forces, the greater the challenge to make above average return profits for businesses in that industry. It is useful to review two of those forces—the power of suppliers and the power of buyers—and reexamine how they might influence the profitability of any business in the supply chain.
Porter identifies the following factors that might contribute to the overall strength of each force. He argued that suppliers are powerful (see "The Core Elements of a Supply Chain Management System") when the following occurs:
• They are concentrated. When an industry is dominated by only a few suppliers, these suppliers generally have a greater ability to dictate terms to their customers. The mining company DeBeers, which controls more than 50 percent of the world diamond production, is able to set the selling price of diamonds for most of the world’s jewelers.Mason A. Carpenter and William G. Sanders, Strategic Management and Dynamic Perspective (Upper Saddle River, NJ: Prentice Hall, 2008), 108. It should be pointed out, however, that in some cases concentration, particularly a duopoly, provides an opportunity for customers to force the two competing firms to compete more readily against each other. Think of the situation of Boeing and Airbus and their relationship to their customers—various airlines. At present, there are only two major producers of commercial aircraft, and airlines sometimes obtain better deals from one manufacturer because of their desire to maintain parity in market share.
• The size of the suppliers is large relative to the buyers. Suppliers are powerful when they are large and sell to a set of fragmented buyers. Think of the largest oil companies that sell gasoline to independent stations. The power in this scenario lies with the large oil companies.
• Switching costs are high. Suppliers have power when the cost of switching to an alternative supplier is expensive. Many businesses stay with Microsoft products because to do otherwise means that they would have to repurchase new hardware and software for the entire organization.
Problems may also arise from a heavier reliance on one customer in the supply chain. Even large companies need to be aware of their relative strength in the supply chain. Rubbermaid is the most admired corporation in America, as voted by Fortune magazine in 1993 and 1994, yet it had significant difficulties when dealing with one of its major customers—Walmart. In the early 1990s, Rubbermaid found that the cost for a key ingredient—resin—had increased by 80 percent.Mary Ethridge, “News about the Wal-Mart Struggle,” accessed February 2, 2012, www.dsausa.org/lowwage/walmart/Dec17_03.html. Walmart’s almost total focus on lowering its prices led it to drop many of Rubbermaid’s products. This began a downward spiral for Rubbermaid, which led to its acquisition by Newell Inc. Rubbermaid went from the status of the most admired corporation to being a basket case because it failed to recognize its excessive dependence on one customer.
Web Resources
The Benefits of Supply Chain Management
A list of benefits from SAP, a software company.
searchsap.techtarget.com/feature/Checklist-Quantifying-Supply-Chain-Management-benefits
The Risks of Supply Chain Management
A Forbes article on the risks associated with supply chain management.
www.forbes.com/2006/11/15/risks-supply-chain-strategies-biz-logistics-cx_rm_1115strategies.html
Risk and Rewards in Supply Chain Management
A Harvard working paper.
hbswk.hbs.edu/archive/4971.html
KEY TAKEAWAYS
• There are significant benefits for businesses that adopt supply chain management systems.
• The benefits stem from improved customer relations, cost cutting, and increased operational efficiencies.
• The adoption of a supply chain management perspective can pose risks.
• Businesses must consider the relative power of both their suppliers and their customers.
EXERCISES
1. Interview the owners of local businesses who say they have some form of a supply chain management system and ask them if they believe they have benefited from the system.
2. Ask them how they have benefited.
3. Ask them to identify the major problems they had with implementing and using the system.
4. Ask them if they believe they have the “power” in their supply chain or if the “power” is in the hands of their suppliers. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/11%3A_Supply_Chain_Management_-_You_Better_Get_It_Right/11.04%3A_The_Benefits_and_the_Risks_of_Participating_in_a_Supply_Chain.txt |
Learning Objectives
1. Understand how customer value is enhanced by supply chain management.
2. Understand how cash flow can be increased, in the long term, by using supply chain management.
3. Understand the various computer programs that make up a supply chain management program.
4. Recognize the risks that can stem from adopting a single supplier program.
Customer Value Implications
Throughout this text, we have emphasized the importance for small businesses to constantly focus on the notion of improving value for their customers. Successfully implementing a supply chain management system offers tremendous possibilities for not only improving value to customers but also significantly enhancing the capabilities and profitability of the small business itself. Supply chain management improves customer value in the following ways:
• Reduced inventory. A well-executed supply chain management system means that customers receive orders when they need them. Further, this does not necessarily imply that the supplier will be holding the inventory for the customer—although that might occur. It refers to the fact that better communication and better scheduling may enable the supplier to produce the item exactly when it is needed.
• Improvement in the order accuracy. Supply chain management should guarantee that when orders are shipped, the right items are shipped in the right quantity. This does not disrupt the production of the customer and eliminates product returns, which results in economic benefits for both the customer and the supplier.
• Reduced cycle time for product development. To ensure success, the customer and the supplier must develop new levels of trust. This trust will evolve into a long-term relationship. Both parties begin to know each other better, including each other’s needs and capabilities. As this evolves, the supplier is in a better position to help the customer develop new products far more rapidly. It greatly reduces the product cycle time.
• Financial benefits. These value improvements all translate into significant cost savings. Cost savings experienced by the supplier can be transferred into cost savings for the customer. Relatively modest improvements in inventory reduction, reduced safety stock size, reduce stockouts, improved order fill rates, and reduced transit time can yield surprisingly large financial benefits to both parties.
• Peace of mind. Having a supplier that one can trust to accurately deliver items in a timely low-cost fashion, which has also developed contingency plans to cope with potential problems, is relatively unique and provides the customer with a high level of comfort. One may be unable to place an economic price on such peace of mind.
Cash-Flow Implications
It must be recognized that committing to a supply chain management system from scratch will entail a major investment. New approaches to software can reduce both the cost and the risk of such a commitment. However, businesses will want to recoup most of the investment as quickly as possible—perhaps six months or less. Given the potential for cost savings, the impact on increasing cash flow should be obvious.
What is not obvious is the potential for significant improvements in cash flow from minor improvements generated by supply chain management systems. To illustrate this, let us look at an example adapted from Coyle et al. (2009).John J. Coyle, C. John Langley, Brian Gibson, Robert A. Novak, and Edward J. Bardi, Supply Chain Management: A Logistics Perspective, 8th ed. (Mason, OH: South-Western, 2008), 301. Assume that a firm is in the following situation: It ships orders to customers; if the orders are incomplete or inaccurate, the firm assumes the full cost of the return and follow-up shipping. When an incorrect shipment is made, to ameliorate their upset customers, the firm takes \$100 off the bill. However, when some customers find that the order is incomplete or inaccurate, they are so upset that they cancel the order. Here are the data:
Number of orders per year 50,000
Number of items per order 25
Profit per unit (\$) 30
Price reduction for incorrect order (\$) 100
Back order cost per order (\$) 200
Percentage of totally correct orders 90
Percentage of incorrect orders cancelled 25
It can be readily seen that the profit per order is \$750 (25 × \$30). We now examine the lost cash flow from the situation. The lost cash flow has several components. The first component is the back order cost, which is composed of the number of orders that will have to be back filled. The second component is associated with the losses from the incorrect orders that were canceled. The last component is the price reduction for the incorrect order.
lost cash flow = backorder costs + cancelled sales costs + price reduction costs
These can be computed as follows:
lost cash flow = [number of orders × (1 − percentage of totally correct orders) × backordered cost per order][number of orders × (1 − percentage of totally correct orders) × percentage of incorrect orders cancelled × profit per order] + [number of orders × (1 − percentage of totally correct orders) × price reduction for incorrect order]
Now let us substitute the correct values into this equation.
lost cash flow = [50,000 × (1 − .90) × \$200] + [50,000 × (1 − .90) × (.25) × \$750] + [50,000 × (1 − .90) × \$100]lost cash flow = \$1,000,000 + \$937,500 + \$500,000 = \$2,437,500
We now assume that an “improved” supply chain management system has been installed. The percentage of correctly filled orders increases from 90 percent to 96 percent. If we substitute 96 percent into these equations, we find that the new lost cash flow would decrease to \$975,000. This means that a 6 percent increase in order accuracy leads to a 60 percent decrease in the loss of cash flow.
Implications of Technology and the E-Environment
It should be obvious that contemporary supply chain management cannot be conducted through paper and pencil procedures. The backbone of today’s supply chain management is software. Initially, it would be impossible to think of developing such systems without electronic data interchange. Today, the Internet serves as the basis for sharing communication between suppliers and customers. However, there is more to the technology behind supply chain management system than merely the exchange of data.
Supply chain management requires several types of software packages and the need to successfully integrate them. One can identify several major software components of a supply chain management system (see Figure \(1\) . One section would be supplier relationship management programs. These programs involve planning and controlling the actions with upstream suppliers. Such programs would cover many aspects of procurement—supplier analysis, order execution, payment, and performance monitoring.Joel D. Wisner, G. Keong Leong, and Keah-Choon Tan, Principles of Supply Chain Management: A Balanced Approach (Mason, OH: South-Western, 2004), 76. There would also be customer relationship management (CRM) software that would handle all interactions with customers. Enterprise resource planning (ERP) would handle the necessary integration of all data. ERP coordinates data flows from finance, accounting, and operations to provide management with a seamless overview of the performance of a business. It may also have a decision support system, which allows for data manipulation or the use of analytical modeling tools to provide a better decision-making environment. It may involve using mathematical programming models to optimize decisions. Another set of modules dedicated to logistics would focus on the optimal use of warehousing and shipping. These functions are sometimes handled externally by either a third- or fourth-party logistics provider.
Figure 11.4 Schematic for a Supply Chain Management Information SystemNot too long ago, the acquisition and the operation of these software packages would have been prohibitive for most small businesses from both a cost standpoint and a technical standpoint. Fortunately, software providers now recognize that small and midsize businesses represent a tremendous market for supply chain management software. It was estimated in 2008 that the demand for business enterprise software applications for small and midsized businesses would grow at a nearly 11 percent annualized growth rate until 2012.“Small and Medium-Sized Business Enterprise Applications Market to Grow to \$80.3 Billion by 2012,” Business Wire, June 11, 2008, accessed February 2, 2012, www.reuters.com/article/2008/06/11/idUS117514+11-Jun-2008+BW20080611. Microsoft, Oracle, and SAP have developed systems that enable small to midsize companies to handle all the complexities of global supply chain management.Carol Lawrence, “Enterprise Resource Planning Software Become More Accessible to Small and Midsize Companies,” McClatchy Tribune Business News, August 8, 2010. Large software vendors such as Oracle estimated that the midmarket clientele was approximately 4,500 out of their total client base of 7,000 customers. Several factors can be attributed to this rapid growth in small to midsize businesses. The first was that many software providers were willing to offer in-house installation at a predictable cost. Second and perhaps the most important factor is the increasing move to cloud-based software, where software resides on an external server to which the businesses are connected to via the Internet. It provides several substantial benefits to small businesses: lowers software and hardware costs, installation is significantly easier, maintenance and training costs are lower, and free upgrades may sometimes be available. The use of Internet-based systems also makes it easier to maintain lines of communications with one’s suppliers and customers. Robert LaGarde, president of LaGarde E-business Solution, has stated that “using Internet technology to provide customers with online demand access to supply chain systems is critical to nurturing and growing relationships with customers.”David Hayes, “When Size Doesn’t Matter (in business),” McClatchy Tribune Business News, March 4, 2010. What initially appeared to be a remarkably complex system of programs has now been made available to even very small businesses.
Video Clip \(1\):
Impact of RFID Technology on Supply Chain Management
The impact of RFID technology on supply chains.
Video Clip \(2\):
Supply Chains and Information Technology
Modern-day supply chains are tasked with responding at lightning speed.
Video Clip \(3\):
Future Supply Chain 2016
The main supply chain challenges for consumer products and retail for the next decade.
Video Link \(4\):
Japan: The Business Aftershocks
Japan is a small country with a supersized role in the global supply chain (a short ad precedes the video clip).
Web Resources
List of Supply Chain Management Software
A comprehensive list of SCM software with links.
www.capterra.com/supply-chain-management-software
About.com SCM Software
Supply chain management software with links to other sites.
https://www.thebalancesmb.com/supply-chain-software-4161399
The Benefits of Supply Chain Management Software
Identifies benefits and includes option to download a report on the top fifteen ERP providers.
www.business-software.com/erp/supply-chain/benefits-of-supply-chain-erp.php
KEY TAKEAWAYS
• Supply chain management can enhance customer value in many ways.
• Cost savings brought about by supply chain management systems can produce amplified improvements in cash flow.
• Supply chain management systems can be seen as a collection of interconnected software packages.
• The advent of cloud computing can make supply chain management systems available for small businesses.
EXERCISES
1. Interview the owners of five local businesses and ask them how supply chain management has or could enhance their customers’ value.
2. For those small business owners who have a functioning supply chain management system, ask them if they have noticed improvements in cash flow attributable to the system.
3. Ask them what system(s) they use and why they went with these computer packages.
4. Ask them if they have contingency plans for the loss of key suppliers.
Disaster Watch
This chapter has emphasized that successful supply chain management requires successful integration across the supply chain. It has been argued that businesses should actively seek to have a single source supplier for particular parts and components. Having a single source supplier may result in a closer relationship that should yield significant economic benefit. Many businesses, both large and small, have moved toward, if not a single supplier, then a significantly reduced number of suppliers for particular parts. This, however, may have some serious negative consequences.
Apple introduced its new iPad 2 tablet on March 2, 2011. Little more than a week later, on March 11, Japan was struck by a major earthquake and damage from the resulting tsunami. Although the two events may seem to be unrelated, there were several connections. It was estimated that Japanese firms manufactured at least five major components in the iPad 2. Although some of these firms were not damaged by either the earthquake or the tsunami, they found that maintaining production schedules was a challenge due to curtailment and available electricity, the movement of supplies, and employees being unable to arrive at work. “These factors are having a major impact on ‘delicate processes, such as semiconductor lithography,’ said the report, especially as the country continues to experience aftershocks.”Michelle Maisto, “Apple iPad 2 Production Hindered by Japan Earthquake: IHS iSuppli,” eWeek.com, March 19, 2011, accessed February 2, 2012. Apple was not the only firm affected by the Japanese disaster. The port of Sendai was heavily damaged, and many goods could not be shipped out. As one commentator put it, “It is a nuclear winter for the economy.”Peter Müller and Alexander Neubacher, “Disaster in Japan Sends Ripples through the Global Economy,” Spiegel Online International, March 22, 2011, accessed February 2, 2012.
Further exacerbating the situation for Apple was an explosion at Foxconn Technology Group’s plant in Chengdu, China. The explosion killed three workers and injured many more. In addition, the initial estimate was that Apple might lose production of more than half a million iPad 2 units while the plant was closed for repairs.“Blast Could Cut iPad 2 Production by 500,000: iSuppli,” Taipei Times, May 25, 2011, accessed February 12, 2012.
Disruptions in the supply chain need not be caused by natural disasters. They can occur because of human failings and can have significant consequences. Toys “R” Us was severely damaged in 1999 when its online customer order system proved to be inadequate for demand at Christmastime. In the same time frame, The Hershey Company, which expended approximately \$100 million on developing software for its supply chain, found that attempting to develop an order system, a CRM system, and a supply chain planning system proved to be too much of a technical challenge. Because of failures in the system, Hershey missed at least \$150 million in orders. Hershey was guilty of trying to implement these systems simultaneously. They had gone a “bridge too far.”“The 11 Greatest Supply Chain Disasters,” SupplyChainDigest, January 2006, accessed February 2, 2012.
There is actually a field called supply chain sensitivity analysis that attempts to identify the extent of disruptions in the supply chain caused by external factors. It relies on computer simulation analysis.Jack Kleijen, “Supply Chain Simulation Tools and Techniques: A Survey,” International Journal of Simulation and Process Modeling 1, no. 1/2 (2005): 82. Obviously, such an approach is beyond the capability of most small businesses. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/11%3A_Supply_Chain_Management_-_You_Better_Get_It_Right/11.05%3A_The_Three_Threads.txt |
Unnamed Publisher
The idea for Unnamed Publisher, the publisher of this book, started on a business trip to Chicago in 2006. Co-founders Jeff Shelstad and Eric Frank, who were both working at a large educational publisher at the time, decided they wanted to move away from the limitations and the frustrations of the traditional publishing industry. Veterans of the higher education publishing industry. Their vision was to create a new publishing company that offered a lot more choices to students, professors, and authors.
“Students can’t afford to pay \$200 for a textbook. The old business model wasn’t adapting fast enough to the Internet, where so much information was available for free or low-cost,” says Jeff, referring to traditional publishers. “We knew there had to be a better way to publish high-quality material and eliminate price and access barriers.”
Since its beginning in 2007, more than thirty employees have joined this fast-growing start-up, located just north of New York City, in Irvington, New York. The company has become a recognized pioneer in transforming higher educational publishing and textbook affordability.
FWK is upending the \$8 billion college textbook industry with a new business model that focuses on affordability and personalization. Professors who assign FWK books are free to revise and edit the material to match their course and help improve student success. Students have a choice of affordable print and digital formats that they can access online or on a laptop, tablet, e-reader or smartphone for a fraction of the price that most traditional publishers charge.
Rather than hamper the company’s growth, the economic downturn has actually highlighted the value of its products and the viability of its business model. Despite the bad economy, FWK has been able to raise over \$30 million in venture capital. Clearly, they are doing something right.
The numbers tell the story. Since the launch of their first ten books in spring 2009 (there are more than one hundred fifteen books to date), faculty at more than two thousand institutions in forty-four countries have adopted FWK books. As a result, more than 600,000 students have benefited from affordable textbook choices that lower costs, increase access and personalize learning.
In 2010, 2011 and 2012, EContent magazine named FWK as one of the top one hundred companies that matter most in the digital content industry. FWK was also named 2010 Best Discount Textbook Provider by the Education Resources People’s Choice Awards.
What is particularly refreshing is Jeff’s philosophy about people and work. “Give talented people an opportunity to build something meaningful, the tools to do it, and the freedom to do one’s best.” He believes in flexibility with people and their jobs, and, to that end, employees have the option to work remotely. There is no question that FWK is an innovator in the educational publishing industry, but it also knows how to treat people well and provide a challenging environment that fosters personal growth.
Source: Interview with Jeff Shelstad, March 31, 2011; “Unnamed Publisher Named to EContent Magazine Top 100 Digital Companies of 2010,” Pressitt, December 15, 2010, accessed February 2, 2012.
Alexandra Torres, “Company Offers Alternatives to Enter the World of Knowledge,” The Ticker, October 10, 2010, accessed February 2, 2012.
John Tozzi, “Online Startups Target College Book Costs,” Bloomberg BusinessWeek, September 23, 2010 | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/12%3A_People_and_Organization/12.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Understand the functions of management.
2. Explain the three basic leadership styles.
3. Explain the three basic levels of management.
4. Understand the management skills that are important for a successful small business.
5. Understand the steps in ethical decision making.
All small businesses need to be concerned about management principles. Management decisions will impact the success of a business, the health of its work environment, its growth if growth is an objective, and customer value and satisfaction. Seat-of-the-pants management may work temporarily, but its folly will inevitably take a toll on a business. This section discusses management principles, levels, and skills—all areas that small business owners should understand so that they can make informed and effective choices for their businesses.
What Is Management?
There is no universally accepted definition for management. The definitions run the gamut from very simple to very complex. For our purposes, we define management as “the application of planning, organizing, staffing, directing, and controlling functions in the most efficient manner possible to accomplish meaningful organizational objectives.”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 172. Put more simply, management is all about achieving organizational objectives through people and other resources.David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 254.
Management principles apply to all organizations—large or small, for-profit or not-for-profit. Even one-person small businesses need to be concerned about management principles because without a fundamental understanding of how businesses are managed, there can be no realistic expectation of success. Remember that the most common reason attributed to small business failure is failure on the part of management.
Management Functions
On any given day, small business owners and managers will engage in a mix of many different kinds of activities—for example, deal with crises as they arise, read, think, write, talk to people, arrange for things to be done, have meetings, send e-mails, conduct performance evaluations, and plan. Although the amount of time that is spent on each activity will vary, all the activities can be assigned to one or more of the five management functions: planning, organizing, staffing, directing, and controlling (Figure \(1\)).
Planning
Planning “is the process of anticipating future events and conditions and determining courses of action for achieving organizational objectives.”David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 257. It is the one step in running a small business that is most commonly skipped, but it is the one thing that can keep a business on track and keep it there.“Management Principles,Small Business Notes, accessed February 2, 2012. Planning helps a business realize its vision, get things done, show when things cannot get done and why they may not have been done right, avoid costly mistakes, and determine the resources that will be needed to get things done.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 176; David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 257. Business planning for the small business is discussed in "The Business Plan", and marketing planning is discussed in "The Marketing Plan".
Organizing
“. . . consists of grouping people and assigning activities so that job tasks and the mission can be properly carried out.”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 176. Establishing a management hierarchy is the foundation for carrying out the organizing function.
Contrary to what some people may believe, the principle of organizing is not dead. Rather, it is clearly important “to both the organization and its workers because both the effectiveness of organizations and worker satisfaction require that there be clear and decisive direction from leadership; clarity of responsibilities, authorities, and accountabilities; authority that is commensurate with responsibility and accountability; unified command (each employee has one boss); a clear approval process; and, rules governing acceptable employee behavior.”“Traditional Management Principles,” Small Business Notes, accessed February 2, 2012, www.smallbusinessnotes.com/managing-your-business/traditional-management -principles.html. Except for a small business run solely by its owner, every small business needs a management hierarchy—no matter how small. Each person in the business should know who is responsible for what, have the authority to carry out his or her responsibilities, and not get conflicting instructions from different bosses. The absence of these things can have debilitating consequences for the employees in particular and the business in general.“Traditional Management Principles,” Small Business Notes, accessed February 2, 2012, www.smallbusinessnotes.com/managing-your-business/traditional-management -principles.html.
The organizational design and structure of a small business are important parts of organizing, which are discussed in Section 12.2 "Organizational Design".
Video Link \(1\):
Glassblowing Business Thrives
Lesson learned: Everyone should know his or her role in the business.
Staffing
The staffing function involves selecting, placing, training, developing, compensating, and evaluating (the performance appraisal) employees.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 176. Small businesses need to be staffed with competent people who can do the work that is necessary to make the business a success. It would also be extremely helpful if these people could be retained. Many of the issues associated with staffing in a small business are discussed in Section 12.4 "People".
Directing
Directing is the managerial function that initiates action: issuing directives, assignments, and instructions; building an effective group of subordinates who are motivated to do what must be done; explaining procedures; issuing orders; and making sure that mistakes are corrected.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 177; David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 257. Directing is part of the job for every small business owner or manager. Leading and motivating work together in the directing function. Leading “is the process of influencing people to work toward a common goal [and] motivating is the process of providing reasons for people to work in the best interests of an organization.”William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 224.
Different situations call for different leadership styles. In a very influential research study, Kurt Lewin established three major leadership styles: autocratic, democratic, and laissez-faire.Kurt Lewin, Ronald Lippitt, and Ralph K. White, “Patterns of Aggressive Behavior in Experimentally Created ‘Social Climates,’” Journal of Social Psychology 10, no. 2 (1939): 269–99. Although good leaders will use all three styles depending on the situation, with one style normally dominant, bad leaders tend to stick with only one style.Don Clark, “Leadership Styles,” Big Dog and Little Dog’s Performance Juxtaposition, June 13, 2010, accessed February 2, 2012.
Autocratic leadership occurs when a leader makes decisions without involving others; the leader tells the employees what is to be done and how it should be accomplished.Kurt Lewin, “Lewin’s Leadership Styles,” Changing Minds, accessed February 2, 2012; Don Clark, “Leadership Styles,” Big Dog and Little Dog’s Performance Juxtaposition, June 13, 2010, accessed February 2, 2012. Lewin et al. found that this style creates the most discontent.Kurt Lewin, Ronald Lippitt, and Ralph K. White, “Patterns of Aggressive Behavior in Experimentally Created ‘Social Climates,’” Journal of Social Psychology 10, no. 2 (1939): 269–99. However, this style works when all the information needed for a decision is present, there is little time to make a decision, the decision would not change as a result of the participation of others, the employees are well motivated, and the motivation of the people who will carry out subsequent actions would not be affected by whether they are involved in the decision or not.Kurt Lewin, “Lewin’s Leadership Styles,” Changing Minds, accessed February 2, 2012, ; Don Clark, “Leadership Styles,” Big Dog and Little Dog’s Performance Juxtaposition, June 13, 2010, accessed February 2, 2012. This leadership style should not be used very often.
Democratic leadership involves other people in the decision making—for example, subordinates, peers, superiors, and other stakeholders—but the leader makes the final decision. Rather than being a sign of weakness, this participative form of leadership is a sign of strength because it demonstrates respect for the opinions of others. The extent of participation will vary depending on the leader’s strengths, preferences, beliefs, and the decision to be made, but it can be as extreme as fully delegating a decision to the team.“Participative Leadership,” Changing Minds, accessed February 2, 2012. This leadership style works well when the leader has only part of the information and the employees have the other part. The participation is a win-win situation, where the benefits are mutual. Others usually appreciate this leadership style, but it can be problematic if there is a wide range of opinions and no clear path for making an equitable, final decision.Kurt Lewin, “Lewin’s Leadership Styles,” Changing Minds, accessed February 2, 2012; Don Clark, “Leadership Styles,” Big Dog and Little Dog’s Performance Juxtaposition, June 13, 2010, accessed February 2, 2012. In experiments that Lewin et al. conducted with others, the democratic leadership style was revealed as the most effective.Kurt Lewin, Ronald Lippitt, and Ralph K. White, “Patterns of Aggressive Behavior in Experimentally Created ‘Social Climates,’” Journal of Social Psychology 10, no. 2 (1939): 269–99.
Laissez-faire leadership (or delegative or free-reign leadership) minimizes the leader’s involvement in decision making. Employees are allowed to make decisions, but the leader still has responsibility for the decisions that are made. The leader’s role is that of a contact person who provides helpful guidance to accomplish objectives.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 178. This style works best when employees are self-motivated and competent in making their own decisions, and there is no need for central coordination; it presumes full trust and confidence in the people below the leader in the hierarchy.Kurt Lewin, “Lewin’s Leadership Styles,” Changing Minds, accessed February 2, 2012; Don Clark, “Leadership Styles,” Big Dog and Little Dog’s Performance Juxtaposition, June 13, 2010, accessed February 2, 2012. However, this is not the style to use if the leader wants to blame others when things go wrong.Don Clark, “Leadership Styles,” Big Dog and Little Dog’s Performance Juxtaposition, June 13, 2010, accessed February 2, 2012. This style can be problematic because people may tend not to be coherent in their work and not inclined to put in the energy they did when having more visible and active leadership.Kurt Lewin, Ronald Lippitt, and Ralph K. White, “Patterns of Aggressive Behavior in Experimentally Created ‘Social Climates,’” Journal of Social Psychology 10, no. 2 (1939): 269–99; Kurt Lewin, “Lewin’s Leadership Styles,” Changing Minds, accessed February 2, 2012.
Good leadership is necessary for all small businesses. Employees need someone to look up to, inspire and motivate them to do their best, and perhaps emulate. In the final analysis, leadership is necessary for success. Without leadership, “the ship that is your small business will aimlessly circle and eventually run out of power or run aground.”Susan Ward, “5 Keys to Leadership for Small Business,” About.com, accessed February 2, 2012.
Don’t Be This Kind of Leader or Manager
Here are some examples of common leadership styles that should be avoided.
• Post-hoc management. As judge and jury, management is always right and never to blame. This approach ensures security in the leader’s job. This style is very common in small companies where there are few formal systems and a general autocratic leadership style.“Post-hoc Management,” Changing Minds, accessed February 2, 2012.
• Micromanagement. Alive and well in businesses of all sizes, this style assumes that the subordinate is incapable of doing the job, so close instruction is provided, and everything is checked. Subordinates are often criticized and seldom praised; nothing is ever good enough. It is really the opposite of leadership.“Micromanagement,” Changing Minds, accessed February 2, 2012.
• Seagull management. This humorous term is used to describe a management style whereby a person flies in, poops on you, and then flies away.“Leadership Styles,” Changing Minds, accessed February 2, 2012. When present, such people like to give criticism and direction in equal quantities—with no real understanding of what the job entails. Before anyone can object or ask what the manager really wants, he or she is off to an important meeting. Everyone is actively discouraged from saying anything, and eye contact is avoided.“Seagull Management,” Changing Minds, accessed February 2, 2012.
• Mushroom management. This manager plants you knee-deep (or worse) in the smelly stuff and keeps you in the dark.“Leadership Styles,” Changing Minds, accessed February 2, 2012. Mushroom managers tend to be more concerned about their own careers and images. Anyone who is seen as a threat may be deliberately held back. These managers have their favorites on whom they lavish attention and give the best jobs. Everyone else is swept away and given the unpopular work. Oftentimes, mushroom managers are incompetent and do not know any better. We have all seen at least one manager of this type.
• Kipper management. This is the manager who is, like a fish, two-faced because employees can see only one face at a time. To senior managers, this person is typically a model employee who puts business first and himself last. To subordinates, however, the reverse is often the case. The subordinates will work hard to get things done in time, but they are blamed when things go wrong—even if it is not their fault. The kipper will be a friend when things need to get done and then stab the subordinates in the back when glory or reward is to be gained.“Leadership Styles,” Changing Minds, accessed February 2, 2012. We have all seen this kind of manager, perhaps even worked for one.
Controlling
Controlling is about keeping an eye on things. It is “the process of evaluating and regulating ongoing activities to ensure that goals are achieved.”William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 224. Controlling provides feedback for future planning activities and aims to modify behavior and performance when deviations from plans are discovered.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 176. There are four commonly identified steps in the controlling process.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 176; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 224. (Figure \(2\).) Setting performance standards is the first step. Standards let employees know what to expect in terms of time, quality, quantity, and so forth. The second step is measuring performance, where the actual performance or results are determined. Comparing performance is step three. This is when the actual performance is compared to the standard. The fourth and last step, taking corrective action, involves making whatever actions are necessary to get things back on track. The controlling functions should be circular in motion, so all the steps will be repeated periodically until the goal is achieved.
Levels of Management
As a small business grows, it should be concerned about the levels or the layers of management. Also referred to as the management hierarchy (Figure \(3\)), there are typically three levels of management: top or executive, middle, and first-line or supervisory. To meet a company’s goals, there should be coordination of all three levels.
Top management, also referred to as the executive level, guides and controls the overall fortunes of a business.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 226. This level includes such positions as the president or CEO, the chief financial officer, the chief marketing officer, and executive vice presidents. Top managers devote most of their time to developing the mission, long-range plans, and strategy of a business—thus setting its direction. They are often asked to represent the business in events at educational institutions, community activities, dealings with the government, and seminars and sometimes as a spokesperson for the business in advertisements. It has been estimated that top managers spend 55 percent of their time planning.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 183.
Middle management is probably the largest group of managers. This level includes such positions as regional manager, plant manager, division head, branch manager, marketing manager, and project director. Middle managers, a conduit between top management and first-line management, focus on specific operations, products, or customer groups within a business. They have responsibility for developing detailed plans and procedures to implement a firm’s strategic plans.David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 255.
First-line or supervisory management is the group that works directly with the people who produce and sell the goods and/or the services of a business; they implement the plans of middle management.David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 255. They coordinate and supervise the activities of operating employees, spending most of their time working with and motivating their employees, answering questions, and solving day-to-day problems.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 227. Examples of first-line positions include supervisor, section chief, office manager, foreman, and team leader.David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 255; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 227.
In many small businesses, people often wear multiple hats. This happens with management as well. One person may wear hats at each management level, and this can be confusing for both the person wearing the different hats and other employees. It is common for the small business owner to do mostly first-level management work, with middle or top management performed only in response to a problem or a crisis, and top-level strategic work rarely performed.John Seiffer, “3 Levels of Management,” Better CEO, April 14, 2006, accessed June 1, 2012. This is not a good situation. If the small business is large enough to have three levels of management, it is important that there be clear distinctions among them—and among the people who are in those positions. The small business owner should be top management only. This will eliminate confusion about responsibilities and accountabilities.
Management Skills
Management skill “is the ability to carry out the process of reaching organizational goals by working with and through people and other organizational resources.”Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 11. Possessing management skill is generally considered a requirement for success.Les Worral and Cary Cooper, “Management Skills Development: A Perspective on Current Issues and Setting the Future Agenda,” Leadership & Organization Development Journal 22, no. 1 (2001): 34–39, as cited in Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 11. An effective manager is the manager who is able to master four basic types of skills: technical, conceptual, interpersonal, and decision making.
Technical skills “are the manager’s ability to understand and use the techniques, knowledge, and tools and equipment of a specific discipline or department.”David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 256. These skills are mostly related to working with processes or physical objects. Engineering, accounting, and computer programming are examples of technical skills.Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 11. Technical skills are particularly important for first-line managers and are much less important at the top management level. The need for technical skills by the small business owner will depend on the nature and the size of the business.
Conceptual skills “determine a manager’s ability to see the organization as a unified whole and to understand how each part of the overall organization interacts with other parts.”David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 257. These skills are of greatest importance to top management because it is this level that must develop long-range plans for the future direction of a business. Conceptual skills are not of much relevance to the first-line manager but are of great importance to the middle manager. All small business owners need such skills.
Interpersonal skills “include the ability to communicate with, motivate, and lead employees to complete assigned activities,”David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 256. hopefully building cooperation within the manager’s team. Managers without these skills will have a tough time succeeding. Interpersonal skills are of greatest importance to middle managers and are somewhat less important for first-line managers. They are of least importance to top management, but they are still very important. They are critical for all small business owners.
The fourth basic management skill is decision making (Figure \(4\) ), the ability to identify a problem or an opportunity, creatively develop alternative solutions, select an alternative, delegate authority to implement a solution, and evaluate the solution.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 188.
Making good decisions is never easy, but doing so is clearly related to small business success. “Decisions that are based on a foundation of knowledge and sound reasoning can lead the company into long-term prosperity; conversely, decisions that are made on the basis of flawed logic, emotionalism, or incomplete information can quickly put a small business out of commission.”“Decision Making,” eNotes, March 17, 2011, accessed June 1, 2012, www.enotes.com/decision-makin...-making-178403.
A Framework for Ethical Decision Making
Small business decisions should be ethical decisions. Making ethical decisions requires that the decision maker(s) be sensitive to ethical issues. In addition, it is helpful to have a method for making ethical decisions that, when practiced regularly, becomes so familiar that it is automatic. The Markkula Center for Applied Ethics recommends the following framework for exploring ethical dilemmas and identifying ethical courses of action.“A Framework for Thinking Ethically,” Santa Clara University, accessed June 1, 2012, www.scu.edu/ethics/practicing/decision/framework.html. However, in many if not most instances, a small business owner or manager and an employee will usually know instinctively whether a particular decision is unethical.
Recognize an Ethical Issue
• Could this decision or situation be damaging to someone or some group? Does this decision involve a choice between a good and a bad alternative or perhaps between two “goods” or between two “bads”?
• Is this issue about more than what is legal or most efficient? If so, how?
Get the Facts
• What are the relevant facts of the case? What facts are not known? Can I learn more about the situation? Do I know enough to make a decision?
• What individuals and groups have an important stake in the outcome? Are some concerns more important? Why?
• What are the options for acting? Have all the relevant persons and groups been consulted? Have I identified creative options?
Evaluate Alternative Actions
• Which option will produce the most good and do the least harm?
• Which option best respects the rights of all who have a stake?
• Which option treats people equally or proportionately?
• Which option best serves the community as a whole, not just some members?
• Which option leads me to act as the sort of person I want to be?
Make a Decision and Test It
• Considering all these approaches, which option best addresses the situation?
• If I told someone I respect—or told a television audience—which option I have chosen, what would they say?
Act and Reflect on the Outcome
• How can my decision be implemented with the greatest care and attention to the concerns of all stakeholders?
• How did my decision turn out, and what have I learned from this specific situation?
KEY TAKEAWAYS
• Management principles are important to all small businesses.
• Management decisions will impact the success of a business, the health of its work environment, its growth if growth is an objective, and customer value and satisfaction.
• Management is about achieving organizational objectives through people.
• The most common reason attributed to small business failure is failure on the part of management.
• On any given day, a typical small business owner or manager will be engaged in some mix of planning, organizing, staffing, directing, and controlling.
• Different situations call for different leadership styles. The three major styles are autocratic, democratic, and laissez-faire. Bad leaders typically stick with one style.
• The management hierarchy is typically composed of three levels: top or executive, middle, and first-line or supervisory. If a small business is large enough to have these three levels, it is important that there be a clear distinction between them.
• Management skills are required for success. Technical, conceptual, interpersonal, and decision-making skills will be of differing importance depending on the management level.
EXERCISE
1. Apply the four steps in the controlling function for Frank’s BarBeQue. Identify and discuss examples of performance standards that Frank might use. Indicate which standards should be numerically based. How could he measure performance? What corrective action should he take if performance does not meet the established performance standards? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/12%3A_People_and_Organization/12.02%3A_Principles_of_Management_and_Organization.txt |
Learning Objectives
1. Understand why an organizational structure is necessary.
2. Understand organizational principles.
3. Explain the guidelines for organizing a small business.
4. Describe the different forms of organizational structure and how they apply to small businesses.
Organizing consists of grouping people and assigning activities so that job tasks and the mission of a business can be properly carried out. The result of the organizing process should be an overall structure that permits interactions among individuals and departments needed to achieve the goals and objectives of a business. David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 272. Although small business owners may believe that they do not need to adhere to the organizing principles of management, nothing could be farther from the truth.
Principles represent guidelines that managers can use in making decisions. They are not laws etched in stone. At times, principles can be used exactly as the way they are stated; at other times they should be modified or even completely ignored. Small business owners must learn through experience when and where to use [the] principles or to modify them [emphasis added]. Principles when used effectively and in the right context often bring organizational efficiencies and thus result in the growth of the business. Some organizing principles…would apply to small businesses as well as they would to large enterprises and would lead to similar benefits.Hal Babson and John Bowen, Instructor’s Manual to Accompany Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2004), 8–9.
There is no single best way to organize. Rather, the organization decision is based on a multitude of factors, including business size, market, product mix, competition, the number of employees, history, objectives and goals, and available financial resources.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 199. Each small business must decide what organizational design best fits the business.
Fundamentals of Organization
Ivancevich and DueningJohn M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 200–204. maintain that there are several fundamental issues that managers need to consider when making any kind of organizational decision: clear objectives, coordination, formal and informal organization, the organization chart, formal authority, and centralization versus decentralization. Understanding these fundamentals can facilitate the creation of an organizational structure that is a good fit for a small business.
Clear Objectives
Objectives “give meaning to the business—and to the work done by employees—by determining what it is attempting to accomplish.”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 200–204. Objectives provide direction for organizing a firm, helping to identify the work that must be done to accomplish the objectives. This work, in turn, serves as the basis on which to make staffing decisions.
Coordination
The resources of a small business and its employees must be coordinated to minimize duplication and maximize effectiveness.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 263. Coordination requires informal communication with and among employees every day. All businesses must continually coordinate the activities of others—an effort that should never be underestimated. Business leaders must make sure that employees have the answers to six fundamental questions:“Reinventing the Strategic Communicator,” Strategic Communication Management, August/September 2001, 32–35, as cited in John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 201.
1. What is my job?
2. How am I doing?
3. Does anyone care?
4. How are we doing?
5. What are our vision, mission, and values?
6. How can I help?
Formal and Informal Organization
When a one-person small business adds employees, some kind of hierarchy will be needed to indicate who does what. This hierarchy often becomes the formal organization—that is, the details of the roles and responsibilities of all employees.“Formal Organizational Structure—What Is It?,” The Business Plan, accessed February 2, 2012, www.the-business-plan.com/formal-organizational-structure.html. Formal organization tends to be static, but it does indicate who is in charge of what. This helps to prevent chaos. The formal organizational structure helps employees feel safe and secure because they know exactly what their chain of command is. The downside of a formal organizational structure is that it typically results in a slower decision-making process because of the numerous groups and people who have to be involved and consulted.“Formal Organizational Structure—What Is It?,” The Business Plan, accessed February 2, 2012, www.the-business-plan.com/formal-organizational-structure.html.
The informal organization is almost never explicitly stated. It consists of all the connections and relationships that relate to how people throughout the organization actually network to get a job done. The informal organization fills the gaps that are created by the formal organization.Marshall Goldsmith and Jon Katzenbach, “Navigating the ‘Informal’ Organization,” Bloomberg BusinessWeek, February 14, 2007, accessed February 2, 2012, www.BusinessWeek.com/careers/content/feb2007/ca20070214_709560.htm. Although the informal organization is not written down anywhere, it has a tremendous impact on the success of a small business because it is “composed of natural leaders who get things done primarily through the power granted to them by their peers.”Charles Hall, Getting Results…for the Hands-On Manager (Saranac Lake, NY: American Management Association, 1986), 40–42. Informal groups and the infamous grapevine are firmly embedded in the informal organization. The grapevine (or water cooler) “is the informal communications network within an organization,…completely separate from—and sometimes much faster than—the organization’s formal channels of communication.”William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 264. Small business owners must acknowledge the existence of the grapevine and figure out how to use it constructively.
Video Clip 12.1
Leading Outside the Lines
The formal and informal organizations need to work together to sustain peak performance over time.
Organization Chart
The organization chart is a visual representation of the formal organization of a business. The chart shows the structure of the organization and the relationships and relative ranks of its positions; it helps organize the workplace while outlining the direction of management control for subordinates.“Introduction to Organizational Charts,” OrgChart.net, July 18, 2011, accessed February 2, 2012, www.orgchart.net/wiki/Main_Page. Even the one-person small business can use some kind of organization chart to see what functions need to be performed; this will help ensure that everything that should be done is getting done.“Organization Charts,” Small Business Notes, accessed February 2, 2012, www.smallbusinessnotes.com/managing-your-business/organization-charts.html. Figure \(1\) illustrates a simple organization chart for a one-person retail business.“Organization Charts,” Small Business Notes, accessed February 2, 2012, www.smallbusinessnotes.com/managing-your-business/organization-charts.html.
Organization charts offer the following benefits:“Introduction to Organizational Charts,” OrgChart.net, March 16, 2011, accessed February 2, 2012, www.orgchart.net/wiki/Main_Page; “Organization Chart,12 Manage—The Executive Fast Track, accessed February 2, 2012. Effectively communicate organizational, employee, and enterprise information
• Allow managers to make decisions about resources, provide a framework for managing change, and communicate operational information across the organization
• Are transparent and predictable about what should happen in a business
• Provide a quick snapshot about the formal hierarchy in a business
• Tell everyone in the organization who is in charge of what and who reports to whom
There are, of course, several limitations to organization charts:“Organization Chart,” 12Manage—The Executive Fast Track, accessed February 2, 2012.
• They are static and inflexible, often being out of date as organizations change and go through growth phases.
• They do not aid in understanding what actually happens within the informal organization. The reality is that organizations are often quite chaotic.
• They cannot cope with changing boundaries of firms due to outsourcing, information technology, strategic alliances, and the network economy.
In its early stages, a small business may choose not to create a formal organization chart. However, organization must exist even without a chart so that the business can be successful. Most small businesses find organization charts to be useful because they help the owner or the manager track growth and change in the organizational structure.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 247. The real challenge is to create an organizational chart that reflects the real world. Small businesses have a definite advantage here because their size allows for more flexibility and manageability.
Video Clip 12.2
Burn Your Org Chart
Not all organizational charts reflect the real world.
Formal authority is “the right to give orders and set policy.”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 203. It is organized according to a hierarchy, typically expressed in the organization chart, where one manager may have authority over some employees while being subject to the formal authority of a superior at the same time. Formal authority also encompasses the allocation of an organization’s resources to achieve its objectives.Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 276; John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 203. The position on the organization chart will be indicative of the amount of authority and formal power held by a particular individual.
Two major types of authority that the small business owner should understand are line and staff. These authorities reflect the existing relationships between superiors and subordinates.Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 278. Line authority refers to having direct authority over lower positions in the hierarchy. “A manager with line authority is the unquestioned superior for all activities of his or her subordinates.”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 203. The day-to-day tasks of those with line authority involve working directly toward accomplishing an organization’s mission, goals, and objectives.K. J. Henderson, “Features of the Line & Staff Organization Structure,” Chron.com, accessed February 2, 2012, smallbusiness.chron.com/features-line-staff -organization-structure-449.html. Examples of positions with line authority are the president, the vice president of operations, and the marketing manager. In a small business, the owner or the top manager will have line authority over his or her subordinates. The extent of line authority beyond the owner or the top manager will depend on the size of the business and the organizational vision of the owner.
Staff authority is advisory only. There is no authority to take action (except when someone is a manager of a staff function, e.g., human resources), and there is no responsibility for revenue generation. Someone with staff authority assists those with line authority as well as others who have staff authority. Examples of staff authority are human resources, legal, and accounting, each of which is relevant to a small business. Staff personnel can be extremely helpful in improving the effectiveness of line personnel. Unfortunately, staff personnel are often the first to go when cutbacks occur. As a small business grows, a decision may be made to add staff personnel because the most significant factor in determining whether or not to add personnel is the size of a business. The larger the organization, the greater the need and the ability to hire staff personnel to provide specialized expertise.Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 278. Small businesses, however, may prefer to hire outside service providers for staff functions such as legal and accounting services because it would be difficult to keep such people busy full time. Remember, cash flow is king.
Centralization and Decentralization
Centralization and decentralization are about the amount of authority to delegate. Centralization means that little or no authority and job activities are delegated to subordinates. A relatively small number of line managers make the decisions and hold most of the authority and power. Decentralization is the opposite. Authority and job activities are delegated rather than being held by a small management group.Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 283; John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 204.
Depending on various factors, organizations move back and forth on the centralization-decentralization continuum. For example, managing a crisis requires more centralized decision making because decisions need to be made quickly.Zhiang Lin and Kathleen M. Carley, “Organizational Design and Adaptation in Response to Crises: Theory and Practice,” Academy of Management Proceedings, 2001, B1–B6. A noncrisis or a normal work situation would favor decentralized decision making and encourages employee empowerment and delegated authority.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 204. There are no universally accepted guidelines for determining whether a centralized or a decentralized approach should be used. It has been noted, however, that, “the best organizations are those that are able to shift flexibly from one level of centralization to another in response to changing external conditions.”Francis Fukuyama, “Why There Is No Science of Public Administration,” Journal of International Affairs, Fall 2004, 189–201. Given the flexibility and the responsiveness of small businesses that originate from their size, any movement that is needed along the centralization-decentralization continuum will be much easier and quicker.
Guidelines for Organizing
Several management principles can be used as guidelines when designing an organizational structure. Although there are many principles to consider, the focus here is on unity of command, division of work, span of control, and the scalar principle. These principles are applicable to small businesses although, as has been said earlier, they should not be seen as etched in stone. They can be modified or ignored altogether depending on the business, the situation at hand, and the experience of management.Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 33; John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 205–206.
Unity of Command
Unity of command means that no subordinate has more than one boss. Each person in a business should know who gives him or her the authority to make decisions and do the job. Having conflicting orders from multiple bosses will create confusion and frustration about which order to follow and result in contradictory instructions.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 207. In addition, violating the unity of command will undermine authority, divide loyalty, and create a situation in which responsibilities can be evaded and work efforts will be duplicated and overlapping. Abiding by the unity of command will provide discipline, stability, and order, with a harmonious relationship—relatively speaking, of course—between superior and subordinate.“Principles of Management,” Management Study Guide, accessed February 2, 2012, www.managementstudyguide.com/management_principles.htm. Unity of command makes the most sense for everyone, but it is violated on a regular basis.
Division of Labor
The division of labor is a basic principle of organizing that maintains that a job can be performed much more efficiently if the work is divided among individuals and groups so that attention and effort are focused on discrete portions of the task—that is, the jobholder is allowed to specialize.Samuel C. Certo and S. Trevis Certo, Modern Management: Concepts and Skills (Upper Saddle River, NJ: Prentice Hall, 2012), 33; John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 206. The result is a more efficient use of resources and greater productivity. As mentioned earlier, small businesses are commonly staffed with people who wear multiple hats, including the owner. However, the larger the business, the more desirable it will be to have people specialize to improve efficiency and productivity. To do otherwise will be to slow down processes and use more resources than should be necessary. This will have a negative impact on the bottom line.
Span of Control
Span of control (span of management) refers to the number of people or subordinates that a manager supervises. The span of control typically becomes smaller as a person moves up the management hierarchy. There is no magic number for every manager. Instead, the number will vary based on “the abilities of both the manager and the subordinates, the nature of the work being done, the location of the employees, and the need for planning and coordination.”Marce Kelly and Jim McGowen, BUSN (Mason, OH: South-Western, 2008), 206. The growing trend is to use wider spans of control. Companies are flattening their structures by reducing their layers of management, particularly middle management. This process has increased the decision-making responsibilities that are given to employees.Ashim Gupta, “Organization’s Size and Span of Control,” Practical Management, January 10, 2010, accessed February 2, 2012; Marce Kelly and Jim McGowen, BUSN (Mason, OH: South-Western, 2008), 206; David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 275. As a small business grows, there will likely be more management hierarchy unless the small business owner is committed to a flatter organization. Either approach will have implications for span of control.
Scalar Principle
The scalar principle maintains “that authority and responsibility should flow in a clear, unbroken line from the highest to the lowest manager.”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 207. Abiding by this principle will result in more effective decision making and communication at various levels in the organization. Breaking the chain would result in confusion about relationships and employee frustration. Following this principle is particularly important to small businesses because the tendency may otherwise be to operate on a more informal basis because of the size of the business. This would be a mistake. Even a two-person business should pay attention to the scalar principle.
Types of Organization Structures
Knowledge about organization structures is important for a small business that is already up and running as well as a small business in its early stages. Organizations are changing every day, so small business owners should be flexible enough to change the structure over time as the situation demands, perhaps by using the contingency approach. “The contingency approach to the structure of current organizations suggests there is no ‘one best’ structure appropriate for every organization. Rather, this approach contends the ‘best’ structure for an organization fits its needs for the situation at the time.”Patricia M. Buhler, “Changing Organizational Structures and Their Impact on Managers,” Supervision, 2011, 24–26. If a small business employs fewer than fifteen people, it may not be necessary to worry too much about its organizational structure. However, if the plans for the business include hiring more than fifteen people, having an organizational structure makes good sense because it will benefit a company’s owner, managers, employees, investors, and lenders.“A Strong Business Organization Structure Is Paramount to Business Success,” The Business Plan, accessed February 2, 2012. There are many structure options. Functional, divisional, matrix, and network or virtual structures are discussed here.
Functional Structure
The functional structure is overwhelmingly the choice of business start-ups and is probably the most common structure used today. This structure organizes a business according to job or purpose in the organization and is most easily recognized by departments that focus on a single function or goal. (See Figure \(2\) for an example of a functional structure.) A start-up business is not likely to have an organization that looks like this. There may be only one or two boxes on it, representing the founder and his or her partner (if applicable).“Small Business Management Skills,” How to Start a Small Business, accessed February 2, 2012. As a small business grows, the need for additional departments will grow as well.
The functional structure gives employees and their respective departments clear objectives and purpose for their work. People in accounting can focus on improving their knowledge and skills to perform that work. This structure has also been shown to work well for businesses that operate in a relatively stable environment.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 210; Kristie Lorette, “Organizational Structure Types in Companies,” Chron.com, accessed February 2, 2012, smallbusiness.chron.com/organizational-structure-types-companies-2791 .html.
At the same time, the functional structure can create divisions between departments if conflict occurs,Kristie Lorette, “Organizational Structure Types in Companies,” Chron.com, accessed February 2, 2012, smallbusiness.chron.com/organizational-structure-types -companies-2791.html. and it can become an obstruction if the objectives and the environment of the business require coordination across departments.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 211.
Divisional Structure
The divisional structure can be seen as a decentralized version of the functional structure. The functions still exist in the organization, but they are based on product, geographic area or territory, or customer. Each division will then have its own functional department(s).Kristie Lorette, “Organizational Structure Types in Companies,” Chron.com, accessed February 2, 2012, smallbusiness.chron.com/organizational-structure-types -companies-2791.html. (See Figure \(3\) for an example of a divisional structure.)
The divisional structure can work well because it focuses on individual geographic regions, customers, or products. This focus will enable greater efficiencies of operation and the building of “a common culture and esprit de corps that contributes both to higher morale and a better knowledge of the division’s portfolio.”Jason Gillikin, “Advantages and Disadvantages of Divisional Organizational Structure,” Chron.com, accessed February 2, 2012, smallbusiness.chron.com/advantages-disadvantages-divisional-organizational-structure-611.html. There are, of course, disadvantages to this structure. Competing divisions may turn to office politics, rather than strategic thinking, to guide their decision making, and divisions may become so compartmentalized as to lead to product incompatibilities.Jason Gillikin, “Advantages and Disadvantages of Divisional Organizational Structure,” Chron.com, accessed February 2, 2012, smallbusiness.chron.com/advantages-disadvantages-divisional-organizational-structure-611.html.
As a small business starts to grow in the diversity of its products, in the geographic reach of its markets, or in its customer bases, there is an evolution away from the functional structure to the divisional structure. However, significant growth would be needed before the divisional structure should be put into place.
Matrix Structure
The matrix structure combines elements of the functional and the divisional structures, bringing together specialists from different areas of a business to work on different projects on a short-term basis. Each person on the project team reports to two bosses: a line manager and a project manager. (See Figure \(4\): for an example of a matrix structure.) The matrix structure, popular in high-technology, multinational, consulting, and aerospace firms and hospitals, offers several key advantages, including the following: flexibility in assigning specialists, flexibility in adapting quickly to rapid environmental changes, the ability to focus resources on major products and problems, and creating an environment where there is a higher level of motivation and satisfaction for employees.Marce Kelly and Jim McGowen, BUSN (Mason, OH: South-Western 2008), 208; David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 278; Kristie Lorette, “Organizational Structure Types in Companies,” Chron.com, accessed February 2, 2012, smallbusiness.chron.com/organizational -structure-types-companies-2791.html. The disadvantages include the following: the violation of the “one boss” principle (unity of command) because of the dual lines of authority, responsibility, and accountability;Robert C. Ford and W. Alan Randolph, “Cross-Functional Structures: A Review and Integration of Matrix Organization and Project Management,” Journal of Management, June 1992, 2. employee confusion and frustration from reporting to two bosses; power struggles between the first-line and the project managers; too much group decision making; too much time spent in meetings; personality clashes; and undefined personal roles.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 214; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 259. The disadvantages notwithstanding, many companies with multiple business units, operations in multiple countries, and distribution through multiple channels have discovered that the effective use of a matrix structure is their only choice.Jay R. Galbraith, “Matrix Is the Ladder to Success,” Bloomberg BusinessWeek, August 2009, accessed February 2, 2012, www.BusinessWeek.com/debateroom/archives/2009/08/matrix_is_the_l.html.
The matrix structure is for project-oriented businesses, such as aerospace, construction, or small manufacturers of the job-shop variety (producers of a wide diversity of products made in small batches).
Virtual Organization
The virtual organization (or network organization) is becoming an increasingly popular business structure as a means of addressing critical resource, personnel, and logistical issues. (See Figure \(5\) for an example of a virtual organization.) Administration is the primary function performed; other functions—such as marketing, engineering, production, and finance—are outsourced to other organizations or individuals. Individual professionals may or may not share office space, the organization is geographically distributed, the members of the organization communicate and coordinate their work through information technology, and there is a high degree of informal communication. The barriers of time and location are removed.Manju K. Ahuja and Kathleen M. Carley, “Network Structure in Virtual Organizations,” Organization Science 10, no. 6 (November 1999): 741–57; Les Phang, “Understanding Virtual Organizations,” ISACA Journal 6 (2001): 42–47; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 260.
Figure 12.9 An Example of a Virtual Organization
Source: “Supporting Skills,” Eviton, Inc., accessed February 2, 2012, http://eviton.com/organizations.htm.
The positives associated with a virtual organization include reduced real-estate expenses, increased productivity, higher profits, improved customer service, access to global markets, environmental benefits (such as reduced gas mileage for employees, which contributes to reduced auto emissions), a wider pool of potential employees, and not needing to have all or some of the relevant employees in the same place at the same time for meetings or delivering services.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 214; Les Phang, “Understanding Virtual Organizations,” ISACA Journal 6 (2001): 42–47. The negatives include setup costs; some loss of cost efficiencies; cultural issues (particularly when working in the global arena); traditional managers not feeling secure when their employees are working remotely, particularly in a crisis; feelings of isolation because of the loss of the camaraderie of the traditional office environment; and a lack of trust. John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 214; Les Phang, “Understanding Virtual Organizations,” ISACA Journal 6 (2001): 42–47.
The virtual organization can be quite attractive to small businesses and start-ups. By outsourcing much of the operations of a business, costs and capital requirements will be significantly reduced and flexibility enhanced. Given the lower capital requirements of a virtual business, some measures of profitability (e.g., return on investment [ROI] and return on assets [ROA]), would be significantly increased. This makes a business much more financially attractive to potential investors or banks, which might provide funding for future growth. ROI “is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of investments.”“Return on Investment—ROI,” Investopedia, accessed February 2, 2012. ROA is “an indicator of how profitable a company is relative to its assets…[giving] an idea as to how efficient management is at using its assets to generate earnings.”“Return on Assets—ROA,” Investopedia, accessed February 2, 2012.
Creating an Effective Business Organization Structure
Thinking and rethinking the business organization structure is important for all businesses—large or small. Conditions, products, and markets change. It is important to be flexible in creating a business structure that will best allow a business to operate effectively and efficiently. Each of the following should be considered:
• Competitors. Make an educated guess of the structure of competitors. Try to find out what works for them. Look at their reporting line structures and their procurement, production, marketing, and management systems. Perhaps there are some good ideas to be had.
• Industry. Is there a standard in an industry? Perhaps an industry lends itself to flexible organization structures, or perhaps more hierarchical structures are the norm. For example, auto manufacturers are usually set up regionally.
• Compliance or legal requirements. If an industry is regulated, certain elements may be required in the business structure. Even if an industry is not regulated, there may be compliance issues associated with employing a certain number of employees.
• Investors and lending sources. Having a business organization structure will give potential investors and funding institutions a window into how the business organizes its operations. The structure also lets investors and lenders know what kind of talent is needed, how soon they will be needed, and how the business will find and attract them.“A Strong Business Organization Structure Is Paramount to Business Success,” The Business Plan, accessed February 2, 2012.
KEY TAKEAWAYS
• Organizations are changing every day, so small business owners should be flexible enough to change their structure over time as the situation demands.
• The functional structure is overwhelmingly the choice of business start-ups and is probably the most commonly used structure today.
• The functional structure organizes a business according to the job or the purpose in the organization and is most easily recognized by departments that focus on a single function or goal.
• The divisional structure is a decentralized version of the functional structure. The functions still exist, but they are based on product, geographic area or territory, or customer.
• As a small business starts to grow, there is an evolution away from the functional to the divisional structure. However, significant growth is required before the divisional structure is put into place.
• The matrix structure brings specialists from different areas of a business together to work on different projects for a short-term basis. This structure is for project-oriented businesses, such as aerospace, construction, or small manufacturers.
• In the virtual structure, administration is the primary function performed, with other functions—such as marketing, engineering, production, and finance—outsourced to other companies or individuals. This structure can be quite attractive to small businesses and start-ups.
• Creating an effective business organization structure should take the competition, the industry, compliance or legal requirements, investors, and lending sources into consideration.
EXERCISES
1. Select two small businesses that market two very different products, for example, a small manufacturer and a restaurant. Contact the manager of each business and conduct a fifteen-minute interview about the organizational structure that has been chosen. Ask each manager to describe the existing organizational structure (drawing an organization chart), explain why that structure was chosen, and reflect on the effectiveness and efficiency of the structure. Also ask each manager whether any thoughts have been given to changing the existing structure.
2. Frank Rainsford has been, in effect, the CEO of Frank’s All-American BarBeQue since its inception. His major role has been that of restaurant manager, receiving support from his assistant manager Ed Tobor for the last fourteen years. Frank has two children, a son and daughter, who both worked in the restaurant as teenagers. His daughter has worked periodically at the restaurant since she graduated from high school. Frank’s son, who recently lost his job, has returned to work for his father. The son produced several plans to expand the business, including the opening of a second restaurant and the extensive use of social media. After careful consideration, Frank has decided to open a second restaurant, but this has presented him with a major problem—how to assign responsibilities to personnel. His son wants to be designated the restaurant manager of the second restaurant and made the vice president of marketing. Ed Tobor also wants to be the manager of the new restaurant. His daughter has expressed an interest in being the manager of either restaurant. How should Frank resolve this problem? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/12%3A_People_and_Organization/12.03%3A_Organizational_Design.txt |
Learning Objectives
1. Understand the different legal forms that a small business can take.
2. Explain the factors that should be considered when choosing a legal form.
3. Understand the advantages and disadvantages of each legal form.
4. Explain why the limited liability company may be the best legal structure for many small businesses.
Every small business must select a legal form of ownership. The most common forms are sole proprietorship, partnership, and corporation. A limited liability company (LLC) is a relatively new business structure that is now allowed by all fifty states. Before a legal form is selected, however, several factors must be considered, not the least of which are legal and tax options.
Factors to Consider
The legal form of the business is one of the first decisions that a small business owner will have to make. Because this decision will have long-term implications, it is important to consult an attorney and an accountant to help make the right choice. The following are some factors the small business owner should consider before making the choice:[citation redacted per publisher request]; “Small Business Planner: Choose a Structure,” US Small Business Association, accessed February 3, 2012, archive.sba.gov/smallbusinessplanner/start/chooseastructure/index.html.
• The owner’s vision. Where does the owner see the business in the future (size, nature, etc.)?
• The desired level of control. Does the owner want to own the business personally or share ownership with others? Does the owner want to share responsibility for operating the business with others?
• The level of structure. What is desired—a very structured organization or something more informal?
• The acceptable liability exposure. Is the owner willing to risk personal assets? Is the owner willing to accept liability for the actions of others?
• Tax implications. Does the owner want to pay business income taxes and then pay personal income taxes on the profits earned?
• Sharing profits. Does the owner want to share the profits with others or personally keep them?
• Financing needs. Can the owner provide all the financing needs or will outside investors be needed? If outside investors are needed, how easy will it be to get them?
• The need for cash. Does the owner want to be able to take cash out of the business?
The final selection of a legal form will require consideration of these factors and tradeoffs between the advantages and disadvantages of each form. No choice will be perfect. Even after a business structure is determined, the favorability of that choice over another will always be subject to changes in the laws.“Limited Liability Company,” Entrepreneur.com, July 9, 2007, accessed February 3, 2012, www.entrepreneur.com/article/24484.
Sole Proprietorship
A sole proprietorship is a business that is owned and usually operated by one person. It is the oldest, simplest, and cheapest form of business ownership because there is no legal distinction made between the owner and the business (see TTable \(1\) ). Sole proprietorships are very popular, comprising 72 percent of all businesses and nearly \$1.3 trillion in total revenue.US Internal Revenue Service, “Selected Returns and Forms Filed or to Be Filed by Type During Specified Calendar Years 1980–2005,” SOI Bulletin, Historical Table, Fall 2004, as cited in John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 60. Sole proprietorships are common in a variety of industries, but the typical sole proprietorship owns a small service or retail operation, such as a dry cleaner, accounting services, insurance services, a roadside produce stand, a bakery, a repair shop, a gift shop, painters, plumbers, electricians, and landscaping services.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 60; adapted from David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 163. Clearly, the sole proprietorship is the choice for most small businesses.
Table \(1\): Sole Proprietorships: A Summary of Characteristics
Liability Taxes Advantages Disadvantages
Unlimited: owner is responsible for all the debts of the business. No special taxes; owner pays taxes on profits; not subject to corporate taxes
• Tax breaks
• Owner retains all profits
• Easy to start and dissolve
• Flexibility of being own boss
• No need to disclose business information
• Pride of ownership
• Owner absorbs all losses
• Unlimited liability
• Difficult to get financing
• Management deficiencies
• Lack of stability in case of injury, death, or illness
• Time demands
• Difficult to hire and keep highly motivated employees
Source: John M. Ivancevich and Thomas N. Duening, Business: Principles, Practices, and Guidelines (Mason, OH: Atomic Dog Publishing, 2007), 60; David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 163; “How to Choose the Right Business Structure for Your Small Business,” National Federation of Independent Business, accessed February 3, 2012; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 150–51.
Partnership
A partnership is two or more people voluntarily operating a business as co-owners for profit. Partnerships make up more than 8 percent of all businesses in the United States and more than 11 percent of the total revenue.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 150. Like the sole proprietorship, the partnership does not distinguish between the business and its owners (see Table 12.2 "Partnerships: A Summary of Characteristics"). There should be a legal agreement that “sets forth how decisions will be made, profits will be shared, disputes will be resolved, how future partners will be admitted to the partnership, how partners can be bought out, and what steps will be taken to dissolve the partnership when needed.”“Small Business Planner: Choose a Structure,” US Small Business Association, accessed February 3, 2012, archive.sba.gov/smallbusinessplanner/start/chooseastructure/index.html.
There are two types of partnerships. In the general partnership, all the partners have unlimited liability, and each partner can enter into contracts on behalf of the other partners. A limited partnership has at least one general partner and one or more limited partners whose liability is limited to the cash or property invested in the partnership. Limited partnerships are usually found in professional firms, such as dentists, lawyers, and physicians, as well as in oil and gas, motion-picture, and real-estate companies. However, many medical and legal partnerships have switched to other forms to limit personal liability.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 60; David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 163; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 150.
Before creating a partnership, the partners should get to know each other. According to Michael Lee Stallard, cofounder and president of E Pluribis Partners, a consulting firm in Greenwich, Connecticut, “The biggest mistake business partners make is jumping into business before getting to know each other…You must be able to connect to feel comfortable expressing your opinions, ideas and expectations.”Shelley Banjo, “Before You Tie the Knot…,” Wall Street Journal, November 26, 2007, accessed February 3, 2012.
Table \(2\): Partnerships: A Summary of Characteristics
Liability Taxes Advantages Disadvantages
Unlimited for general partner; limited partners risk only their original investment. Individual taxes on business earnings; no income taxes as a business
• Owner(s) retain all profits
• Unlimited for general partner; limited partners risk only their original investment. Individual taxes on business earnings; no income taxes as a business
• Easy to form and dissolve
• Greater access to capital
• No special taxes
• Clear legal status
• Combined managerial skills
• Prospective employees may be attracted to a company if given incentive to become a partner
• Unlimited financial liability for general partners
• Interpersonal conflicts
• Financing limitations
• Management deficiencies
• Partnership terminated if one partner dies, withdraws, or is declared legally incompetent
• Shared decisions may lead to disagreements
Source: John M. Ivancevich and Thomas N. Duening, Business: Principles, Practices, and Guidelines (Mason, OH: Atomic Dog Publishing, 2007), 64–65; David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 163; “How to Choose the Right Business Structure for Your Small Business,” National Federation of Independent Business, accessed February 3, 2012; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 154–55; “Small Business Planner—Choose a Structure,” US Small Business Administration, accessed February 3, 2012.
Corporation
A corporation “is an artificial person created by law, with most of the legal rights of a real person. These include the rights to start and operate a business, to buy or sell property, to borrow money, to sue or be sued, and to enter into binding contracts” William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 157. (see Table 12.3 "Corporations: A Summary of Characteristics"). Corporations make up 20 percent of all businesses in the United States, but they account for almost 90 percent of the revenue. Jeff Madura, Introduction to Business (St. Paul, MN: Paradigm Publishers International, 2010), 150. Although some small businesses are incorporated, many corporations are extremely large businesses—for example, Walmart, General Electric, Procter & Gamble, and Home Depot. Recent data show that only about one-half of the small business owners in the United States run incorporated businesses. Matthew Bandyk, “Turning Your Small Business into a Corporation,” US News & World Report, March 14, 2008, accessed February 3, 2012.
Scott Shane, author of The Illusions of Entrepreneurship (Yale University Press, 2010), argues that small businesses that are incorporated have a much higher rate of success than sole proprietorships, outperforming unincorporated small businesses in terms of profitability, employment growth, sales growth, and other measures.Matthew Bandyk, “Turning Your Small Business into a Corporation,” US News & World Report, March 14, 2008, accessed February 3, 2012. Shane maintains that being incorporated may not make sense for “tiny little businesses” because the small amount of risk may not be worth the complexity. However, Deborah Sweeney, incorporation expert for Intuit, disagrees, saying that “even the smallest eBay business has a risk of being sued” because shipping products around the country or the world can create legal problems if a shipment is lost.Matthew Bandyk, “Turning Your Small Business into a Corporation,” US News & World Report, March 14, 2008, accessed February 3, 2012. Ultimately, it is the small business being successful that may be the biggest factor for the owner to move from a sole proprietorship to a corporation.
Table \(3\): Corporations: A Summary of Characteristics
Liability Taxes Advantages Disadvantages
Limited; multiple taxation
• Limited liability
• Skilled management team
• Ease of raising capital
• Easy to transfer ownership by selling stock
• Perpetual life
• Legal-entity status
• Economies of large-scale operations
• Double taxation
• Difficult and expensive to start
• Individual stockholder has little control over operations
• Financial disclosure
• Lack of personal interest unless managers are also stockholders
• Credit limitations
• Government regulation and increased paperwork
Source: “How—and Why—to Incorporate Your Business,” Entrepreneur, accessed February 3, 2012, ; John M. Ivancevich and Thomas N. Duening, Business: Principles, Practices, and Guidelines (Mason, OH: Atomic Dog Publishing, 2007), 64–65; “How to Choose the Right Business Structure for Your Small Business,National Federation of Independent Business, accessed February 3, 2012; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 154–55.
Limited Liability Company
The limited liability company is a relatively new form of business ownership that is now permitted in all fifty states, although the laws of each state may differ. The LLC is a blend of a sole proprietorship and a corporation: the owners of the LLC have limited liability and are taxed only once for the business.“How to Choose the Right Business Structure for Your Small Business,” National Federation of Independent Business, accessed February 3, 2012. The LLC provides all the benefits of a partnership but limits the liability of each investor to the amount of his or her investment (see Table \(4\)"). “LLCs were created to provide business owners with the liability protection that corporations enjoy without the double taxation.”“Limited Liability Company,” Entrepreneur.com, July 9, 2007, accessed February 3, 2012.
According to Carter Bishop, a professor at Suffolk University Law School, who helped draft the uniform LLC laws for several states, “There’s virtually no reason why a small business should file as a corporation, unless the owners plan to take the business public in the near future.”Annalyn Censky, “Business Structures 101,” CNN Money, August 4, 2008, accessed February 3, 2012. In the final analysis, the LLC business structure is the best choice for most small businesses. The owners will have the greatest flexibility, and there is a liability shield that protects all owners.Annalyn Censky, “Business Structures 101,” CNN Money, August 4, 2008, accessed February 3, 2012.
Table \(4\): Limited Liability Companies: A Summary of Characteristics
Liability Taxes Advantages Disadvantages
Limited; owners taxed at individual income tax rate
• Limited liability
• Taxed at individual tax rate
• Shareholders can participate fully in managing company
• No limit on number of shareholders
• Easy to organize
• LLC members can agree to share profits and losses disproportionately
• Difficult to raise money
• No perpetual life
• Is dissolved at death, withdrawal, resignation, expulsion, or bankruptcy of one member unless there is a vote to continue
• No transferability of membership without the majority consent of other members
Source: Annalyn Censky, “Business Structures 101,” CNN Money, August 4, 2008, accessed February 3, 2012; “Limited Liability Company,” Entrepreneur.com, accessed February 3, 2012; John M. Ivancevich and Thomas N. Duening, Business: Principles, Practices, and Guidelines (Mason, OH: Atomic Dog Publishing, 2007), 64–65; “How to Choose the Right Business Structure for Your Small Business,” National Federation of Independent Business, accessed February 3, 2012; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 159.
KEY TAKEAWAYS
• Every small business must select a legal form of ownership. It is one of the first decisions that a small business owner must make.
• The most common forms of legal structure are the sole proprietorship, the partnership, and the corporation. An LLC is a relatively new business structure.
• When deciding on a legal structure, every small business owner must consider several important factors before making the choice.
• The sole proprietorship is the oldest, simplest, and cheapest form of business ownership. This business structure accounts for the largest number of businesses but the lowest amount of revenue. This is the choice for most small businesses.
• A partnership is two or more people voluntarily operating a business as co-owners for profit. There are general partnerships and limited partnerships.
• A corporation is an artificial person with most of the legal rights of a real person. Corporations make up about 20 percent of all businesses in the United States, but they account for almost 90 percent of the revenue.
• Small businesses that are incorporated outperform unincorporated small businesses in terms of profitability, employment growth, sales growth, and other measures.
• The LLC is a hybrid of a sole proprietorship and a corporation. It is the best choice for most small businesses.
EXERCISES
1. Select three small businesses of different sizes: small, medium, and large. Interview the owners, asking each about the legal structure that the owner chose and why. If any of the businesses are sole proprietorships, ask the owner if an LLC was considered. If not, try to find out why it was not considered.
2. Frank’s BarBeQue is currently a sole proprietorship. Frank’s son, Robert, is trying to persuade his father to either incorporate or become an LLC. Assume that you are Robert. Make a case for each legal structure and then make a recommendation to Frank. It is expected that you will go beyond the textbook in researching your response to this assignment. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/12%3A_People_and_Organization/12.04%3A_Legal_Forms_of_Organization_for_the_Small_Business.txt |
Learning Objectives
1. Understand the complexities of hiring, retaining, and terminating employees.
2. Be aware of the laws that apply to businesses of all sizes and specifically to small businesses of certain sizes.
3. Understand outsourcing: what it is; when it is a good idea; and when it is a bad idea.
4. Describe ways to improve office productivity.
The term human resources has been deliberately avoided in this section. This term is more appropriate for large bureaucratic organizations that tend to view their personnel as a problem to be managed. Smaller and midsize enterprise personnel, however, are not mere resources to be managed. They should not be seen as cogs in a machine that are easily replaceable. Rather, they are people to be cultivated because they are the true lifeblood of the organization.
Many small businesses operate with no employees. The sole proprietor handles the whole business individually, perhaps with help from family or friends from time to time. Deciding to hire someone will always be a big leap because there will be an immediate need to worry about payroll, benefits, unemployment, and numerous other details.“Human Resources,” Small Business Notes, accessed June 1, 2012, www.smallbusinessnotes.com/managing-your-business/human-resources. A small business that looks to grow will face the hiring decision again and again, and additional decisions about compensation, benefits, retention, training, and termination will become necessary. Other issues of concern to a growing small business or a small business that wants to stay pretty much where it is include things such as outsourcing, how to enhance and improve productivity, and legal matters.
Hiring New People
All businesses want to attract, develop, and retain enough qualified employees to perform the activities necessary to accomplish the organizational objectives of the business. David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 288. Although most small businesses will not have a department dedicated to performing these functions, these functions must be performed just the same. The hiring of the first few people may end up being pretty simple, but as the hiring continues, there should be a more formal hiring process in place.
Figure \(1\) illustrates the basics of any hiring process, whether for a sole proprietorship or a large multinational corporation.
Identify Job Requirements
A small business owner should not proceed with hiring anyone until he or she has a clear idea of what the new hire will do and how that new hire will help attain the objectives of the business. Workforce planning, the “process of placing the right number of people with the right skills, experiences, and competencies in the right jobs at the right time,”“Workforce Planning,” accessed February 3, 2012, . is a way to do that. The scope of this planning will be very limited when a business is very small, but as a business grows, it will take on much greater importance. Doing things right with the first new hire will establish a strong foundation for hiring in the future. Forecasting needs for new people, both current and future, is part of workforce planning. No forecast is perfect, but it will provide a basis on which to make hiring decisions.
As an employer, every small business should prepare a job description before initiating the recruitment process. A good job description describes the major areas of an employee’s job or position: the duties to be performed, who the employee will report to, the working conditions, responsibilities, and the tools and equipment that must be used on the job.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 159. It is important not to create an inflexible job description because it will prevent the small business owner and the employees from trying anything new and learning how to perform their jobs more productively.“Job Descriptions,Small Business Notes, accessed February 3, 2012.
Choose Sources of Candidates
Because hiring a new employee is an expensive process, it is important to choose sources that have the greatest potential for reaching the people who will most likely be interested in what a small business has to offer. Unfortunately, it is not always possible to know what those sources are, so selecting a mix of sources makes good sense.
• Internet. The Internet offers a wealth of places to advertise a job opportunity. Monster.com, CareerBuilder.com, and LinkedIn.com are among the largest and most well-known sites, but there may be local or regional job sites that might work better, particularly if a business is very small. A business will not have the resources to bring people in from great distances. If a business has a Facebook or a Twitter presence, this is another great place to let people know about job openings. There may also be websites that specialize in particular occupations.
• Schools and colleges. Depending on the nature of the job, local schools and colleges are great sources for job candidates, particularly if the job is part time. Full-time opportunities may be perfect for the new high school or college graduate. It would be worth checking out college alumni offices as well because they often offer job services.
• Employee referrals. Referrals are always worth consideration, if only on a preliminary basis. The employee making the referral knows the business and the person being referred. Going this route can significantly shorten the search process…if there is a fit.
• Promotion from within. Promoting from within is a time-honored practice. The owner sends a positive signal to employees that there is room for advancement and management cares about its employees. It is significantly less costly and quicker than recruiting outside, candidates are easier to assess because more information is available, and it improves morale and organization loyalty.“When Is It Better to Promote from Within Your Company?,” AllBusiness, accessed February 3, 2012. On the downside, there may be problems between the person who is promoted and former coworkers, and the organization will not benefit from the fresh ideas of someone hired from the outside.
• Want ads. Want ads can be very effective for a small business, especially if a business is looking locally or regionally. The more dynamic the want ad, the more likely it will attract good candidates. Newspapers and local-reach magazines might be a business’s first thoughts but also consider advertising in the newsletters of relevant professional organizations and at the career services offices of local colleges, universities, and technical colleges.
Review Applications and Résumés
When looking for the best qualified candidates, be very clear about the objectives of the business and the associated reason(s) for hiring someone new. It is also critical to know the law. Some examples are provided here. This would be a good time to consult with a lawyer to make sure that everything is done properly.
1. Employee registration requirement. All US employers must complete and retain Form I-9 for each individual, whether a citizen or a noncitizen, hired for employment in the United States. The employer must verify employment eligibility and identity documents presented by the employee.“Hiring Issues,” Small Business Notes, accessed February 3, 2012.
2. The Civil Rights Act of 1964, the Civil Rights Act of 1991, and the Equal Employment Opportunity Act of 1972. Attempt to provide equal opportunities for employment with regard to race, religion, age, creed, gender, national origin, or disability.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 299. The closest Equal Employment Opportunity Commission (EEOC) district office should be contacted for specific information.
3. Immigration Reform and Control Act of 1986. This law places a major responsibility on employers for stopping illegal immigration.
Labor Laws Governing Employers
The following is a brief synopsis of some of the federal statutes governing employers that may apply to a small business. In many instances, they are related to the size of the business.“Labor Laws Governing Employers,” Small Business Notes, accessed February 3, 2012, . There are definite advantages to staying small.
The following laws apply no matter the size of the business:
• Fair Labor Standards Act
• Social Security
• Federal Insurance Contributions Act
• Medicare
• Equal Pay Act
• Immigration Reform and Control Act
• Federal Unemployment Tax Act
This additional law applies if a business has more than ten employees:
• Occupational Safety and Health Administration Act
The following additional laws apply if a business has more than fourteen employees:
• Title VII Civil Rights Act
• Americans with Disabilities Act (ADA)
• Pregnancy Discrimination Act
The following additional laws apply if a business has more than nineteen employees:
• Age Discrimination in Employment Act
• Older Worker Benefit Protection Act
• Consolidated Omnibus Budget Reconciliation Act
This additional law applies if a business has more than forty-nine employees:
• Family Medical Leave Act
The following additional laws apply if a business has more than ninety-nine employees:
• Worker Adjustment and Retraining Notification Act
• Employee Retirement Income Security Act
Interview Candidates
Just as knowing the law is important when reviewing applications and résumés, it is also important when interviewing candidates. Several interview questions are illegal to ask—for example, “Do you have dependable child care in place?” and “Do you rent or own your own home?”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 303. In general, the off-limit topics in most employment interviews include religion, national origin, race, marital status, parental status, age, disability, gender, political affiliation, criminal records, and other personal information such as financial and credit history.“Interviewing Guidelines,” Small Business Notes, accessed February 3, 2012. In short, keep the interview focused on the job, its requirements, and the qualifications of the candidate.
Select a Candidate and Negotiate an Offer
After any desired follow-up interviews are conducted, it is time to select a candidate and negotiate an offer. There are three main issues to consider: compensation, job performance and expectations, and accommodations for disabilities.
Compensation includes wages, salaries, and benefits. Although wages and salaries are often used interchangeably, they are different. Wages are payments based on an hourly pay rate or the amount of output. Production employees, maintenance workers, retail salespeople (sometimes), and part-time workers are examples of employees who are paid wages.David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 294–95.Salaries are typically calculated weekly, biweekly, or monthly. They are usually paid to office personnel, executives, and professional employees.David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 295. Every small business should do its best to offer competitive wages and salaries, but a small business will generally not be able to offer wages and salaries that are comparable to those offered by large corporations and government. Employee benefits, such as health and disability insurance, sick leave, vacation time, child and elder care, and retirement plans, are paid entirely or in part by the company; they represent a large component of each employee’s compensation.David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 296. Most employees have come to expect a good benefits program, even in a small business, so “the absence of a program or an inadequate program can seriously hinder a company’s ability to attract and keep good personnel.”“Employee Benefits,” Small Business Notes, accessed February 3, 2012, . Not surprisingly, small businesses are also not in a position to offer the same level of benefits that can be offered by large corporations and the government. However, small businesses can still offer a good benefits program if it includes some or all the following elements: health insurance, disability insurance, life insurance, a retirement plan, flexible compensation, leave, and perks.“Employee Benefits,” Small Business Notes, accessed February 3, 2012. In addition, small businesses can offer benefits that only a small business can offer—for example, the flexibility to dress casually, half days on Friday, and bringing one’s pet to work. Other ideas include gym memberships or lunch programs. These things have proven to increase employee loyalty, and they will fit the budget of even the smallest business.“Improve Your Employee Retention Rate,” Small Business Notes, accessed February 3, 2012.
Set Performance Expectations
It is in the best interests of a business for prospective new employees to know and understand their performance expectations. This means that a business must determine what these expectations are. New employees should understand the goals of the organization and, as applicable, the department in which they will be working. It should also be made clear how the employee’s work can positively impact the achievement of these goals.“Setting Clearer Performance Expectations,” SmallBusinessLand.com, accessed February 3, 2012, www.smallbusinessland.com/article/setting-clearer -performance-expectations.html.
Make Accommodations for Disabilities
If a business is hiring someone with a disability and has fifteen or more employees, it is required by the ADA (enacted in 1990) to make reasonable workplace accommodations for employees with disabilities. Though not required, businesses with fewer than fifteen employees should consider accommodations as well.
Reasonable accommodations are adjustments or modifications which range from making the physical work environment accessible to restructuring a job, providing assistive equipment, providing certain types of personal assistants (e.g., a reader for a person who is blind, an interpreter for a person who is deaf), transferring an employee to a different job or location, or providing flexible scheduling.
Reasonable accommodations are tools provided by employers to enable employees with disabilities to do their jobs. For example, employees are provided with desks, chairs, phones, and computers. An employee who is blind or who has a visual impairment might need a computer which operates by voice command or has a screen that enlarges print.“What Is Reasonable Accommodation?,” Marines, accessed February 27, 2012. A tax credit is available to an eligible small business, and businesses may deduct the costs (up to \$15,000) of removing an architectural barrier. Small businesses should check with the appropriate government agency before making accommodations to make sure that everything is done correctly.
Is a Business Hiring and Breeding Greedy and Selfish Employees?
If a business is worried about hiring a bunch of jerks, the EGOS Survey (Evaluation Gauge for Obnoxious Superstars) from Fast Company will help it find out. If a business owner answers truthfully, the owner can learn whether he or she is a leader of obnoxious superstars. Hiring jerks can happen in any size business.Robert I. Sutton, “Quiz: Are You Hiring and Breeding Greedy and Selfish Employees?,” Fast Company, September 2, 2010, accessed February 3, 2012.
Retention and Termination
Acquiring skilled, talented, and motivated employees will be a continuing concern for all small businesses. But the concerns do not end there. There will be issues concerning retention and termination of employment. Retention refers to keeping employees, and termination is about ending the employment of current employees against their will.
Retention
Employee retention rates play an important role in the cost of running a business. The first few years of an employee’s service are the most costly because money will be spent on recruiting and training the employee. It is only after the employee has been working for some time that he or she will start making money for the business.“Improve Your Employee Retention Rate,” Small Business Notes, accessed February 3, 2012.
Because of the costly and time-consuming nature of hiring new employees, many companies today increasingly emphasize retaining productive people.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 295. Even the smallest of businesses should be concerned about retention because high turnover will be disruptive to the operations of the business and, as a result, may lessen the quality of the customer experience and customer satisfaction.
A good training and orientation program at the outset of employment can set the stage for increased retention. Training “is a continual process of providing employees with skills and knowledge they need to perform at a high level.”John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 309. This continuing process is important. According to Inc.com, “the quality of employees and the continual improvement of their skills and productivity through training, are now widely recognized as vital factors in ensuring the long-term success and profitability of small businesses.”“Training and Development,” Inc.com, accessed February 3, 2012. Training programs will vary greatly depending on the size and the nature of the business. However, all training programs must be based on both organizational and individual needs, spell out the problems that will be solved, and be based on sound theories of learning. John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 309. Many training and management development programs are not for amateurs, but the extent to which a small business can provide professionally delivered programs will be budget and needs related. In some instances, training is performed by someone who is currently doing the job—for example, using a particular machine, operating the cash register, stocking merchandise, and learning office procedures and protocols. Nothing additional is required.
Employee incentive programs are particularly important for small businesses because benefits satisfaction in small businesses typically lags behind benefits satisfaction in large corporations. A recent study“Building a Better Benefits Program without Breaking the Budget: Five Practical Steps Every Small Business Should Consider,” MetLife, 2010, accessed February 3, 2012, www.metlife.com/assets/institutional/services/insights-and-tools/ebts/small-market -whitepaper-v2.pdf. revealed that 81 percent of employees who are satisfied with their benefits are also satisfied with their jobs, whereas 23 percent of employees who are dissatisfied with their benefits are very satisfied with their jobs (Figure \(2\):).
Given the importance of benefits to employees, small businesses need to be very creative about what kinds of incentives are offered to their employees. One of the biggest incentives may be the flexibility and camaraderie that are not available in larger businesses,“Employee Incentives for Small Business,” Yahoo! Voices, May 24, 2007, accessed February 3, 2012, voices.yahoo.com/employee-incentives-small-business -359161.html. but to increase employee retention and attract the best and brightest, there will need to be more.Sharon McLoone, “How Do I…Offer Employee Incentives,” Washington Post, December 4, 2008, voices.washingtonpost.com/small-business/2008/12/how_do _ioffer _employee_incenti.html. Creating a sense of community, offering leadership opportunities, creating a culture of recognition, and constantly offering opportunity can be powerful incentives.“Employee Incentive Programs on a Small Business Budget,” Small Business Notes, accessed February 3, 2012. They can be very effective at increasing employee retention, particularly when there is insufficient money to provide large raises. People want to enjoy their jobs as well as earn money, and they may care about their community and passions equally as much as their salaries. This is an opportunity for small businesses because “smaller companies may be better positioned to provide work-life balance that makes for happier, healthier employees.”“Report: Cost-Effective Benefits Strategies for Small Businesses,ESBJournal.com, October 19, 2010, accessed February 3, 2012.
Video Clip \(1\):
Keeping Small Business Employees
Some ideas for keeping small business employees. They begin with a good job description.
Termination
Termination or firing will always be unavoidably painful,“Employee Termination,” Inc.com, accessed February 3, 2012. but it is a managerial duty that is sometimes necessary. In small businesses, terminations are usually carried out by the owner. They should be done promptly to preserve the health of the business.“Employee Termination,” Inc.com, accessed February 3, 2012. Terminations can be termination at will or termination for cause.
• Termination at will. Employment at will means that a person does not have an employment contract. The person is employed “at the will” of the employer for as little or as long as the owner desires. It also means that a person can stop working for an employer at any time. An employer “doesn’t need to give a reason for termination of an ‘at will’ employee, as long as the termination isn’t unlawful or discriminatory…Termination can be due to a merger, workforce reduction, change in company direction and business focus, poor company performance, or any number of other legitimate reasons.”“Employees: Job Termination Rights FAQs,” Lawyers.com, accessed February 3, 2012.
• Termination for cause. When someone is terminated for cause, that person is being fired for a specific reason,Alison Doyle, “Terminated for Cause,” About.com, accessed February 3, 2012one of which may be behavior. Common causes for termination include but are not limited to stealing, lying, falsifying records, embezzlement, insubordination, deliberately violating company policies or rules, absenteeism and tardiness, unsatisfactory performance, changed job requirements, sexual harassment, and failing a drug or alcohol test.Alison Doyle, “Terminated for Cause,” About.com, accessed February 3, 2012; “Employee Termination,Inc.com, accessed February 3, 2012. Sexual harassment is a form of sex discrimination that violates Title VII of the Civil Rights Act of 1964. According to the EEOC, sexual harassment is “unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature constitutes sexual harassment when submission to or rejection of this conduct explicitly or implicitly affects an individual’s employment, unreasonably interferes with an individual’s work performance or creates an intimidating, hostile or offensive work environment.”“Facts about Sexual Harassment,US Equal Employment Opportunity Commission, June 27, 2002, accessed February 3, 2012.
When an employee has been terminated, the small business owner should inform the other employees. As a general rule, the less said to coworkers and other employees about an employee’s termination, the better. People will be curious, but do not infringe on the terminated employee’s privacy or say something that might leave a person open to legal action.“Employee Termination: Informing Other Employees,Small Business Notes, accessed February 3, 2012. The best approach is to inform immediate coworkers, subordinates, and clients by simply telling them that the company no longer employs the employee. Do not mention any details but do include an explanation of how the terminated employee’s duties will be carried out in the future.“Employee Termination: Informing Other Employees,” Small Business Notes, accessed February 3, 2012.
Outsourcing
Outsourcing is the practice of using outside firms, some of which may be offshore, to handle work that is normally performed within a company.“The Benefits of Outsourcing for Small Businesses,” New York Times, January 1, 2008, accessed February 3, 2012, . Small business owners routinely outsource a range of services, such as landscaping; building, utility, and furniture maintenance; distribution; and cleaning.Joanna L. Krotz, “Tips for Outsourcing Your Small-Business Needs,” Microsoft, accessed February 3, 2012, www.microsoft.com/business/en-us/resources/management/recruiting-staffing/tips-for-outsourcing-your-small-business-needs .aspx?fbid=WTbndqFrlli#T; David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 303. Consistent with the trend set by larger corporations, small businesses are outsourcing a range of services, many of which were once considered fundamental internal functions.David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 303.
A major reason for outsourcing is cost reduction. Other benefits of outsourcing include increasing efficiency, enabling a company to start new projects quickly, allowing a company to focus on its core business, leveling the playing field with larger companies, and reducing risk.“The Benefits of Outsourcing for Small Businesses,New York Times, January 1, 2008, accessed February 3, 2012, . There is no question that outsourcing can be a good idea, but outsourcing is not always a good idea.
When Is Outsourcing a Good Idea?
Outsourcing is a good idea when it allows a small business “to continue performing the functions it does best, while hiring other companies [many of which may be other small businesses] to do tasks that they can handle more competently and cost-effectively.”David L. Kurtz, Contemporary Business, 13th Edition Update (Hoboken, NJ: John Wiley & Sons, 2011), 303. Traditionally, payroll and personnel services have been outsourced by small businesses, but small businesses now use outside providers for a much greater range of services, including the following:Joanna L. Krotz, “Tips for Outsourcing Your Small-Business Needs,” Microsoft, accessed February 3, 2012, www.microsoft.com/business/en-us/resources/management/recruiting-staffing/tips-for-outsourcing-your-small-business-needs .aspx?fbid=WTbndqFrlli#T.
• Accounting and bookkeeping. A growth area here is outsourcing accounts receivable. This enables a small business to sell off its accounts receivable and invoices to a financing company.Peter Emerson, “Accounts Receivable Outsourcing,” Streetdirectory.com, accessed February 3, 2012. As a small business grows, the process of collecting accounts receivable may become too cumbersome to handle without collection agencies becoming involved.“When Does Outsourcing Accounts Receivables Make Sense,” Streetdirectory.com, accessed February 3, 2012.
• Specialist and expert help. Elance offers a range of services for small businesses. It has access to thousands of professionals around the world who can provide services such as graphic design, multimedia presentations, engineering, sales and marketing, writing, and translation.Joanna L. Krotz, “Tips for Outsourcing Your Small-Business Needs,” Microsoft, accessed February 3, 2012, www.microsoft.com/business/en-us/resources/management/recruiting-staffing/tips-for-outsourcing-your-small-business-needs .aspx?fbid=ZR0tpRAO-q#T.
• Public relations and marketing services. These services are costly, require specialized expertise, and are not usually full-time needs.“When Does Outsourcing Accounts Receivables Make Sense,Streetdirectory.com, accessed February 3, 2012. Many service providers specialize in the needs of small businesses.
• Virtual assistants. These people are independent entrepreneurs who provide administrative, creative, or technical support. A growing phenomenon, they work on a contractual basis via online or electronic communications. Virtual Office Temps and VirtualAssistants.com are examples of companies that can connect virtual assistants with any company that is interested.Adapted from Joanna L. Krotz, “Tips for Outsourcing Your Small-Business Needs,” Microsoft, accessed February 3, 2012, www.microsoft.com/business/en-us/resources/management/recruiting-staffing/tips-for-outsourcing-your-small-business-needs .aspx?fbid=ZR0tpRAO-q#T.
• Creating benefits package. A tremendous amount of time and creativity would be required for a smaller company to create a benefits package that is competitive in the marketplace.“Benefits Packages for Emerging Businesses: Creating Long-Term Value for Your Employees,” Monster Hiring Center, accessed February 3, 2012 Given the vast complexities of health care, including health-care laws that differ by state, outsourcing this activity makes good sense.
• Legal services. A small business may need to consult an attorney for a variety of reasons, including the following:
• Choosing the business structure
• Constructing a partnership agreement
• Obtaining a corporate charter
• Registering a corporation’s stock
• Obtaining a trademark, a patent, or a copyright or intellectual property
• Filing for licenses or permits at the local, state, and federal levels
• Purchasing an existing business or real estate
• Hiring employees, independent contractors, and other external suppliers (outsourcing)
• Extending credit and collecting debts
• Creating valid contracts
• Initiating or defending against lawsuits
• Keeping current on and compliant with business law and regulations (e.g., advertising, employment and labor, finance, intellectual property, online business law, privacy law, environmental regulations, and the Uniform Commercial Code)
• Protecting intellectual property
• Protecting ideas or inventions from others’ infringement“Business Law and Regulations,” US Small Business Association, accessed February 3, 2012. “Small Business Planner: Protect Your Ideas,” US Small Business Administration, accessed February 3, 2012; adapted from William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 159.
However, the cost of a full-time attorney would probably be prohibitive. Outsourcing these services is an appropriate choice. Some legal firms offer small businesses a flat monthly fee instead of charging them by the hour,Rob Johnson, “Legal Advice…on a Budget,” Wall Street Journal, November 15, 2010, accessed February 3, 2012. a practice that is very helpful to the small business budget.
When Is Outsourcing a Bad Idea?
Although outsourcing has benefits, there are times when it is a bad idea. For example, sales and technology development are operations that are generally best handled in-house because they are full-time needs that are at the heart of any business.“When Does Outsourcing Accounts Receivables Make Sense,” Streetdirectory.com, accessed February 3, 2012, Outsourcing might actually end up being the more expensive alternative, leading to a financial loss instead of a gain. An example would be the cost of a highly specialized expert.“When Outsourcing Is Not a Good Idea,” Streetdirectory.com, accessed February 3, 2012. In addition, when outsourcing overseas, the small business owner and/or managers may not be prepared to manage projects across time differences and cultural barriers and may not have clear guidelines, expectations, and processes in place to manage product or service quality.“The Benefits of Outsourcing for Small Businesses,” New York Times, January 1, 2008, accessed February 3, 2012.
Office Productivity
All small businesses want their employees to work better and smarter. In fact, the smaller a business is, the more efficient and effective it must be. Productivity is an issue in two places: the office and in manufacturing. Office productivity (which applies to all levels in the organization) is discussed in this section, and the role of technology is the focus. “Office” is used broadly to include, for example, physical offices, virtual offices, work situations that involve in-the-car time (e.g., realtors and salespeople), restaurant kitchens, and people who work on the sales floor in retail establishments.
Even the smallest of businesses can improve productivity by using technology, even though such use may be very limited in some instances. For example, goods and services needed to run a business can often be ordered online; e-mail can be used for customer and supplier communication; taxes can be filed online; and a simple software package like Microsoft Communicator allows intra- and extracompany communication via e-mail, text, and video. It will be the rare business that uses no technology.
Some have referred to technology as the road map to small business success—helping grow the business, work smarter, attract more customers, enhance customer service, and stay ahead of the competition.“Technology: Your Roadmap to Small-Business Success,” Intel, accessed February 3, 2012. An important component of all this is high office productivity. Efficiency and effectiveness in the office will benefit the entire business.
With the proliferation of social networks, small businesses are implementing more Facebook-like applications into their day-to-day operations.Donna Fuscaldo, “Using Social Networking to Boost Office Productivity,” Fox Business, November 12, 2010, accessed February 3, 2012, . Yammer, for example, “enables a company’s employees to gather inside a private and secure social network that can be controlled and monitored by the employer. The goal is to increase productivity…[It] is about making people work more productively using communication that’s becoming very popular in the consumer space.”Donna Fuscaldo, “Using Social Networking to Boost Office Productivity,” Fox Business, November 12, 2010, accessed February 3, 2012,. Other similar products include Conenza and Chatter.
Some see the iPad as changing how business relationships are built—providing opportunities to connect with prospects in a more meaningful way and allowing people to collaborate with others in real time from wherever they are.Brent Leary, “The iPad: Changing How We Build Business Relationships,” Inc.com, May 2010, accessed February 3, 2012. The iPad is also changing the way people can work. The SoundNote application allows note taking and recording a meeting simultaneously; once written, the notes can be e-mailed directly to the participants.Ken Burgin, “20 Ways an iPad can Improve Your Restaurant, Café, Hotel or Bar,” ProfitableHospitality.com, March 14, 2011, accessed February 3, 2012, profitablehospitality.com/news/index.php/kitchen-management/20-ways-an-ipad -can-improve-your-restaurant-cafe-hotel-or-bar. Just want to take notes? Use Evernote. Michael Hyatt, “How to Use Evernote with an iPad to Take Meeting Notes,” accessed February 3, 2012, michaelhyatt.com/how-to-use-evernote-with-an-ipad-to-take-meeting-notes.html. The iPad can be used in the kitchen of a restaurant, a café, a hotel, or a bar for finding recipes and cooking instructions, displaying recipes as PDF files, and working on budgets and cost analyses.Ken Burgin, “20 Ways an iPad can Improve Your Restaurant, Café, Hotel or Bar,” ProfitableHospitality.com, March 14, 2011, accessed February 3, 2012, profitablehospitality.com/news/index.php/kitchen-management/20-ways-an -ipad-can-improve-your-restaurant-cafe-hotel-or-bar. In retailing, the iPad can be used as a virtual sales assistant. In a dress department, coordinating accessories from a jewelry store or the shoe department can be accessed and recommended to the customer. Car dealers could customize a car by showing colors and finishes to the customer—all while standing in the parking lot.Natalie Zmuda, “iPad Poised to Revolutionize Retail Industry,Business Insider, April 24, 2010, accessed February 3, 2012, www.businessinsider.com/ipad-poised -to-revolutionize-retail-industry-2010-4. In real estate, the iPad can be used for buyer consultations, listing presentations, tracking properties, and chatting with clients—just to name a few.Patrick Woods, “Tips for Using the iPad for Real Estate,” PatrickWoods.com, July 5, 2010, www.patrickwwoods.com/tips-for-using-the-ipad-for-real-estate.
Video Clip \(2\):
Using the iPad for Real Estate
Some tips on how to use the iPad in real estate.
Although every small business owner may not see an immediate need for an iPad, it is a technology worth checking out. New applications for office productivity are coming out all the time.
A smartphone is a device that lets a person make phone calls but has other features found on a digital assistant or a computer, such as sending and receiving e-mail and editing Microsoft Office documents.Liane Cassavoy, “What Is a Smartphone?,” About.com, accessed February 3, 2012, cellphones.about.com/od/glossary/g/smart_defined.htm. A popular brand is the Apple iPhone. Smartphones give a person access to company data that is normally not possible without a laptop; make it possible to accomplish more, faster; enable mobile workers to connect to company information while on the road; keep your calendar, address book, and task lists organized; and, perhaps most importantly, keep frustrations to a minimum because the technology is designed to work in tandem with a server and a personal digital assistant (PDA).Christopher Elliott, “5 Ways Smartphones & Servers Boost Productivity,” Microsoft, accessed February 3, 2012, www.microsoft.com/business/en-us/resources/technology/communications/smartphones-and-business-productivity.aspx?fbid=WTbndqFrlli. A server is a computer or a series of computers that link other computers or electronic devices together.“Server (Computing),” Wikipedia, February 2010, accessed February 3, 2012, en.Wikipedia.org/wiki/Server_(computing). A PDA is a handheld computer that acts “as an electronic organizer or day planner that is portable, easy to use and capable of sharing information with your PC.”Craig Freudenrich and Carmen Carmack, “How PDAs Work,” accessed February 2, 2012. Blackberry is a popular brand of the PDA. The smartphone can be used for numerous business functions, such as tracking equipment and accounts, keeping calendars and address books, connecting to the Internet, acting as a global positioning system (GPS), and running multimedia software.Craig Freudenrich and Carmen Carmack, “How PDAs Work,” accessed February 2, 2012.
Like everyone else, small businesses have to do more with less. This means that effective collaboration is increasingly critical to success. Because collaboration is a daily requirement for all small businesses, the question becomes how to have productive collaboration without using up too much time and costing too much money. What is needed is a way to “spur employees to share ideas and increase productivity while protecting work-life balance.”“Evaluating Shift to Online Communication Tools,” Pgi.com, accessed February 3, 2012, www.pgi.com/us/en/content/download/7845/130408/file/PGi_WhitePaper _Return%2Bon%2BCollaboration_v05.pdf. A recent study reported that among companies that used collaboration tools, 72 percent reported better business performance.“Evaluating Shift to Online Communication Tools,” Pgi.com, accessed February 3, 2012, www.pgi.com/us/en/content/download/7845/130408/file/PGi_WhitePaper _Return%2Bon%2BCollaboration_v05.pdf. One popular collaboration tool is web conferencing: “Web conferencing services enable users to hold collaborative meetings with interactive whiteboard tools, give sales demonstrations with real-time efficacy, stage presentations with full and select moderator control or hold enhanced, multimedia roundtable discussions…And, with recording and playback tools available in the leading Web conferencing service providers, audience members and other authorized users can access meetings, presentations and demonstrations again and again or continually reference whiteboard sessions.”“Web Conferencing Review,” Top Ten Reviews, accessed February 3, 2012, web-conferencing-services.toptenreviews.com.
Although Top Ten Reviews ranked Infinite Conferencing, Netviewer Meet, and Adobe Connect Pro as the 2011 top three web conferencing services, each small business should select the product that best serves its needs and its budget.
Virtual or Telecommuting Employees
Another boon to office productivity and adding to the bottom line is the virtual or telecommuting employee. This is an employee that works from a location other than the traditional office. They can work from anywhere.Ruth Mayhew, “What Are the Advantages & Disadvantages of Virtual Offices and Telecommuting?” Chron.com, accessed May 30, 2012, smallbusiness .chron.com/advantages-disadvantages-virtual-offices-telecommuting-1167.html. There is no agreement on the number of US workers that are already telecommuting. However, it has been estimated that 40 percent of the US workforce hold jobs that lend themselves to telecommuting.“Analysis Shows Telecommuting Can Cut Persian Gulf Oil Use by Almost Half,” Telecommunte Connecticut, accessed May 30, 2012; Peter Suciu, “Telecommuting Can Save Employers Money, Too,” AllBusiness.com, March 9, 2011, accessed February 3, 2012, www.allbusiness.com/labor-employment/working-hours-patterns -telecommuting/15480193-1.html.
The advantages of virtual employees include the following:“Flexible Telecommuting Has Many Benefits for Your Small Business,” AllBusiness.com, March 9, 2011, accessed February 3, 2012, www.allbusiness.com/labor-employment/working-hours-patterns-telecommuting/11493648-1.html; Peter Suciu, “Telecommuting Can Save Employers Money, Too,” AllBusiness.com, March 9, 2011, accessed February 3, 2012, www.allbusiness.com/labor-employment/working-hours-patterns-telecommuting/15480193-1.html; James Ware and Charles Grantham, “Flexible Work: Rhetoric and Reality,” Tech Republic, accessed February 3, 2012, www.techrepublic.com/whitepapers/flexible-work-rhetoric-and-reality/384538.
• Companies could save \$6,500 annually per employee.
• Virtual employees tend to be happier, healthier, and less stressed compared to their office-bound coworkers.
• Virtual workers are significantly more productive than their office-bound colleagues. The differential is estimated at 15 percent.
• Virtual employees almost always give back more than 50 percent of the time they save by not commuting.
• Some virtual workers actually put in more time per week than those who commute.
From the perspective of the virtual employee, the advantages of telecommuting are as follows: no distractions from coworkers; no stress from office politics; spending more time with the family; saving money on transportation, parking, and clothing; and avoiding traffic or saving time by not commuting.Arnold Anderson, “Advantages of Telecommuting Jobs,” Chron.com, accessed May 30, 2012, http://smallbusiness.chron.com/advan...-jobs-765.html.
Virtual employees offer terrific advantages to the small business owner who is always looking to cut costs and attract high-quality employees. However, it is not something that works for everyone and every kind of business. For example, a restaurant cannot have a virtual waiter…at least not yet. A small business that wants to use virtual employees must create the appropriate infrastructure—that is, technology, security, policies, behavioral protocols, performance management, and so forth—to provide the best support for telecommuting workers in how, where, and when they do their jobs.Stegmeier Consulting Group, “The Business Case for Web Commuting: How to Reduce Workplace Costs and Increase Workforce Performance,” Computer World, accessed February 3, 2012, www.computerworld.com/pdfs/Citrix_Business _Case_Web_Commuting.pdf. For support with telecommuting challenges, small business owners can tap into The Alternative Board, an organization with three thousand small- and midsized-business owners.“Flexible Telecommuting Has Many Benefits for Your Small Business,” AllBusiness.com, March 9, 2011, accessed February 3, 2012, www.allbusiness.com/labor-employment/working-hours-patterns-telecommuting/11493648-1.html.
Video Link \(3\): NOT TO BE FOUND> FIND OTHER VIDEO
Making Telecommuting Work
Looking at telecommuting from the employee and the employer perspectives.
www.cbsnews.com/video/watch/?id=10162239n?tag=bnetdomain
KEY TAKEAWAYS
• Deciding to hire someone will always be a big step because there will be an immediate need to worry about payroll, benefits, unemployment, and numerous other issues.
• The hiring process includes identifying job requirements, choosing sources of candidates, reviewing applications and résumés, interviewing candidates, conducting employment tests (if desired), checking references, conducting follow-up interviews if needed, selecting a candidate, and making an offer.
• It is very important to know employment law before proceeding with the hiring process. For example, several potential questions are illegal to ask.
• Whether it is required or not, small businesses should be willing to make accommodations for employees with disabilities.
• Retention is an important concern for all small businesses.
• When an employee is to be terminated, it is best to do it promptly.
• Outsourcing is about using outside firms, some of which may be offshore, to handle work that is normally performed within a company. Outsourcing can be either good or bad; it depends on the situation.
• Office productivity is about working smarter and better. Social networking, the iPad, smartphones, online collaboration tools, and virtual employees can all help increase productivity.
EXERCISES
1. As the owner of a one-hundred-employee business, you just learned that some of your employees were “dumpster diving” in the trash outside a competitor’s offices. In other words, they were looking for information that could provide your company with a competitive advantage. With investigation, you found out that the head of the espionage operation was a personal friend. You have decided to fire your friend immediately, along with his dumpster divers. How should you proceed with the termination of your friend and his operatives so that you will not be held liable in a lawsuit? Would you reconsider the firing of the operatives? Why or why not?
2. Robert is trying to convince his father, Frank of Frank’s BarBeQue, to integrate more technology into his restaurant operations because it will increase productivity. Assuming the role of Robert, select technologies that you think would be a good fit for Frank’s restaurant. Prepare your recommendations for Frank. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/12%3A_People_and_Organization/12.05%3A_People.txt |
Learning Objectives
1. Explain how people and organization can add to customer value.
2. Explain how decisions about people and organization can impact cash flow.
3. Explain how technology and the e-environment are impacting people and organization.
Customer Value Implications
By definition, a small business is small. The CEO and the top management team have a much greater understanding of the tasks and operations of the entire business and what their employees are doing. (Sometimes their employees wish they did not have such a good knowledge of the tasks they, the employees, are supposed to be performing.) In a small business, it is much more likely for the CEO and the top management team to have a personalized relationship with their customer base. Sometimes this functions on a one-to-one basis and is predicated on a true sense of personal friendship. This intimacy between those at the top of a small business and their customers or clientele can yield tremendous benefits for both the business and the customers. Knowing the true needs of the customer on a personalized level greatly enhances the value produced by a business.
Small business organizations are flatter and less bureaucratic. Sometimes they are less centralized. This enables frontline personnel to be closer to the customer, where they can better ascertain the needs of the customer and make decisions more quickly to satisfy those needs. This adds to the value of these businesses in the eyes of their customers because of a more positive customer experience.
In addition to being closer to the customers, the owner of a smaller business has a closer relationship with the employees. There generally is no need for a formal “human resources” department that bureaucratizes relationships. The owner knows the strengths and the weaknesses of the employees and will best use them in the business. The owner can develop personal relationships with employees that are impossible in larger organizations. This closeness can often translate into an intangible strength—loyalty. Employees who are happy with their employment will provide greater value to the customer.
Cash-Flow Implications
The simpler the organizational structure, the more positive will be the impact on cash flow. Having unnecessary positions will negatively impact small business operations in terms of not only costs but also efficiency and effectiveness.
Improper hiring and termination procedures will also adversely affect cash flow. Recruiting employees is an expensive process, so errors in the hiring process will be a drain on the cash flow of a business and, as a result, its profitability. Termination is a particularly sensitive process, so a careful and thoughtful procedure should be developed for carrying it out. Errors in either hiring or termination may open up a business to lawsuits, another major hit to cash flow and profitability.
Technology adoption for office productivity improvements (e.g., social networking, iPads, and smartphones) may adversely affect the cash flow in the short term, but (hopefully) the higher productivity should offset those losses in the longer term. As an example, recall Lloyd’s Construction in Eagan, Minnesota, from "Foundations for Small Business". The company switched to a smartphone system that allowed for integrated data entry and communication. The company reduced its routing and fuel costs by as much as 30 percent, and they estimated that they saved \$1 million on a \$50,000 investment.Jonathan Blum, “Running an Entire Business from Smartphones,” CNN Money, March 12, 2008, accessed February 3, 2012.
Implications of Technology and the E-Environment
New technology solutions are being introduced every day, many of them potentially very useful for small businesses. This chapter discussed the productivity enhancement possibilities offered by social networking, the iPad, smartphones, and collaboration tools, but the discussion was only the tip of the iceberg. Technology is so pervasive in today’s workplace that ignoring it will be done at each business’s peril. Mobile technology is now even pervading the hiring process; the world of recruiting via mobile technology is moving at the speed of light. The result? More and more organizations are trying to figure out how to start using mobile devices to recruit new employees.Julie Bos, “Top Trends in Staffing: Is Your Organization Prepared for What Lies Ahead?,” Workforce Management 90, no. 2 (2011): 33–38. The prospect of targeting all populations of people is an exciting—but certainly challenging—one.
Another interesting technology product is talent management software developed by Taleo, which is targeted to the small business to simplify recruiting, hiring, and performance management with “unmatched flexibility.”“Taleo Business Edition,” Taleo.com, accessed February 3, 2012. There are undoubtedly other similar products available. The point is that this is an example of the small business technology solutions that are available for exploration and consideration.
The e-environment is a small business facilitator extraordinaire. The web is a fabulous place, making collaboration and communication so much better and faster. It has opened the door to enhanced productivity, and a potentially important part of that is the virtual employee. Small businesses should seriously consider the advantages of virtual employees because they can help the small business expand its reach, increase employee morale, and contribute to a much better work-life balance.
KEY TAKEAWAYS
• The less bureaucratic organizational structure of small businesses tends to open the door for more personalized relationships between the CEO and other top managers and customers. This adds considerable value to the business and the customer experience.
• The simpler the organizational structure, the more positive the impact on cash flow.
• Technology investments for increased productivity will be a drain on cash flow in the short term, but productivity improvements should offset the loss in the long term.
• New technology products are being introduced every day, many of them geared to the small business. Small businesses should make it a point to learn about what’s available and keep an open mind about adopting a new solution to an old problem.
• The e-environment has opened the door to multiple ways to improve office productivity, not the least of which is the virtual employee.
EXERCISE
1. Select a small business with between fifty and seventy-five employees. Set up an interview with the president or one of the other members of top management. Ask the person to describe the organizational structure of the business, and then ask him or her to discuss whether the structure helps or hinders his or her relationships with customers. Lastly, ask if there is anything about the organizational structure he or she would change—and why.
Disaster Watch
John owns a very successful electronics business. He has been in business for only three years and already has several large stores. He has seventy-five part- and full-time employees. The business thrives on a sales force that must be able to close deals, particularly on high-priced items.
Jennifer is John’s administrative assistant. She has been with him from the beginning, and John considers her to be a vital element in the success of the business. He had wooed her away from another large electronics chain. On Tuesday, Jennifer requested a private meeting with him. She arrived at the meeting clearly distressed. He asked her to sit down and tell him what was troubling her. She struggled not to cry but could not hold back the tears. She recounted the following story.
Ed Smith, a salesperson, had for the last five weeks been making inappropriate and suggestive comments to her. She told John that at first she tried to dismiss and deflect Ed’s comments with humor, and the humor clearly indicated that she had no interest. The result was that the comments became more frequent, more aggressive, and more vulgar. At this point (last Friday), Jennifer indicated to Ed that she found his remarks offensive and harassing. He laughed and, in the intervening days, continued the remarks, which became even more progressively lewd. It was Jennifer’s opinion that Ed was incapable of understanding how inappropriate his behavior was. She believes that his presence creates a significantly hostile working environment for her and other women. She thinks it would be best for the organization if Ed were fired immediately.
John expressed his profound sympathy to Jennifer and said that he would speak to Ed right away. This clearly was not what Jennifer wanted to hear. She left John’s office simply stating, “It’s either him or me.”
Although John was extremely sympathetic to Jennifer’s position, he recognized that he had to speak to Ed to protect himself. Further, John had to consider the fact that Ed was unquestionably his best salesperson. Two hours later, John called Ed into his office and related Jennifer’s story. Ed laughed it off as harmless word play, even going as far as saying, “Could you possibly see me being interested in a woman who looks like she does?” He then countered with, “Look. You know I’m your best salesman, and if I’m fired because of some slanderous comments, I’ll sue.” He then stormed out of John’s office.
What should John do? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/12%3A_People_and_Organization/12.06%3A_The_Three_Threads.txt |
Carrot Creative
The small in small business refers only to the number of employees or the volume of sales. It seldom refers to the level of enthusiasm, the amount of creativity, or the ability to innovate. A great example of this is Carrot Creative, a new social media agency headquartered in the Dumbo section of Brooklyn, New York. Mike Germano and Robert Gaafar started their first company while Mike was a college student and serving as a city councilman in Hamden, Connecticut. They developed sites that enabled students to sell used textbooks and rate their professors. In 2005, they opened Carrot Creative. When it was in its infancy, Carrot Creative was not a traditional marketing agency, and social media barely existed. The social media industry, as a whole, is one of the most innovative and fast-paced industries in the world, forcing companies such as Carrot Creative to stay ahead of the curve and adapt quickly.
Source: Used with permission from Carrot Creative.
From the very beginning, Carrot Creative has been innovative and progressive—not only because of its founders and team members but also out of necessity. It started with no available business model to copy, no rules to follow, and no resources on which to rely. They had one rule: do not accept the status quo. Carrot Creative was designed to become what its founders envisioned and what the market needed. They view themselves as a business that is always open to a challenge. They dare anyone to present them with a problem that they cannot solve. Germano, in a recent interview, put it this way, “We help brands build on social networks, teach them and help them in great ways for them to have conversations with their customers and really turn brands into people.”Julie Kanfer, “Brooklyn Tech: Carrot Creative’s Mike Germano,” Brooklyn Heights Blog, May 14, 2010, accessed February 4, 2012, brooklynheightsblog.com/archives/18448.
Some of the brands that they have signed include Crayola, the National Football League, Major League Baseball, AOL, Disney, PepsiCo, Budweiser, the Islands of the Bahamas, and Ford Motor Company. Creative Carrot was the driving force behind Ford’s social media campaign for its new Fiesta vehicle. This small business has partnerships with some of the world’s largest advertising agencies and public relations (PR) firms. They also have the honor to be on the forefront of designing the very tools that define social media. They view their title as an official “Facebook Preferred Developer” as just icing on the cake.
Today, Carrot Creative remains on top of the creative game by giving all its employees the freedom to create in their own way. It keeps creativity flowing by cultivating an environment and culture that removes the idea of micromanaging and gives each Carrot Creative employee the freedom, trust, and responsibility for their own work and actions. One never knows when creativity will strike, but it certainly will not be inside a cubicle or under someone’s thumb. Creativity flows through individual expression and personal work style. The Carrot Creative office is designed for just those things. There is space to work on couches, in a room of Astroturf, and private offices with maple desks, and, most importantly, the ability to be freely collaborative. As Germano said, “We appreciate the individual nature of small companies.”Julie Kanfer, “Brooklyn Tech: Carrot Creative’s Mike Germano,” Brooklyn Heights Blog, May 14, 2010, accessed February 4, 2012, brooklynheightsblog.com/archives/18448. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/13%3A_The_Search_for_Efficiency_and_Effectiveness/13.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Recognize the difference between effectiveness and efficiency.
2. Understand the differences among first-, second-, third-, and fourth-generation time-management systems.
3. Learn how using an activity log to see how time is spent.
4. Learn the dos and don’ts of time management.
Open any basic management textbook, and there will always be a discussion of the importance for an organization to be both effective and efficient. These are fundamental concepts. An organization demonstrates effectiveness when it achieves the outcomes that it wishes to produce.Amitai Etzioni, Modern Organizations (Englewood Cliffs, NJ: Prentice Hall, 1964), 17. Efficiency is “the capacity of an organization, institution or business to produce the desired results with the minimum expenditure of energy, time, money, personnel, material, etc.”“Efficiency, Organizational,” Mondofacto, December 12, 1998, accessed February 4, 2012, www.mondofacto.com/facts/dictionary?efficiency%2C+organizational. In discussing the distinction between the two concepts, Peter Drucker once said, “Efficiency is doing things right; effectiveness is doing the right things.”“Peter Drucker Quotes,” Brainy Quote, accessed February 4, 2012, www.brainyquote.com/quotes/authors/p/peter_drucker.html. Regardless of the exact definition of these concepts, it should be clear that any business should strive to be both effective and efficient.
It is important to recognize that for any given endeavor, one can be effective and but not efficient and vice versa. This can be illustrated with the following example. Two students are working in their college mail room. Each is given a stack of five hundred individual class schedules that are to be sorted and placed in the mailboxes of the undergraduate students. They are told that when they are done, they will be given another job. The first student is meticulous and carefully checks that each class schedule goes to the right recipient. She completes the job in 4.5 hours. The second student is less careful about accuracy and makes several errors by putting the wrong schedule in the wrong box. However, he completes his work in 3 hours. The first student was effective because the task was to get the right schedule to the right student. The second student was more efficient, if efficiency is measured in the number of schedules dispensed per hour.
In the late 1950s and early 1960s, two important works on the nature of a firm introduced an expanded concept known as “organizational slack.”James G. March and Herbert A. Simon, Organizations (New York: John Wiley & Sons, 1958), 46; Richard M. Cyert and James G. March, A Behavioral Theory of the Firm (Oxford, UK: Blackwell, 1963), 121. Slack was seen as the excess capacity maintained by an organization. By definition, slack implies that an organization is not perfectly efficient. Some argue that slack provides resources for innovation and change. Others see it as a buffer for a firm. Joseph L. C. Cheng and Idalene F. Kesner, “Organizational Slack and Response to Environmental Shifts: The Impact of Resource Allocation Patterns,” Journal of Management 23, no. 1 (1997): 1–18. Although these debates might make for interesting academic discussions, it must be recognized that most small businesses do not have the luxury of maintaining any appreciable slack. Their survival hinges on being both highly effective and highly efficient. Therefore, any technique, program, or methodology that improves those ends is vital to the well-being of a small business.
Time Management
Strategy is the art of making use of time and space. I am less concerned about the latter than the former. Space we can recover, lost time never.“Napoleon Speaks on Increasing Market Share,” Stealing Share, Inc., accessed June 1, 2012, http://www.stealingshare.com/pages/N...gy%20works.htm.
Napoleon
Throughout this chapter, the focus will be on the simple fact that one of the great enemies in life—particularly a businessperson’s life—is the existence and acceptance of waste. One of the resources that we can least afford to waste is time. In many ways, time is the most precious of all resources. Other resources can often be purchased or acquired, but time cannot be purchased. Once lost, time can never be recaptured. Time, as a resource, should be of particular importance for the small business owner.
If one is serious about maximizing the use of time, then one should consider two venues: use a time-management system and avoid what are referred to as “time wasters.” The term time-management system is a broad concept and covers many different approaches. Regardless of the approach used, its adoption provides multiple benefits. As one author puts it—“‘Time management’ involves working on the right things [effectiveness] and doing them the best way [efficiency].”Peggy Duncan, The Time Management Memory Jogger (Salem, NH: Goal/QPC Publishers, 2008), xi. Steven Covey, author of First Things First,Steven Covey, A. Roger Merrill, and Rebecca R. Merrill, First Things First (New York: Simon and Shuster, 1994), 35. a “bible” for time management, identifies four generations of time-management systems. He defines a first-generation time-management system as being composed of essentially a list of tasks that must be done. A second-generation time-management system ties deadlines to those tasks. A third-generation time-management system incorporates task prioritization. Many business people are familiar with paper-and-pencil or computerized systems for listing tasks, noting their due dates, and prioritizing them in terms of relative importance. Covey argues for a fourth-generation time-management system. This system is designed to bring balance into the personal and the professional lives of individuals. It is best illustrated by Covey’s 2 × 2 matrix, where one axis is composed of tasks that can be categorized as urgent or not urgent. The other axis is composed of tasks that can be characterized as either important or not important (see Figure 13.1 "Time-Management Matrix"). He emphasizes that those tasks that might be found in the important/not urgent quadrant (quadrant 2) might be critical to an individual’s well-being. Unfortunately, because they are listed as not urgent, they might fall by the wayside. His goal is to produce a “balanced manager.” This balance refers to what he argues are the four fundamental human needs: physical needs, social needs, mental needs, and spiritual needs. His approach to time management is based on valuing relationships and recognizing that the proper management of relationships will reduce the amount of time wasted in activities.
Figure 13.1 Time-Management Matrix
Source: Steven Covey, A. Roger Merrill, and Rebecca R. Merrill, First Things First (New York: Simon and Shuster, 1994), 37; James Cooper, “3 Vital Time Management Principles for Small Business Owners & Entrepreneurs,” mimosaPLANET, December 2, 2010, accessed February 4, 2012, mimosaplanet.com/Small-Busine...epreneurs.html.
Covey advocates that an individual should have a deep understanding of what is important in one’s life and recognize that, on any day, one will assume different roles. Both elements need to be incorporated into the time-management system. For Covey, we all have to assume different roles in our personal and professional lives. The objective is to identify what these roles require time-wise and how they can be successfully integrated. To achieve integration, we need to better understand ourselves. Covey suggests that developing a personal mission statement is vital to achieving balance. Some characteristics of such a statement might include the following:
• What represents the deepest and best within a person?
• What is an expression of a person’s unique capacity to contribute to one’s family, the organization, and the world at large?
• What represents pursuits that are higher than self-interest?
• What integrates all four fundamental human needs?
• What principles produce quality-of-life results?
• What inspires a person?
The following is an example of a personal mission statement that uses the Covey approach:
I am at my best when I am challenged by a task that has some significance.
I will try to prevent times when I have to work with individuals who think only of their own advancement.
I will enjoy my work when my company provides customers with value and earns a profit.
I will find enjoyment in my personal life when I feel that I have done something that benefits all members of my immediate family.
I will find opportunities that will allow my firm to double its sales every three years.
I can do anything I set my mind to; I will grow my business to the point where I can retire when I am 55.
My life’s journey is building my business and providing a comfortable life for my family.
I will be a person who has created a business that provides value to its customers, and I will be an individual who made his family understand how much he loved them.
My most important future contribution to others will be that I expanded my business’s operations so that I might provide opportunities and gainful employment for additional workers.
I will stop procrastinating and start working on the following:
• Broadening the products offered by my business
• Being more tolerant of others who hold conflicting opinions
• Developing plans for my retirement
I will strive to incorporate the following attributes into my life:
• The ability to make all individuals who work for my business feel as though their views are valued and counted.
• Illustrate to others that one does not have to limit oneself to a narrow domain of interests.
• Never give up regardless of the difficulty of a situation.
I will constantly renew myself by focusing on the four dimensions of my life:
• Exercise
• Greater tolerance for others
• Find more time for reading
• Control my temper
Covey’s complete system of time management is comprehensive and is supported by both paper-and-pencil and software support materials.
If Covey’s comprehensive approach appears to be initially overwhelming, where else might a person begin to improve their time-management skills? An excellent—in fact a critical—takeoff point would be to ask the following question: “Where has the time gone?” How often have we asked ourselves or heard others pose this question, and how often are we unable to answer it? Until one has a solid idea of how time is spent, it is impossible to manage time effectively. It is comparable to beginning a journey to a location without knowing the exact starting point. An excellent way of knowing how time is spent is to use an activity log.
An activity log involves writing down every task and activity a person is involved with during a day. It also requires noting when these activities occurred during the day and how long they lasted. It would be very useful to also comment on one’s emotional state and energy level while performing these tasks and activities. The log should be maintained for a period of time—generally one or two weeks. At the end of this period, analyze how time was spent. This analysis should look for some common threads:
• How much time per day or week is spent on particular activities?
• When during the day did you feel the most productive?
• When during the day did you feel the least productive or have the most disruptions to workflow?
• What activities were individuals who created these disruptions to workflow?
• What activities seem to provide little or no value?
The goal of this analysis is to identify what task or activity should be eliminated and when, if there is a pattern to productivity, a high-value challenging task should be scheduled. The activity log should provide useful insights into how a person should structure time flow.“Activity Logs: Finding Out How You Really Spend Your Time,” Mind Tools, accessed February 4, 2012, www.mindtools.com/pages/article/newHTE_03.htm. As one author put it, “Find your rhythm and schedule around.”“5 Time-Management Tricks,” Shifting Careers, December 12, 2007, accessed February 4, 2012, shiftingcareers.blogs.nytimes.com/2007/12/12/5-time-management-tricks.
After identifying workflow patterns, then seriously begin planning for time management. The first stage of this process involves identifying the required tasks to be performed across various time horizons, such as the upcoming year, month, week, or day. Draw on Covey and others to include a broad spectrum of life activities, not just work-oriented activities.Rachna D. Jain, “10 Ways for Entrepreneurs to Find More Time,” PowerHomeBiz.com, September 9, 2003, accessed February 4, 2012, www.powerhomebiz.com/vol124/findtime.htm.
In addition to identifying these tasks, it is vital that a person prioritize these tasks. Some tasks are clearly more important than others. As an example, securing a major sale would have a much higher priority than selecting the appropriate stationery for a business. The next step is determining—or more likely estimating—how much time and what resources will be required to complete the tasks. Use these estimates of time to generate a to-do list specifying the completion date for the tasks and the activities. Plan on working within realistic blocks of time.Susan Giurleo, “11 Time Management Tips for Small Business Success,” DrSusanGiurleo.com, April 11, 2011, accessed February 4, 2012, drsusangiurleo.com/11-time-management-tips-for-small-business-success. When dealing with a large complex project, learn to break it down into manageable segments and components.
It is one thing to create a prioritized time schedule; it is something entirely different to successfully follow such a schedule. Time management involves learning how to consistently carry out these tasks while avoiding the many time-robbing traps that exist in all our lives.Donald Wetmore, “Some Time Savers,” PowerHomeBiz.com, accessed February 4, 2012, www.powerhomebiz.com/vol70/timesavers.htm.
The following are some dos and don’ts of time management:
• Learn to “chunk.” Chunking is a process by which similar activities are grouped into common blocks of time. As an example, one might schedule several activities associated with the financial operations of the business—such as paying bills, tallying receipts, and so forth—together during a specific time period.Rachna D. Jain, “10 Ways for Entrepreneurs to Find More Time,” PowerHomeBiz.com, September 9, 2003, accessed February 4, 2012, www.powerhomebiz.com/vol124/findtime.htm.
• Learn to delegate. A common complaint leveled at entrepreneurs and small business owners is their propensity to be involved in every aspect of the business. The effective use of one’s time will involve recognizing that one person cannot do everything. It is important to learn how to delegate a particular task to subordinates. The challenge is to properly supervise the subordinates so that the task is carried out as desired.Susan Giurleo, “11 Time Management Tips for Small Business Success,” DrSusanGiurleo.com, April 11, 2011, accessed February 4, 2012, drsusangiurleo.com/11-time-management-tips-for-small-business-success.
• Learn to say “no.” It is often said that the most important word for a manager to learn is the word no. Time management involves discipline. It means that at times we must stop activities that would become time robbers.Carol Halsey, “The Greatest Technique of Time Management,” PowerHomeBiz.com, accessed February 4, 2012, www.powerhomebiz.com/vol94/time.htm. What about the colleague who drifts into your work space and asks, “Do you have a few minutes?” When we know that this colleague will be talking more about his or her own personal life rather than work-related activities, then we must have the courage to say, “Sorry, but I do not have the time.” In periods of time pressure, we must even find strength to forgo some activities, such as going out to lunch.“5 Time-Management Tricks,” Shifting Careers, December 12, 2007, accessed February 4, 2012, shiftingcareers.blogs.nytimes.com/2007/12/12/5-time-management-tricks.
• Learn to not procrastinate. For many of us, this is the great challenge. It is best dealt with by maintaining a clear focus on the required tasks. This is why a to-do list of tasks tied with prioritization is so important. One way to deal with procrastination is to concentrate on one task and staying with the task until it is complete.“5 Time-Management Tricks,” Shifting Careers, December 12, 2007, accessed February 4, 2012, shiftingcareers.blogs.nytimes.com/2007/12/12/5-time-management-tricks. Another form of procrastination is the willing acceptance of wasting time. Waiting is a form of wasting time if one is not engaged in some useful activity while waiting for some other outcome—such as working while on hold during a phone call.Susan Giurleo, “11 Time Management Tips for Small Business Success,” DrSusanGiurleo.com, April 11, 2011, accessed February 4, 2012, drsusangiurleo.com/11-time-management-tips-for-small-business-success.
• Learn to manage e-mail. One of the greatest sources of time wasting is the improper management of e-mail. The ping announcing a new e-mail message often lures one away from productive work to read the message. One should plan set blocks of time during the day to handle e-mail. Outside these blocks, one should not open any e-mail. E-mail should be approached so that each item can be dealt with once and then eliminated.“5 Time-Management Tricks,” Shifting Careers, December 12, 2007, accessed February 4, 2012, shiftingcareers.blogs.nytimes.com/2007/12/12/5-time-management-tricks. One should also be prepared to “on deadline days…put up the equivalent of a ‘do not disturb sign.’”“5 Time-Management Tricks,” Shifting Careers, December 12, 2007, accessed February 4, 2012, shiftingcareers.blogs.nytimes.com/2007/12/12/5-time-management-tricks.
• Learn to find private time. It is vital that an individual find time where to be alone with one’s own thoughts and work in isolation without interruptions. Time to think allows the small business owner to think about the “big picture.”Rachna D. Jain, “10 Ways for Entrepreneurs to Find More Time,” PowerHomeBiz.com, September 9, 2003, accessed February 4, 2012, www.powerhomebiz.com/vol124/findtime.htm. This type of break can actually improve one’s efficiency and effectiveness.“10 Time Management Mistakes: Avoiding Common Pitfalls,” Mind Tools, accessed February 4, 2012, www.mindtools.com/pages/article/time-management-mistakes .htm. As with e-mail, one must be prepared to demand no interruptions.
In addition to these suggestions, one should learn to use some form of time-management system: a paper-and-pencil system, such as a day planner; a computer-based system; or a system that works on one’s smartphone or an iPad. Select one system and stay with it.Donald Wetmore, “Some Time Savers,” PowerHomeBiz.com, accessed February 4, 2012, www.powerhomebiz.com/vol70/timesavers.htm.
Do not become addicted to the rush of constantly being busy. For some individuals, there is confusion between being “on the go” and actually accomplishing what one needs to accomplish. Many of these people view themselves as successful multitaskers. This ability to multitask is often referred to as a modern-day requisite skill. However, the reality is that multitasking appears to reduce one’s productivity. Some studies indicate that multitasking prolongs the accomplishment of a list of tasks by as much as 20 percent to 40 percent.“10 Time Management Mistakes: Avoiding Common Pitfalls,” Mind Tools, accessed February 4, 2012, www.mindtools.com/pages/article/time-management-mistakes .htm. A better use of one’s time is to focus on one task at a time.“20 Quick Tips for Better Time Management,” Stepcase Lifehack, accessed March 12, 2012, www.lifehack.org/articles/lifehack/20-quick-tips-for-better-time-management .html#. In conclusion, it is important to recognize that one should not expect to achieve a perfect allocation of one’s time, especially as unexpected events arise. The best that can be hoped for is that “we can actually manage ourselves.”Susan Ward, “11 Time Management Tips: Part 1: Coming to Grips with the Time Management Myth,” About.com, accessed February 4, 2012, sbinfocanada.about.com/cs/timemanagement/a/timemgttips.htm.
Video Clip 13.1
Time-Management Tips Are Really Self-Management Tips!
(click to see video)
Harvard Business Publishing covers time management.
Video Clip 13.2
Secrets of Effective Time Management
(click to see video)
Several time-management techniques are discussed.
Web Resources
Eleven Time-Management Tips, Part 1: Coming to Grips with the Time Management Myth
This site provides useful tips on successful time management.
sbinfocanada.about.com/cs/timemanagement/a/timemgttips.htm
Three Vital Time-Management Principles for Small Business Owners and Entrepreneurs
What principles are key for small business owners and entrepreneurs?
mimosaplanet.com/Small-Business-Blog/bid/55824/3-Vital-Time-Management-Principles-for-Small-Business-Owners-Entrepreneurs.html
Time Management
Learn how to schedule and manage time wisely and effectively, avoid procrastination, and improve productivity.
www.powerhomebiz.com/leadership/time.htm
Time-Management Tips for Small Business Owners
Tips that focus on small businesses.
ezinearticles.com/?Time-Management-Tips-For-Small-Business-Owners&id=4849540
Time Management
A sampling of links on time management.
www.businesstown.com/time/time.asp
KEY TAKEAWAYS
• An effective organization achieves the outcomes it wishes to produce.
• Efficiency is the ability of any organization to produce the desired results with the minimum expenditure of resources.“Efficiency, Organizational,” Mondofacto, December 12, 1998, accessed February 4, 2012, www.mondofacto.com/facts/dictionary?efficiency%2C+organizational.
• Time-management systems have evolved through four generations of models.
• Using an activity log can assist anyone in learning how to better manage time.
• Learning the dos and don’ts of time management can significantly improve one’s efficiency.
EXERCISES
1. Create a time log for a five-day period. Analyze this log and see how you spend time.
2. Identify what you believe to be your own biggest time wasters and how you intend to deal with them.
3. If you do not currently use a formal time-management system, look at several paper-and-pencil or digital versions, evaluate them, and describe which you would select and why. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/13%3A_The_Search_for_Efficiency_and_Effectiveness/13.02%3A_Personal_Efficiency_and_Effectiveness.txt |
Learning Objectives
1. Understand the three fundamental innovation strategies.
2. Understand what supports creativity in individuals and businesses.
3. Learn what may repress creativity in individuals.
4. Learn about some tools that may help individuals and organizations become more creative.
Money never starts an idea; it is the idea that starts the money.“Owen Laughlin Quotes,” Searchquotes, accessed February 4, 2012, www.searchquotes.com/quotation/Money_never_starts_an_idea._It_is_always_the _idea_that_starts_the_money/17400.
Owen Laughlin
Thomas Friedman—the author of That Used to Be Us,Thomas Friedman and Michael Mandelbaum, That Used to Be Us: How America Fell Behind the World It Invented and How We Can Come Back (New York: Farrar, Straus and Giroux, 2011). Hot, Flat, and CrowdedThomas Friedman, Hot, Flat, and Crowded: Why We Need a Green Revolution—and How It Can Renew America (New York: Farrar, Straus and Giroux, 2008). and The World Is FlatThomas Friedman, The World Is Flat: A Brief History of the Twenty-First Century (New York: Farrar, Straus and Giroux, 2005).—and other pundits consistently argue that the future belongs to those societies and businesses that can best capitalize on creativity and innovation. It is a great tragedy that we often think of creativity and innovation in terms of new technologies only. We fail to realize that creativity and innovation can occur anywhere within a business. There is a story—perhaps it is an urban legend—about a member of the cleaning staff for a company that manufactures shampoo. This employee brought a suggestion to the attention of an executive on the marketing team. The employee pointed out that the instructions on the back of the bottle of shampoo said—“Lather and rinse” and suggested that it should read “Lather, rinse, and repeat.” It may be apocryphal and somewhat unethical, but, if true, it would have led to a significant increase in sales. We recount this legend not to advocate any form of chicanery but to point out that creative insights may come from anyone and anywhere. Creativity is not limited to scientists, engineers, designers, or top executives. It is a property that all human beings possess. Likewise, creativity need not be singularly channeled into new high-tech products or advanced designs. Innovation may pursue different strategies. There are three fundamental innovation strategies for firms: need seeker, market reader, and technology driver. Barry Jaruzelski and Kevin Dehoff, “The Global Innovation 1000: How the Top Innovators Keep Winning,” Strategy+Business (Booz & Company), November 3, 2010, accessed February 4, 2012, www.strategy-business.com/article/10408?gko=08375. Need seeker firms actively interact with their present and future customers and carefully listen to them so that they can develop new products and services. These firms tend to be the first in the market. A market reader firm maintains a close relationship with its customers and provides them value through small innovative changes. A technology-driven firm is a business that puts money into research and development to produce revolutionary breakthroughs and/or incremental changes. Such a firm spends more time and effort in anticipating future customer needs and carefully listening to what customers believe they want at this point in time. None of these three innovation strategies is clearly superior to the other. It is interesting to know, however, that none of these strategies precludes or minimizes the potential contribution that could come from a small business. If one examines the three innovation strategies, it could be clearly argued that small businesses have an advantage over their larger rivals for the first two strategies. Both rely on a business having a deep and intimate understanding of the needs and desires of its customers. Small businesses also are better positioned to actively listen to their customers and, because of their size, respond more rapidly. Even the third innovation strategy often is the domain of the smaller business. Think of the number of technological breakthroughs that were initiated by smaller firms (at least, smaller at that time) than the large behemoths.
At one level, creativity should be thought of as a rare flower that should be nurtured at both the individual level and the organizational level. Many businesses create an environment that not only does not foster creativity among its personnel but also actively crushes it. Such firms punish any failure, which increases fear in the personnel to try something new. These firms fail to reward innovative successes. They foster groupthink, often responding with the following reply: “We have always done it this way.” The leadership team believes that leaders are the only ones responsible for creative actions. This type of organization is toxic to creativity.
Before examining the tools and techniques that might enhance creativity, it is important to understand what personal and organizational factors might inhibit creativity.
• Accepting the belief that one may not be creative. At a recent sports event, the coach of the team wore a t-shirt that had the following saying: “If you believe you can do something or if you believe you can’t do something, you are right.” Individuals who tell themselves that they are not creative are producing a self-fulfilling prophecy. They will not even attempt to break through barriers that might preclude them from having brilliant, creative, and innovative ideas. It is absolutely vital for the small business owner to be open to the possibility of his or her own tremendous creativity.
• Acceptance of the current situation. Sometimes we assume that the current situation is not only fully acceptable but also the only way that it can be. With that type of mental framework, we never will be in a position even to ask, “How could the situation be made better?” This corresponds with the old idiom, “If it ain’t broke, don’t fix it.” A creative mind is always operating under the assumption that things can be different and can be made better.
• Self-censorship. This is a situation when an idea occurs to us, but we initially consider it too outlandish or too impractical to successfully implement. We dismiss the idea without any further consideration. One does not even take the opportunity to record the idea. We engage in self-sabotage of our own creativity by dismissing our own ideas out of hand.
• Allowing ideas to die. It is not enough to have a creative idea. One must have the courage to defend the idea and the fortitude to see it through to fruition. Unfortunately, individuals adopt the philosophy of W. C. Fields: “If at first you don’t succeed, try, try again. Then quit. No use being a damn fool about it.”“W. C. Fields Quotes,” Goodreads, accessed February 4, 2012, www.goodreads.com/author/quotes/82951.W_C_Fields. A good counterexample of this failure to pursue ideas is the genesis of FedEx. Fred Smith, FedEx’s CEO and founder, was an economics major at Yale University. While there in 1965, Smith wrote a term paper outlining the concept behind FedEx. Legend has it that this paper received a grade of C. Most students would feel that this grade was a clear indication that the concept was infeasible, but Fred Smith was not persuaded, and nine years later he began FedEx. It is not enough to be creative; one also must be courageous.
• Not maintaining a record of ideas. What is called inspiration may be rather fickle. Ideas may come to us in the most unlikely of places and at unexpected times. Individuals should be prepared to make note of these ideas as they come. It might simply require having a notepad available at all times or a digital recorder to take down ideas. Sometimes it is useful to write out the ideas, place them where they are visually accessible, and return to them at some point in the future.
Perhaps one of the most commonly used creativity tools is brainstorming, an approach that emphasizes collaboration within a group. Brainstorming begins by specifying a problem or issue—for example, “How can we boost sales at the restaurant?”; “What can be done to reduce customer complaints?”; or “Why do these particular types of defects keep occurring?” Then one brings together personnel who are directly familiar with the problem or the issue. Sometimes it might be advisable to bring in people not directly familiar with the problem or the issue because they may bring a totally different perspective that might enhance the overall creativity of the problem-solving exercise. The room where the brainstorming exercise is held should be equipped with a whiteboard, or a computer with a projector, or a simple flip chart. The moderator or the facilitator of the brainstorming session should restate the problem. Individuals should be able to shout out possible solutions. The facilitator writes them down or types them into the computer, which is then projected so that all people can see the proposals. The most critical point of the brainstorming session is the openness with which the group accepts any and all ideas. No matter how bizarre or off-the-wall a suggestion might appear to be, no one is allowed to criticize it. Even if an idea is simply crazy, participants do not have the latitude to make any negative remarks. After all the ideas have been presented and written down, the group begins a process of winnowing down the number of suggestions to a smaller number, perhaps five.Jeffrey P. Baumgartner, “The Step by-Step Guide to Brainstorming,” The Wonderful World of Jeffery Paul Baumgartner, accessed February 4, 2012, jpb.com/creative/brainstorming.php. In the real world, most decisions cannot be done with respect to a simple, single criterion. As an example, one might evaluate the five possible solutions with respect to cost. In the freewheeling environment of brainstorming, one possible solution might yield the lowest cost but might be illegal. Before evaluating the reduced set of solutions, the group must identify all the criteria that would be useful in determining the solutions. Examples of such criteria might be cost, viability, the probability of implementing the solution within a given timeline, or customer acceptance. Once these criteria have been identified, the group can then scale (numerically evaluate) each solution with respect to the criteria. Such an approach should help the group identify the overall best solution. This is the most basic and most common format for brainstorming. Other variations exist that are designed to deal with some possible deficiencies of classical brainstorming, such as naturally reticent members.“Brainstorming: Generating Many Radical, Creative Ideas,” Mind Tools, accessed February 4, 2012, www.mindtools.com/brainstm.html.
Another useful approach to stimulate creative thinking about a problem or an issue is mind mapping. This technique is used widely in a variety of contexts, including creative writing courses. It is a visual model that uses words, phrases, tasks, or concepts centered on an idea or a problem. A node or a figure representing the core notion is drawn at the center. Ideas that are related to this central notion are drawn off, as branches, to the sides. These secondary ideas, in turn, may generate other offshoots. This continues until all interrelationships are mapped on the diagram. Figure 13.2 "Mind Map for Expanding Frank’s All-American BarBeQue" is a mind map that might have been drawn for Frank’s All-American BarBeQue, when it was considering an expansion.
Figure 13.2 Mind Map for Expanding Frank’s All-American BarBeQue
The Financial Monitor from Simione Consultants
William Simione Jr., the founding member of Simione Consultants (see the opening vignette of Chapter 9 "Accounting and Cash Flow"), has always believed that there has been a need for the home health and hospice industries to have timely financial benchmarks. Recognizing that this need was not being met, Simione started Financial Monitor LLC in 2009. This company launched a product known as the Financial Monitor. This is an excellent example of a business using its creativity to develop a new business. Using the company’s expertise in the home health and hospice industries, Simione designed a program that would benchmark clients’ quarterly financial reports against industry standards. Two principals, William Simione III and David Berman, have managed the development of the Financial Monitor. In 2009, Rob Simione was added to the Financial Monitor team as the senior manager.
The long-term goal of the Financial Monitor is to become the industry’s major database for financial information. Currently, Simione has a database of 160 providers. With this information, Simione not only provides clients with meaningful financial information but also provides the home health and hospice industry with data that can be used in advocacy efforts on both national and state levels. Simione has begun to work with both the National Association for Home Care and Hospice and several state associations to have the Financial Monitor help them in their advocacy efforts. The short-term goal is to have five hundred home health and hospice agencies on the Financial Monitor by end of 2011, and the long-range goal is to have in excess of five thousand on it by the end of 2014.
Video Clip 13.3
TED Fullerton—Matthew Jenusaitis—Importance of Creativity in Business
(click to see video)
A discussion of the importance of creativity in business. It is seventeen minutes—but very good.
Video Clip 13.4
TEDxPugetSound—Edgar Papke—Creativity and the Human Art of Business
(click to see video)
Discusses how to match creativity and motivation. Another long video, but it has excellent ideas.
Web Resources
Let Creativity & Imagination Grow Your Business
Discusses the importance of creativity for business development.
www.theopensite.com/marketing-business-promotion/small-business-imagination-creativity
Passion & Creativity Go a Long Way for Small Business Owners
Reviews the critical role of passion for start-ups.
www.catalystmarketers.com/passion-creativity-small-business-owners
Creativity: Breaking the Mental Blocks
How to overcome barriers to creativity.
www.smallbusinessadvocate.com/small-business-articles/creativity-breaking-the-mental-blocks-694
Key Takeaways
• All members of an organization can be creative.
• Organizations need to develop environments that support and nurture creativity.
• Mental blocks can stifle an individual’s creative capability.
• Tools such as brainstorming and mind mapping can enhance the creativity of groups.
EXERCISES
1. What do you believe are your own personal blocks to being more creative?
2. Brainstorm with several colleagues and come up with five innovative concepts for a local restaurant.
3. Draw a mind map for how you might become better in managing time. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/13%3A_The_Search_for_Efficiency_and_Effectiveness/13.03%3A_Creativity.txt |
Learning Objectives
1. Understand the eight dimensions of product quality.
2. Understand the five dimensions of service quality.
3. Learn about the Deming philosophy of quality management.
4. Learn about the fundamentals of Six Sigma quality management.
When considering effectiveness or efficiency improvements on an organizational level, one generally thinks in terms of programs: projects with some battery of tools and techniques. Quite often, the businessperson is confronted with choosing from a cornucopia of the most recent business fads. The fad de jour is tried and often found wanting. Eventually, businesspeople become inured to the latest hot trend, continue with their standard operations, and become less willing to try something new. This is extremely unfortunate because some of these programs offer the opportunity for significant improvements. Two such programs are quality management and lean thinking. Both approaches grew out of manufacturing environments. Most of the articles and books about them tend to emphasize manufacturing-based examples. However, this does not mean that they are limited to that domain. More and more service industries are recognizing that the adoption of quality management and/or lean thinking offers tremendous benefits in effectiveness and efficiency. The same can also be said about the acceptance of these business models by smaller firms. Although some quality and lean programs are presented as complete and complex systems requiring extensive training routines, many small businesses have adopted the underlying concepts without resorting to significant expenditures. They recognized that the promulgation of the underlying principles of quality and lean management can yield significant returns without significant expenditures.
Quality Management
Quality is never an accident; it is always the result of high intention sincere effort intelligent direction and skillful execution; it represents the wise choice of many alternatives the cumulative experience of many masters of craftsmanship. Quality also marks the search for an ideal after necessity has been satisfied and mere usefulness achieved.“William A. Foster—‘Quality Is Never an Accident…,” Quotegasm, accessed February 4, 2012, www.quotegasm.com/william-a-foster/william-a-foster-quality-is-never -an-accident.
William A. Foster
Throughout this text, the concept of customer value has been emphasized. Intimately linked to customer value is the notion of quality. Therefore, it is extremely unfortunate that for most people, businesspeople included, the term quality is either totally misunderstood or viewed from a rather narrow perspective. This stems from two reasons. The first is based on a correct assumption that quality is defined by the user (customer); however, many then go on to believe that because quality is subjective, it then becomes impossible to define. The second problem centers on the tendency to view quality, particularly in products, as singularly the result of the use of costly raw materials, components, careful craftsmanship, and detailed processes. It is assumed that together these expensive elements must necessarily produce a quality but costly outcome. In this belief system, if one wants to identify the quality of the product, one has to look only at the price tag. Quality is synonymous with cost. This is a huge error because, as will be shown, a true commitment to quality can reduce costs and expenses—and do so quite significantly.
Quality in Small Business
To see the practical benefits of using the principles of quality management for small businesses, one can simply review the winners of the Malcolm Baldrige Award. This award, started in 1987, seeks to acknowledge businesses that have a solid commitment to quality. Awards were initially given in the categories of manufacturing, service, and small businesses; subsequently, three more categories were added: education, nonprofits, and health care. A sampling of two recent winners in the small business category clearly shows that the smaller enterprise can produce spectacular results by adopting quality management.
K&N Management, a 2010 winner, operates two fast-casual restaurants in Austin, Texas. With a strong commitment to quality, such as using iPads to gather quick survey data from customers, K&N saw its sales increase from \$3 million in 2000 to over \$7.5 million in 2010. Its gross profit was consistently related to quality. In 2010, K&N was named the “best place to work in Austin.”“2010 Award Recipient: K&N Management,” Malcolm Baldrige, accessed February 4, 2012, www.baldrige.nist.gov/PDF_files/2010_K&N_Management_Profile.pdf.
The 2009 winner in the small business category was MidwayUSA, an online retailer for gun owners and hunters. Again, MidwayUSA’s commitment to quality has produced some impressive results. The firm has a customer retention rate of 98 percent. It had a growth rate of 25 percent for 2008, compared to a 10 percent rate for its nearest competitor. From 2003 to 2008, MidwayUSA saw its net profits increase from 2.5 percent to 10 percent.“2009 Award Recipient: MidwayUSA,” Malcolm Baldrige, accessed February 4, 2012, www.baldrige.nist.gov/PDF_files/MidwayUSA_Profile.pdf.
These Baldrige award winners are only a few of the indicators that a focus on quality translates into improved customer satisfaction, improved employee satisfaction, and significant improvements to a firm’s financials.
Without a fundamental understanding of what quality really means, it is impossible to achieve it—consistently. So how should one approach a useful definition of the term quality? Many authors suggest that when discussing quality, it is useful to distinguish between product quality and service quality. Today, there may be no clear-cut distinction between exclusively product-based businesses or exclusively service-based businesses. Few products can be viewed in isolation from supporting services. As an example, an automobile manufacturer clearly produces a product; however, few manufacturers would survive long if they totally excluded the area of follow-up services, such as vehicle maintenance across a car’s lifetime. Likewise, many service businesses rely on ancillary products. An investment company provides a service; however, it may also provide its clients with investment perspective reports. Many view McDonald’s as essentially a service company—the service being the delivery of fast food; obviously, the ancillary product is the food.
The literature indicates that rather than having a unitary definition of quality, it is important to identify the dimensions of quality. In a seminal 1984 article, David Garvin identified eight dimensions of product quality: performance, features, reliability, conformance, durability, serviceability, aesthetics, and perceived quality.David Garvin, “What Does ‘Product Quality’ Really Mean?,” Sloan Management Review 26, no. 1 (1984): 25–43. Table 13.1 "The Eight Dimensions of Product Quality" describes what these dimensions mean and gives examples. Garvin recognized that no consumer will find all eight dimensions equally important. However, to ensure success, a business must identify which of the eight dimensions are important to its customers. As an example, if we are dealing with a product such as a heart pacemaker, customers would be most interested in the reliability and durability dimensions of that product. If a customer is buying a car for street drag racing only, then that person’s focus would be on the performance dimensions of the vehicle.
Table 13.1 The Eight Dimensions of Product Quality
Dimension Characteristics Examples
Performance The primary measurable operating characteristics of a product.
The following outcomes for each category are of greatest importance to consumers:
• Car. Miles per gallon or acceleration time to go from 0 to 60 miles per hour
• Light bulb. Wattage
• Laptop computer. Amount of memory or speed of processor
• Copier. Pages per minute or cost per page
Features The secondary operating characteristics of a product.
The following outcomes for each category may not be initially seen as critical but often influence the purchasing decision of a consumer:
• Car. Comfort of ride or the number of cupholders
• Light bulb. The shade of light given off
• Laptop computer. Size or brightness of the screen
• Copier. Ease of use
Reliability The probability that a product will function for a given period of time or how often it breaks down. This is most often measured by the mean time between failures (MTBF). This is the expectation of how long a product is expected to last.
• Light bulb. Expected lifetime
• Electric watch. Time between replacing batteries
• Copier. Time between replacing toner cartridge or printer drum
Conformance The extent to which a product matches established standards. This is viewed by many as the critical component of quality and is the basis of statistical process control.
• Car. How well replacement parts match original equipment manufacturer components
• Laptop computer. Voltage measurements
Durability The expectation of how long a product will last and how it will function under various working conditions. This dimension refers to how well a product lasts over time and under different environments.
• Car. Expected lifetime of engine or tires; how a car functions under temperature extremes
• Laptop computer. Functionality after being dropped
Serviceability The speed, competence, and courtesy of repairs or maintenance of a product. This dimension corresponds to the ancillary service component of products.
• Car. The conduct of scheduled maintenance or repairs
• Laptop computer. Speed of return to computer after repairs; intact files after repair
Aesthetics This is how a product looks, feels, sounds, tastes, or smells. This is the most subjective of the eight dimensions. This dimension means that it is extremely important to consider design issues with respect to any product.
• Car. The attractiveness of the exterior style of the vehicle; the luxuriousness of the dashboard
• Laptop computer. Stylish exterior; unique colors; uniqueness of its operations, such as a new type of input device
Perceived quality Consumers often do not have direct evidence of objective measures of a product’s quality—both tangible and intangible measures. This concept of quality is most influenced by brand names, advertising, and commonly held perceptions concerning a product. Powerful brands often provide the perception that a product is of higher quality.
• Car. Rolls-Royce: finest quality car produced and commands a premium price
• Aspirin. Compare prices for same number of tablets: generic bottle versus brand name version—price difference due to perceived quality.
Another approach to examining quality, this time in the service context, is to explicitly consider quality as a comparison between a customer’s expectations and a customer’s perception of performance. Parasuraman, Zeithaml, and Berry argued in their 1985 seminal article that there were ten determinants (dimensions) of service quality: reliability, responsiveness, competence, access, courtesy, communication, credibility, security, knowing the customer, and tangibles.A. Parasuraman, Valerie A. Zeithaml, and Leonard L. Berry, “A Conceptual Model of Service Quality and Its Implications for Future Research,” Journal of Marketing 49 (1985): 41. After some major research, they reduced this set to five dimensions: tangibles, reliability, responsiveness, assurance, and empathy.Valerie A. Zeithaml, A. Parasuraman, and Leonard L. Berry, Delivering Quality Service: Balancing Customer Perceptions and Expectations (New York: Free Press, 1990), 38. Again, it is critical to note that customers will not view all five dimensions as equally important. In fact, the relative rank of these dimensions may differ significantly across industries. The approach of Zeithaml et al. has become well known as the SERVQUAL instrument, and it plays a prominent role in improving quality in service environments. The five service quality dimensions are given in Table 13.2 "The Dimensions of Service Quality". This SERVQUAL system explains the notion that quality is associated with a gap between expectations and perceptions. It identifies the following five types of gaps that a service organization should examine and attempt to minimize:
1. The gap between what customers expect and what a business believes are its customers’ expectations
2. The gap between a business’s evaluation of its own performance and how its customers evaluate its performance
3. The gap between a customer’s experience and a business’s specified level of performance
4. The gap between the communicated level of service by a business and what a customer actually experiences
5. The gap between a customer’s expectation and actual experience.
From looking at these five gaps, it should be obvious that a full utilization of the SERVQUAL instrument is quite a challenge and might be beyond the capacity of most small businesses. That does not mean, however, that a business interested in providing its customers with quality service cannot apply some of the elements of the SERVQUAL instrument or use it as a conceptual template.
Table 13.2 The Dimensions of Service Quality
Dimension Characteristics Examples
Tangibles The physical appearance of the facility, personnel, and communications media. The first thing customers notice is appearances. This may involve the cleanliness of a facility, how brightly lit it is, the width of the aisles, or how personnel are dressed. A cheaply designed website may convey a totally inappropriate message about a business. It should be remembered that a business has only one chance to make a first impression. At its start, McDonald’s emphasized not speed of service but the cleanliness of its facilities.
Reliability The ability to perform the service correctly and consistently. Reliability means performing the service correctly each and every time. One failure with a customer may destroy his or her faith in the capability of a business. FedEx emphasizes its guarantee to get a package there overnight—each and every time. An accounting firm must make sure that its clients’ tax returns are done properly and submitted on time.
Responsiveness The speed and courtesy to customer inquiries. A customer who is put on “hold” for any length of time is on the path to becoming an ex-customer. This dimension requires all personnel to be well mannered and focus on the needs of the customer. Disney trains its park staff to recognize that they are not responding for the sixtieth time to the same inquiry; they are responding for the first time to the sixtieth individual who is asking that question.
Assurance The extent to which the customer trusts and has confidence in the service provider. A medical facility’s survival depends on its customers’ belief that they are receiving excellent medical care. The same is true for any professional service. Trust is built over time and is a fragile commodity.
Empathy The extent and quality of individualized attention given to a customer. Empathy should be thought of in terms of a doctor’s “bedside manner.” Customers want to be thought of as individuals, not as numbers. Businesses should avoid using preprinted labels on envelopes because this clearly conveys the image of a mass mailing.
When using the term quality management, we should recognize that there is no universally consistent notion of how one can produce quality products and services. In fact, the quality management movement has been evolving for nearly a century. Perhaps the best way of tracing this evolution is to examine the contributions of some of the key proponents of quality. One of the first bodies of work that should be reviewed is that of Walter A. Shewhart (1891–1967). Similar to two other “quality gurus”—W. Edwards Deming and Joseph Juran (the authors are hesitant to use the term guru because this might question the true value of the work of these individuals)—Shewhart worked for Western Electric Company, a division of AT&T.“Walter A. Shewhart,” ASQ, accessed February 4, 2012, asq.org/about-asq/who -we-are/bio_shewhart.html. There he developed what is now known as statistical process control (SPC), a mathematical approach that measures how well products conform to previously determined standards. The goal here is to develop a control chart that would enable an operator to distinguish between the random change associated with any manufacturing process and specifically assignable causes of such change. As an example, a machine produces 0.25-inch diameter bolts. Not all the manufactured bolts will be exactly 0.25 inches in diameter. There will be some natural variation around this value. Rather than test the diameter of every bolt, in SPC, a sample of bolts is tested on a regular basis. Based on statistical analysis, one can determine if this sample is within acceptable limits around the 0.25-inch value. If a sample is not within these acceptable limits, then the machine is shut down, and every effort is made to determine the assignable cause—faulty materials, machine error, or operator error. The benefit of this approach is that one can determine, with a high degree of accuracy, the operational characteristics of the system without the expense of testing every item produced. A full discussion of all aspects of SPC is beyond the focus of this text.
Shewhart’s two books, Economic Control of Quality of Manufactured ProductWalter A. Shewhart, Economic Control of Quality of Manufactured Product (New York: D. Van Nostrand Company, 1931). and Statistical Method from the Viewpoint of Quality Control, Walter A. Shewhart, Statistical Method from the Viewpoint of Quality Control (Long Island, NY: Dover Publications, 1980). are still available in print and are viewed as the foundation works in the field.
Shewhart also made major contributions in the way we think about implementing a quality program in any organization. He advocated a systematic approach structured in four cyclical phases. This approach is sometimes referred to as the PDCA cycle (see Figure 13.3 "The PDCA Cycle") or the Deming cycle. (Yet the Deming cycle is an improper name for the PDCA cycle.) The PDCA cycle calls for a cycle of continuous improvement. The first step is to plan for a change that would lead to improvement. The planning process requires data collection to make a decision. Regardless of the approach to quality management, all decision making must be data driven. The second step in the cycle is the do phase. This entails implementing the change. It also implies that a business will implement that change on an experimental basis, meaning that the organization would run a pilot program rather than implementing it throughout the entire organization. The third phase of the cycle is check. This means that after a sufficient period of time following the initial implementation phase, the results are evaluated to ascertain if the change produced the desired effect. If that answer is positive, then the organization moves onto the fourth stage of the cycle (act), where the changes are implemented throughout the entire organization. At the end of the act phase, the process is repeated with respect to some new problem area.
Figure 13.3 The PDCA Cycle
The two other quality gurus who worked with Shewhart at Western Electric Company, as previously mentioned, were Joseph Juran and W. Edwards Deming. Juran’s numerous contributions to the field include the first standard reference work in the field of quality management: The Quality Control Handbook.“Joseph M. Juran,” Juran Institute Inc., accessed February 4, 2012, www.juran.com/about_juran_institute_our_founder.html. He also developed the Juran Trilogy, an approach to quality management that involves three phases: quality control, quality improvement, and quality planning.
Deming was born in 1900 and received an engineering degree from the University of Wyoming and a doctorate from Yale University. During his career, he worked for Western Electric Company, Bell Labs, and the US Department of Agriculture. During the Second World War, he taught SPC methods to thousands of engineers and plant personnel. After the war, Deming worked in Japan with Douglas McArthur’s Office of Supreme Command of Allied Powers. Several years later, he returned to Japan and worked with Japanese scientists and engineers and taught them about SPC. Deming’s work with the Japanese improved his understanding of what must transpire in a business organization to ensure quality products and services.Robert B. Austenfeld Jr., “W. Edwards Deming: The Story of a Truly Remarkable Person,” International Quality Federation, May 10, 2011, accessed February 4, 2012, www.iqfnet.org/Ff4203.pdf. The Japanese recognized his accomplishments by creating the Deming Prize, which is awarded to organizations that exemplify a commitment to quality.
Many consider Deming as the world’s preeminent proponent of quality. In fact, many see him as one of the most important business thinkers of the twentieth century. In a November 1999 issue, Fortune identified Deming, along with Peter Drucker and Frederick Taylor, as three individuals who had more impact on the operations of businesses than any CEO. In its April 22, 1991, edition, US News & World Report covered nine important turning points in human history. The final point was Deming’s impact on the Japanese quality movement.“History’s Hidden Turning Points,” Leadership Alliance, accessed March 2, 2012, www.leadershipalliance.com/demingnews.htm.
What distinguishes Deming from all other quality theorists is his comprehensiveness known as the Deming method. It has been stated that Deming proposed an alternative philosophy of doing business. He argued that one should believe that the purpose of a business is to delight a customer. If customers are delighted, then profits will follow. The Deming philosophy was summarized in his fourteen points, which are given in Table 13.3 "Deming’s Fourteen Points".
Table 13.3 Deming’s Fourteen Points
# Point Explanation
1
Create constancy of purpose toward improvement of product and service, with the aim to become competitive and to stay in business, and to provide jobs.
Deming believed that a firm must have a strong future focus. It should be willing to innovate all areas of operations, services, and products with the purpose of improvement and corresponding cost reduction. It must be willing on all levels to invest in these activities.
2
Adopt the new philosophy. We are in a new economic age. Western management must awaken to the challenge, must learn their responsibilities, and take on leadership for change.
Businesses can no longer accept given levels of errors, defects, and mistakes. This means that a small business must challenge its own beliefs about acceptable levels of failure.
3
Cease dependence on inspection to achieve quality. Eliminate the need for inspection on a mass basis by building quality into the product in the first place.
Inspecting 100 percent of the finished goods produced by a business is wasteful, costly, and without purpose. A business should focus on evaluating every process that is used to produce the product or the service. Using SPC and sampling will achieve better results than 100 percent inspection at a far lower cost. See Section 13.4 "Going Lean".
4
End the practice of awarding business on the basis of price tag. Instead, minimize total cost. Move toward a single supplier for any one item, on the long-term relationship of loyalty and trust.
Low price has no meaning if a customer is buying poor quality. It is better to find a business that can ensure the quality of the goods (or services) rather than attempting to play off several suppliers to achieve a lower price. In Chapter 11 "Supply Chain Management: You Better Get It Right", this is a central tenet.
5
Improve constantly and forever the system of production and service, to improve quality and productivity, and thus constantly decrease cost.
The focus of a quality management program should be on processes rather than merely looking at outcomes. The goal is to consistently improve these processes. This will result in lower cost and better utilization of labor.
6
Institute training on the job.
A training program should recognize that people learn in different ways. The training program should be tailored to the learning style of the employees. The central focus of any training program throughout an organization should be to make employees aware of the problems associated with variation.
7
Institute leadership. The aim of supervision should be to help people and machines and gadgets to do a better job. Supervision of management is in need of an overhaul, as well as supervision of production workers.
Businesses have little trouble finding managers and supervisors; the problem is finding leaders. Leadership involves a deep and thorough understanding of the work that is to be done. Leaders provide the vision to employees that enable them to carry out their work with pride.
8
Drive out fear, so that everyone may work effectively for the company.
Fear is often systemic in organizations. It could be the fear of losing one’s job. It can be the fear of making a mistake. It could be the fear of displeasing a supervisor. In all cases, this fear prevents employees from taking an initiative and being innovative. In the long run, this can be fatal for any organization.
9
Break down barriers between departments. People in research, design, sales, and production must work as a team, to foresee problems of production and in use that may be encountered with the product or service.
If people in different functional areas of a business do not know what the others are doing, they cannot adopt the perspective that focuses on what is good for the business at large. They focus on only what is good for their silo. A failure to understand the duties and responsibilities of people in other segments of the business means that people engage in finger-pointing rather than aggressively attempting to solve problems on a system-wide basis.
10
Eliminate slogans, exhortations, and targets for the workforce asking for zero defects and new levels of productivity. Such exhortations only create adversarial relationships, as the bulk of the causes of low quality and low productivity belong to the system and thus lie beyond the power of the work force.
Exhorting people to work harder is pointless if there are fundamental flaws or problems with the system they are working in. People recognize this and resent it. It makes them doubt the sincerity and intelligence of management.
11
1. Eliminate work standards (quotas) on the factory floor. Substitute leadership.
2. Eliminate management by objective. Eliminate management by numbers, numerical goals. Substitute leadership.
Work standards that do not include a quality component may be detrimental to the operation of a business. Refer to the example at the beginning of this chapter. The second student was superior on the measure of the number of schedules sorted per hour; however, the students who received the wrong schedule would take a dim view of the capability of the college. Deming feels that this holds true for not only production workers but also management. Using the wrong set of numbers that drive the business may drive the business into insolvency.
12
1. Remove barriers that rob the hourly paid worker of his right to pride in workmanship. The responsibility of supervisors must be changed from sheer numbers to quality.
2. Remove barriers that rob people in management and engineering of their right to pride in workmanship. This means, inter alia, abolishment of the annual or merit rating and management by objective.
Employees who do not have a chance for some dignity associated with their work are unlikely to take pride in their work. Pride forces individuals to perform tasks correctly and spot errors. Pride should foster individual initiative to improve processes and quality.
13
Institute a vigorous program of education and self-improvement.
Training programs should be available for all levels of employees. Training should not be limited to short-term outcomes; it should focus on providing a deep understanding of the key processes of a business.
14
Put everybody in the company to work to accomplish the transformation. The transformation is everybody’s job.
Quality should never be seen as the responsibility of management or a specialized group, such as quality assurance. It is everyone’s job.
Source: W. Edwards Deming, Out of Crisis (Cambridge, MA: MIT Press, 1982), 23–24.
The last quality theorist who should be discussed is Philip Crosby. Crosby was an executive at ITT and the Martin Company. His approach to quality reflected a practicing manager’s perspective. Although he is often associated (correctly) with the zero-defect program, his great contribution can be found in his first book Quality Is Free.Philip Crosby, Quality Is Free (New York: McGraw-Hill, 1979). In this text, Crosby argued that the definition of quality should be based on conformance to quality, and nonconformance is highly expensive. He estimates that the cost of nonconformance can run as high as 30 percent of revenue.Philip B. Crosby, “Quality Is Free—If You Understand It,” Philip Crosby Associates II Inc., accessed February 4, 2012, www.wppl.org/wphistory/philipcrosby/QualityIsFreeIfYouUnderstandIt.pdf. This figure includes costs associated with rework, scrap, warranties, lost goodwill, reputation, and customers. He further argues that expenditures on quality to guarantee conformance to requirements will always be less than the cost of nonconformance; therefore, quality should be seen as being free. Crosby was embraced by many American executives because of his emphasis on the practical and his formal acknowledgment of the importance of the bottom line. His approach is often referred to as Total Quality Management.
Implementing quality management concepts in American business has had a long and somewhat checkered history. In the last four decades, total quality and continuous quality movements have blossomed in popularity and then quickly died. Two decades ago, Walter Lareau argued that many American businesses, particularly large businesses, have an almost pathological antipathy toward quality management because some of its (quality) fundamental principles run totally counter to corporate belief systems, namely, customers are a pain and employees are an even bigger pain.Walter Lareau, American Samurai: Why Every American Executive Must Fight for Quality (New York: Warner Books, 1991), 47. In the intervening time, however, it appears that one approach to quality has captured the imagination of many businesses—both large and small. This quality program is known as Six Sigma.
Although Six Sigma is often associated, at least in the public’s mind, with General Electric, it began at Motorola in the 1980s and was spearheaded by William Smith.Wolf Akpose, “A History of Six Sigma,” December 2010, accessed February 4, 2012, www.todaysengineer.org/2010/Dec/six-sigma.asp. The term sigma (σ) comes from SPC and represents the concept of the standard deviation. Six standard deviations away from specifications signify that the process produces only 3.4 defects per million opportunities. This is a remarkable accomplishment. Imagine a restaurant that is open 12 hours a day, 365 days per year. On average, the restaurant serves 1 meal every 55 seconds or about 800 meals per day. It would take them approximately 3.4 years to serve one million meals. So if this restaurant was operating at a Six Sigma level, it would make a mistake in taking an order only once a year. Six Sigma draws on a battery of tools and techniques derived from SPC and earlier quality management programs. Six Sigma’s mantra for continuous improvement involves what is referred to as the DMAIC cycle (see Figure 13.4 "The DMAIC Cycle"), where D stands for design, M stands for measurement, A stands for analyze, I stands for improve, and C stands for control. Clearly, this concept is derived from the Shewhart cycle.
Figure 13.4 The DMAIC Cycle
What was different about the Six Sigma program was that all these tools and techniques were packaged in a coherent program. There was a heavy emphasis on quick results and the ability to demonstrate to management tangible cost savings. Six Sigma involves committed training programs that promote statistical tools and management techniques. Graduates of the most basic certification training program are referred to as “green belts,” a term derived from the martial arts. Those who receive more advanced training are known as “black belts.”“Six Sigma Training, History, Definitions: Six Sigma and Quality Management Glossary,” BusinessBalls.com, accessed February 4, 2012, www.businessballs.com/sixsigma.htm. Given that Six Sigma is closely associated with large corporate entities and complex training programs, one might think that it would be irrelevant for smaller enterprises. Nothing could be further from the truth. Six Sigma offers a systematic and pragmatic approach for quality improvement in the smaller firm.Greg Brue, “Six Sigma for Small Business,” Entrepreneur Press, 2006, accessed February 4, 2012, www.entrepreneur.com/downloads/assist/six_sigma_for_smallbusiness.pdf.
Video Clip 13.5
Six Sigma—The Essence Of
(click to see video)
An overview of Six Sigma and a discussion of how organizations use it.
Video Clip 13.6
Pizza Anyone? Six Sigma DMAIC Strategy Introduction
(click to see video)
Explains Six Sigma’s DMAIC strategy in simple, nontechnical terms using the familiar setting of a pizza restaurant business.
Video Clip 13.7
Six Sigma Interview with Jack Welch
(click to see video)
Jack Welch, former CEO of General Electric, talks about implementing Six Sigma at General Electric.
Web Resources
PDCA Cycle
A description of the Shewhart cycle.
asq.org/learn-about-quality/project-planning-tools/overview/pdca-cycle.html
Deming’s Fourteen Points
Discusses Deming’s fourteen points and includes links to allied topics.
leanandkanban.wordpress.com/2011/07/15/demings-14-points
Seven Basic Quality Tools
These seven tools get to the heart of implementing quality principles.
asq.org/learn-about-quality/seven-basic-quality-tools/overview/overview.html
Seven New Management and Planning Tools
Ways to promote innovation, communicate information, and successfully plan major projects.
asq.org/learn-about-quality/quality-tools.html
KEY TAKEAWAYS
• Quality for manufactured goods may be defined by using the eight dimensions of product quality.
• Quality in services may be defined by using the five dimensions of service quality.
• Quality should be seen as a continuing cycle (PDCA) of improvement.
• Quality guru W. Edwards Deming offers a complete philosophy of quality management in the workplace.
• The costs of quality improvements are always less than the costs of poor quality; hence quality is free.
• Six Sigma is a modern and highly practical approach to quality improvements.
EXERCISES
1. Take the eight dimensions of product quality and rank them in terms of relative importance for the following products: a heart pacemaker, a minivan, a laptop computer for high school students, an army assault rifle, an office copy machine, a light bulb, a jet engine, and a pocket lighter.
2. Take the five dimensions of service quality and rank them in terms of relative importance for the following services: a bank, a college classroom, a walk-in clinic, a divorce lawyer’s office, a cell phone service, a credit card company, a financial advisor, and a computer repair company.
3. Assume that your college or university suddenly decided to fully accept the Deming philosophy. How would it have to change? What do you think would be the first change that a student would notice? How would a particular course change if an instructor adopted the Deming philosophy? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/13%3A_The_Search_for_Efficiency_and_Effectiveness/13.04%3A_Organizational_Efficiency.txt |
Learning Objectives
1. Understand the basic logic of lean thinking.
2. Understand the sources of waste for a manufactured product.
3. Understand the sources of waste for a service.
4. Learn about the five Ss of lean.
Waste is worse than loss. The time is coming when every person who lays claim to ability will keep the question of waste before him constantly. The scope of thrift is limitless. Thomas Edison, “Thomas A Edison Quotes,” Brainy Quote, accessed February 5, 2012, www.brainyquote.com/quotes/quotes/t/thomasaed149058.html.
Thomas A. Edison
The most dangerous kind of waste is the waste we do not recognize. Shigeo Shingo, “Lean Quote: A Simple Quote…An Important Idea…,” Matt Hrivnak.com, accessed February 5, 2012, matthrivnak.com/2008/03/19/a -simple-quotean-important-idea.
Shigeo Shingo
Another organization-wide movement that has become popular at a global level during the last two decades is the concept of lean thinking. This concept was first introduced to American businesspeople in the book The Machine That Changed the World: The Story of Lean Production—Toyota’s Secret Weapon in the Global Car Wars That Is Now Revolutionizing World Industry.James P. Womack, Daniel T. Jones, and Daniel Roos, The Machine That Changed the World: The Story of Lean Production—Toyota’s Secret Weapon in the Global Car Wars That Is Now Revolutionizing World Industry (New York, Harper Perennial, 1990). This book focused on the global automobile industry. It highlighted the significant differences in productivity between Japanese firms, Toyota in particular, and their American and European rivals. At the time the book was written, Toyota was half the size of General Motors; today, on a global basis, Toyota is larger than General Motors. The book highlighted the approach adopted by Toyota, which is, as articulated by Taiichi Ohno, its developer, centered on “the absolute elimination of waste.”
Although lean is most closely associated with Toyota, its central principles are applicable for any small and midsize enterprise. Audubon Media Corporation is a publisher of cookbooks. It adopted a program that included a variety of lean techniques. In a two-year period, it increased sales by 25 percent without increasing staffing, reduced lead time by at least 50 percent, and increased available floor space by 20 percent through inventory reduction and more efficient redesign. Corporate Image, a manufacturer of packaging, adopted lean methods and reduced lead times by over 35 percent and reduced costs by nearly \$180,000 in one year.Jim Black, “Kaizen (Continuous Improvement) for Small- and Medium-Sized Companies,” CIRAS News 33, no. 2 (1999), accessed February 4, 2012, www.ciras.iastate.edu/publications/management/Kaizen.asp.
Lean thinking is predicated on five major principles.“The Five Principles of Lean Thinking,” Cardiff University, accessed February 4, 2012, www.cardiff.ac.uk/lean/principles/index.html. The first principle can be summarized as follows: know who your customers are and know how they define value. This principle coincides nicely with the underlying philosophy of the quality movement, namely, placing the customer first. Without understanding what the customer wants and what the customer values, an organization runs the risk of producing a wasteful quantity of goods and services that the customer does not want or need.
The second principle of lean thinking centers on determining and visualizing the value stream. The value stream is the entire set of activities associated with the production of goods and services. The goal of such mapping is to identify any and all activities that provide no value to the customer. Once those nonvalue activities have been identified, they are to be eliminated. Students are required, every semester, to go to their advisor and begin the process to register for the next semester or prepare for graduation. Imagine mapping out every step in that process. Having done that, colleges and universities could probably find some steps or activities that do not add value. In a lean operation, those steps would be eliminated. One could also think in terms of the process that most patients face when going to some type of medical facility. They are often required to fill out multiple forms that require the same information. In Figure 13.5 "Value Stream Map for Supplying Hospitals with Blood", we provide an example of a value stream map for the process of supplying hospitals with blood.
Figure 13.5 Value Stream Map for Supplying Hospitals with Blood
Source: Derived from Value Stream, facultyweb.berry.edu/jgrout/p...ue_stream.html
The third principle of lean thinking argues that every effort should be made to make the remaining steps flow. The term flow here refers to the notion that from design to delivery to the customer, all steps and activities should be structured in such a way that there will be minimal or nonexistent downtime, waste, or waiting within or between the steps.“The Principles of Lean Thinking: Tools and Techniques for Advanced Manufacturing,” Industial Technology Centre, accessed February 4, 2012, www.itc.mb.ca/downloads/resources_by_topic/princ_lean%20thinking/PrinciplesofLeanThinkingRevD2004.pdf. This is perhaps the most challenging of all the five principles of lean thinking. To make operations flow in a seamless manner often requires substantive changes in production and service processes. In fact, it may require substantive changes to the structure of a business.
The fourth principle involves a pull system triggered by customer needs. The term pull means that the production of goods and services is triggered by customer demand. This aspect of lean is what is commonly referred to as just-in-time inventory. The central idea is that the entire value stream is fired up only by customer demand. Thus inventory throughout the system is minimized.
The fifth and last principle is pursuing perfection. This clearly shows that lean thinking is not totally separate and divorced from the concepts of total quality management or Six Sigma. This last principle advocates that removing the impediments to quality will mean a significant reduction in waste. Like Crosby’s work, lean advocates often talk of striving for zero defects.
One of the first steps in any lean program is identifying where waste exists within the system. Taiichi Ohno and Shigeo Shingo, the two cofounders of the Toyota Production System, identified seven possible sources of waste: transportation, inventory, motion, waiting, overprocessing, overproduction, and defects. (A nice mnemonic to remember these seven sources is TIM WOOD.) Table 13.4 "Seven Sources of Manufacturing Wastes" identifies and gives examples of the original seven sources of waste used throughout Toyota.
Table 13.4 Seven Sources of Manufacturing Wastes
Type of Waste Description Examples
Transportation The movement of components and parts not associated with their transformation. Unnecessary movement (that which is not required by the customer) runs the risk of damage. When looking for suppliers, Toyota takes into consideration their proximity to its production plants. Toyota plants are designed so that suppliers can bring their items directly to where they will be used on the factory floor.
Inventory The three types of inventory—raw materials, work in process, and finished goods—are all forms of investment. When these inventories are not being actively used to meet customer demand, they represent a waste of capital. Just-in-time inventory strives to produce inventory according to the demand of the customer. Every effort is made to smooth production processes so that there is no need to produce any component in bulk quantities. Many restaurants cook meals only when ordered by the customer. This minimizes leftovers.
Motion This term refers to employees and equipment, not components or products. Unnecessary motion is a waste of time and money. Like transportation, it runs the risk of damage to the final product or the employees. Excess movement by workers or machinery is to be avoided. Workers and equipment are positioned so that they are in close proximity and movements are minimized. Machines are sometimes grouped in a U-shape so that one worker can operate them with minimal movement.
Waiting If components or products are not being processed, then there is waiting. This represents a waste of investment. Eliminating this form of waste is the reason for the concept of “flow.” Production processes need to be redesigned to minimize the time spent waiting. Special paints are used that dry quickly so that vehicles can move on to the next processing step without having to wait.
Overprocessing A component or a product that requires more time to process than the standard estimate represents a waste. This concept also involves the notion that using inappropriate or excessively complex manufacturing processes or tools also represent a form of waste. The essence here can be summarized by KISS—keep it simple, stupid. This is a well-known engineering principle whereby “less is more.” The process can be accomplished with a simple machine preferable to a complex machine. Simplicity accomplishes the task, minimizes the chance for failure, and reduces waste. A classic example of this would be the engineers who were asked to determine the volume of a complex part. Some began by taking accurate measurements to compute the volume of some segments of the part. Another engineer simply tossed the part into a bucket of water and measured the volume of water displaced.
Overproduction Producing more than the customer wants at a particular point in time is a source of waste. Some businesses have set up operations where they believe that production in large batches is the most economically efficient method. This generally means large inventory levels. Overproduction is seen by some as the driving force behind the other six sources of waste. Lean thinking tasks them to reexamine these basic assumptions. A manufacturer has a good idea of the annual demand of a particular part. Setting up the machine that is used to produce this part is an expense proposition. Financial analysis indicates that the company should produce one batch of the part every quarter (three months’ worth of supply). A three-month supply of the part means that a considerable portion sits in inventory for a long period of time. This quantity of inventory may also mask any defects in manufacturing. It would take quite a while to go through this batch before one would realize that the batch might have had problems in production. A company that focused on reducing the setup cost of the machine could then produce smaller batches, which, in turn, would produce lower inventory levels and therefore catch quality problems earlier.
Defects Defects in products produce expensive waste—rework costs, scrapping costs, or excess warranty costs. Here is where lean thinking and quality management merge. Poor quality of product and service represents a dramatic waste.
The continued references to the Toyota Production System might lead the reader to believe that lean thinking is appropriate only for the manufacturing environment. That would be profoundly misleading because lean has tremendous applicability to service, particularly in the areas of health care, banking, and retail. Some authors believe that these seven sources of waste are absolutely applicable to service environments. Michael George, Lean Six Sigma for Service: How to Use Lean Speed and Six Sigma Quality to Improve Services and Transactions (New York: McGraw-Hill, 2003), 76. Others have suggested that the original seven sources of manufacturing waste be modified to cover the service environment, as follows: delay, duplication, unnecessary motion, unclear communication, incorrect inventory, errors, and opportunity lost.“Seven Wastes of Service | Customer Perception,” Lean Manufacturing Tools, accessed February 5, 2012, leanmanufacturingtools.org/81/seven-wastes-of-service -customer-perceptio. These seven sources and corresponding examples are described in Table 13.5 "Seven Sources of Service Waste".
Table 13.5 Seven Sources of Service Waste
Type of Waste Description Examples
Delay Any instance in which a customer must wait for any aspect of the service. One walks into a fast-food restaurant and finds a long queue (line). Any service time spent in that queue is a delay. Another example of the delay would be waiting on the phone to speak to a sales representative.
Duplication When a customer has to repeat any activity unnecessarily. Patients in a medical facility who have to repeatedly fill out forms would be an example of duplication. A website requires customer input of information, but then the website crashes, causing the customer to reinput the information is another example. Such instances are extremely annoying to most consumers.
Unnecessary motion A customer who is shuttled between a variety of operations and where each move does not substantially add to value. A customer wishes to lodge a complaint. The customer calls the complaint department and then is moved from one sales representative to another. This type of frustration may cause customers to drop the service.
Unclear communication The failure to provide clear instructions for any stage of the service environment. Unclear communication, particularly with respect to instructions to customers, is contained in the entire service experience. Examples would include instructions that are filled with jargon or that easily confuse customers.
Incorrect inventory Services often have ancillary products. If a product is not available, the customer has to wait for it. A customer places an online order for multiple items. At the time of the order, the customer is told that all the items are available and will be shipped at once. When the customer receives the order, not all the items are in the shipment, and some items are on backorder. “Murphy’s Law” would dictate that the items on backorder are the ones the customer most wanted.
Errors Any errors or mistakes associated with either the ancillary goods or the service itself. Telling a customer that the repair service will arrive between 10 a.m. and 1 p.m. and then showing up at 4 p.m. is the type of error that few customers are willing to forgive or forget.
Opportunity lost Every engagement with the customer in a service environment is an opportunity to succeed or fail. Failure can be associated with a bad behavioral interaction with the customer, ignorance about the service, or providing incorrect information to the customer. Services differ from products in many ways. One of the most important is that quality services tend to be in real time. In manufacturing, one can test the product before it is shipped. This does not always occur in services. A few words from a rude clerk can describe the customer’s vision of the company. Subsequent apologies may do nothing to erase this negative image. Providing customers with the wrong information, even about minor details, can also destroy their perception of a company.
Lean thinking uses several techniques to achieve its ends. We have mentioned value stream mapping. Other techniques include just-in-time inventory control, quick changeover (a program to reduce setup times to make it more attractive to produce in smaller batches), Kaisen (a Japanese term that refers to any program that seeks small improvements on a regular basis rather than a huge quality initiative), and visual management (a program of visually presenting key metrics to all personnel so that they can be aware of any and all progress). One technique that has broad application in both manufacturing and service environments is known as the 5 Ss. The five Ss refer to Japanese terms for, in effect, housekeeping.“5S Check List,” Systems2win, accessed March 9, 2012, www.systems2win.com/solutions/5S.htm. The five Ss, which together strive for simplicity and neatness to improve efficiency and effectiveness, are as follows:
• Seiei or organization. Only those tools and equipment that are absolutely needed are available at any one time. All other equipment is stored away until needed.
• Seiton or orderliness. Every part is in its correct place. The Japanese use pegboards to store tools. They sometime draw an outline of the tool on the board so that it is returned to its correct place.
• Seiso or cleanliness. Work environments are kept immaculate. This is done to reinforce the notion of perfect. Some factory floors are painted white so that anything dropped or any litter becomes immediately apparent.
• Seitetsu or standardized cleanup. This is a reinforcement of the prior three points. Starting in Japanese kindergartens, children are required to clean their classroom—together—before they are released to go home.
• Shitsuke or discipline. A program to adhere to set procedures because of pride in one’s own work.
More and more businesses are realizing that lean thinking and quality are not two distinct management approaches but two extremely complementary models. One finds more and more references to a concept known as Lean Six Sigma, which is a program that combines aspects of both lean thinking and quality management. It recognizes that lean by itself cannot bring processes under control, and Six Sigma significantly reduces process time or capital investment. Michael George, Lean Six Sigma for Service: How to Use Lean Speed and Six Sigma Quality to Improve Services and Transactions (New York: McGraw-Hill, 2003), 6. Both approaches offer benefits to small businesses that cannot be ignored if these businesses want to remain viable in an increasingly competitive world.
Video Clip 13.8
Lean Process Improvement—Funny
(click to see video)
A silent comedy to illustrate lean principles.
Video Clip 13.9
Building a Lean Culture
(click to see video)
Lean requires change throughout an organization.
Video Clip 13.10
Lean Office: Applying Lean to Business Processes
(click to see video)
Lean is not limited to manufacturing but can be applied to office management.
Web Resources
Introduction to Lean
A great introduction to lean concepts by a consulting firm.
www.leanthinking.info/aboutlean.html
Glossary of Lean Tools
Definitions of key terms.
www.shopwerkssoftware.com/lean_glossary.aspx
Bringing “Lean” Principles to Service Industries
The application of lean concepts to the service environment.
hbswk.hbs.edu/item/5741.html
Achieving a “Lean Service” Breakthrough
An example of lean concepts applied to the service environment.
www.stratform.com/lean_services.htm
Key Takeaways
• Lean thinking represents a program to eliminate all forms of waste in an organization.
• For any production or service process, one could map out all the currently existing steps and then remove those that do not add value to the customer.
• There are seven sources of waste in manufacturing processes.
• There are seven sources of waste in service processes.
EXERCISES
1. Interview several local small business owners about how they try to minimize waste.
2. Pick a particular college course you are currently taking and identify sources of waste in that class. How could you redesign that college class to minimize those wastes?
3. Discuss how the 5 Ss approach could be used in your personal life to improve efficiency and effectiveness. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/13%3A_The_Search_for_Efficiency_and_Effectiveness/13.05%3A_Going_Lean.txt |
Learning Objectives
1. Understand the importance of meetings.
2. Understand why meetings fail.
3. Understand the importance of an agenda.
4. Learn about behavioral issues in meetings.
If you had to identify, in one word, the reason why the human race has not achieved, and never will achieve, its full potential, that word would be “meetings.” “Wanderings: Dave Barry Learned All This in 50 Years,” Brent Zupp, accessed February 6, 2012, www.wanderings.net/notebook/Main/ThingsLearn50YearsDaveBarry.
Dave Barry
Meetings are indispensable when you don’t want to do anything. Nancy Roman, “Meetings: How to Waste Time at Work,” Cornelius & Associates, accessed June 1, 2012, www.corneliusassoc.com/articles/Meetings%20waste%20time.pdf.
John Kenneth Galbraith
Managing Meetings
As a business grows, it will—in all probability—increase the number of its employees. As the employee base grows, there is increased demand to coordinate activities, exchange information, and engage in decision-making activities. These usually occur at meetings, and one would think that these would be straightforward events. Yet the reality is that many managers and employees come to dread participation at meetings. Data indicate that many, if not most, meetings fail to produce the desired outcome. A study conducted in 1993 found that executives were seen as a spending seventeen hours per week in meetings, and one-third felt that time was wasted. Roy Woodard, “Meetings, Bloody Meetings,” Credit Control 15, no. 5 (1993): 1. Another survey of thirty-eight thousand managers found that 66 percent felt that the meetings they attend were a waste of time. Robert F. Moran Jr., “Meetings: The Bane of the Workplace, It Doesn’t Have to Be,” Library Administration & Management 20, no. 3 (2006): 135–39, accessed February 6, 2012, journals.tdl.org/llm/article/view/1637/917. Still another study found that managers spend as much as 40 percent of their work time in meetings, but only 64 percent of those meetings were seen as achieving their intended outcome; Judith Lindenberger, “Make the Most of Your Meetings,” Office Solutions 24, no. 3 (2007): 40. another study found that executives were spending as much as 70 percent of their time at meetings, but only 40 percent of those meetings had clear objectives, and only 28 percent of those meetings with objectives actually met them. Stuart Levine, “Make Meetings Less Ready,” HR Magazine 52, no. 1 (2007): 107. Yet 80 percent of the participants viewed running a successful meeting as a crucial test of manager’s abilities.Stuart Levine, “Make Meetings Less Ready,” HR Magazine 52, no. 1 (2007): 107. These figures are particularly tragic because so many meetings occur in the business world. One estimate puts the number of meetings, on a daily basis, globally, at 73 million. Charlie Hawkins, “‘F’ Words for Effective Meetings,” Journal for Quality and Participation 22, no. 5 (1999): 56. These are rather depressing figures, but the clear lesson for small business owners is that they cannot afford the luxury of not running their meetings effectively.
The good news is that the successful management of a meeting is a learnable skill.Roy Woodard, “Meetings, Bloody Meetings,” Credit Control 14, no. 5 (1993): 1. Conducting an effective meeting requires that a manager focus on both procedural and behavioral issues. We will first look at procedural issues associated with running a meeting. Before considering holding a meeting, ask the following question: “Is this meeting really necessary?” Frequent meetings are sometimes held merely out of habit.Kelley Robertson, “How to Run an Effective Sales Meeting,” Changing Minds, June 7, 2009, accessed February 4, 2012, changingminds.org/articles/articles09/effective_sales_metting.htm. Can the goals of a meeting be achieved by other mechanisms?Stuart Levine, “Make Meetings Less Ready,” HR Magazine 52, no. 1 (2007): 107. These might include using the Internet; e-mail; teleconferencing; or technologies, such as MS Communicator, which allows for bulletin board interaction, voice communication, and videoconferencing. Interestingly, for all the complaints about meetings, a recent study indicated that face-to-face meetings were seen by 95 percent of those surveyed as being positive, especially in the interest of developing long-term relationships.Jay Boehmer, “Harvard Study Shows Face-to-Face Meeting Value, Rising Virtual Interest,” Successful Meetings, accessed February 6, 2012, www.successfulmeetings.com/Event-Planning/Technology-Solutions/Articles/Harvard-Study-Shows-Face-To-Face-Meeting-Value,-Rising-Virtual-Interest.
After deciding that a meeting is necessary, it is important to determine the nature of that meeting. Meetings may have many different types of goals. They can be directed to problem solving, decision making, conflict resolution, providing information, or generating new ideas.T. L. Stanley, “Make Your Meetings Effective,” SuperVision 67, no. 4 (2005): 6; Curt Smith, “Effective Meetings—Not an Oxymoron!” Manage 51, no. 1 (1999): 10. This is necessary because the nature of the meeting will drive its structure and internal dynamics. As an example, if a meeting is directed to a decision-making task, it should probably proceed in two parts. The first portion should be directed toward identifying solutions, while the second portion should focus on what might be the best solution.Robert F. Moran Jr., “Meetings: The Bane of the Workplace, It Doesn’t Have to Be,” Library Administration & Management 20, no. 3 (2006): 135–39, accessed February 6, 2012, journals.tdl.org/llm/article/view/1637/917. The next decision would be to determine who will participate in the meeting. Ideally, this list would be limited to those who would be directly affected by the outcome of the meeting; however, in the case of informational meetings, the list may be expanded to those who will be directly or indirectly affected. The next decision is associated with determining who will be assigned particular roles in the meeting. The chair is the individual who calls the meeting, provides the initial agenda, and specifies the purpose of the meeting. It may be useful to assign the role of facilitator to an individual. This neutral person can push the meeting along, particularly when conflict arises. It is desirable to have people trained as facilitators and rotate this position among facilitators.Charlie Hawkins, “‘F’ Words for Effective Meetings,” Journal for Quality and Participation 22, no. 5 (1999): 56. Another important role is the individual who is officially assigned to take notes. The notes of the meeting should be written up and sent to all participants in the meeting within two business days. This position should also be rotated among the participants of the meeting. It also might be advisable to assign the role of timekeeper to an individual. The timekeeper has the task of limiting the amount of time spent on anyone agenda item to the previously agreed-on time frame.Wayne Chaneski, “Productive Meetings—Back to Basics,” Modern Machine Shop 79, no. 11 (2007): 52, accessed February 6, 2012, www.mmsonline.com/columns/productive-meetingsback-to-basics.
Perhaps the most important activity prior to the actual meeting is the proper structuring of an agenda. In another study, 75 percent of those surveyed said that a good agenda is critical for a successful meeting.Judith Lindenberger, “Make the Most of Your Meetings,” Office Solutions 24, no. 3 (2006): 40. The agenda is the formal strategic plan for a meeting. It is the mechanism for ensuring that a meeting is focused on relevant topics. A failure to have a clear focus will guarantee that the participants will have a sense that nothing had been accomplished.Jim Sullivan, “Focused Agenda Can Energize Manager Meetings,” Nations Restaurant News 37, no. 5 (2003), accessed February 6, 2012, findarticles.com/p/articles/mi_m3190/is_5_37/ai_97392571. Focus stems from having everyone understand a meeting’s purpose and what one intends to achieve.Anonymous, “Running Meetings Effectively,” The British Journal for Administration Management, October/November 2005, 25. Items on the agenda should be prioritized in terms of their importance, which is often done by allocating a specific amount of time to each agenda item.Charlie Hawkins, “‘F’ Words for Effective Meetings,” Journal for Quality and Participation 22, no. 5 (1999): 56. Any and all resources that will be required for the meeting should be identified along with the individuals who are responsible for securing the resources. The roles of chair, timekeeper, note taker, and facilitator (where possible) should be assigned in advance. The agenda should be sent out at least five business days before the meeting so that participants can gather the required information. This timeline also allows for people to make suggestions for changing the agenda. It is also highly advisable to make it a policy that all participants arrive on time at the beginning of the meeting.Max Messner, “Conducting Effective Meetings,” Strategic Finance 82, no. 12 (2001): 8, accessed February 6, 2012, findarticles.com/p/articles/mi_hb6421/is_12_82/ai_n28842307.
Allowing individuals to contribute to the agenda will provide them with a sense that they are contributing.Kelley Robertson, “How to Run an Effective Sales Meeting,” Changing Minds, June 7, 2009, accessed February 4, 2012, changingminds.org/articles/articles09/effective_sales_metting.htm. In setting the timeline for the different items on the agenda, it is advisable that one allow for a few extra minutes at the end of the meeting to discuss how well the meeting went and how it could be improved.Charlie Hawkins, “‘F’ Words for Effective Meetings,” Journal for Quality and Participation 22, no. 5 (1999): 56. These few moments should be expanded into a formal system. Assessing meeting effectiveness can be done through an external observer conducting an evaluation, focus groups, or surveys.Joseph Allen, Steven Regelberg, and John Scott, “Mind Your Meetings,” Quality Progress, April 2008, 42, 4, 51. Figure 13.6 "Agenda Format" provides a format for a part of the overall agenda that addresses some of the previous suggestions. It is available as an agenda format wizard in Microsoft Word 2007.
Figure 13.6 Agenda Format
Video Clip 13.11
Business Management and Leadership Skills: How to Conduct an Effective Meeting
(click to see video)
The basics of meeting management.
Video Clip 13.12
Conducting Effective Small Scale Meetings
(click to see video)
How to conduct a meeting, even in one’s home.
Video Clip 13.13
How to Avoid Meetings That Suck
(click to see video)
How to escape the traps behind bad meetings.
Web Resources
Managing Business Meetings
An excellent list of suggestions on business meetings.
www.cbsnews.com/8301-505125_162-51057051/managing-business-meetings/?tag=bnetdomain
Managing Your Meeting Monsters
Identifying the types of personalities at meetings.
www.impactfactory.com/p/business_meeting_skills_training_development/friends_111-1107-40530.html
KEY TAKEAWAYS
• Poorly run meetings are common and costly.
• Successful meetings require structure and an agenda.
• The agenda should identify the purpose of the meeting, the participants and their roles, the requisite resources, and agenda topics with timelines.
• Behavioral issues must always be considered when managing a meeting.
EXERCISES
1. Interview the owners of five businesses and determine what percentage of meetings they attend they find to be “effective.”
2. Ask them what constitutes a bad meeting.
3. Ask them what constitutes a good meeting.
4. Create an agenda for a meeting with a fellow student who came up with an idea for a new business. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/13%3A_The_Search_for_Efficiency_and_Effectiveness/13.06%3A_Personnel_Efficiency.txt |
Learning Objectives
1. Understand that in addition to quality management and lean thinking, creativity, time management, and well-executed meetings can improve value to customers.
2. Understand that quality management and lean programs can produce significant increases in operational efficiency that increases positive cash flow.
3. Learn about computer tools that can improve time management, creativity, quality management, and lean operations.
When all think alike, then no one is thinking.Walter Lippman, “When All Think Alike, Then No One Is Thinking,” Uneven Chopsticks, accessed February 6, 2012, unevenchopsticks.com/when-all-think-alike-then-no-one -is-thinking.
Walter Lippman
Customer Value Implications
It should be clear that quality management and lean thinking have the notion of customer value at their cores. Both approaches actively incorporate needs and wants into the design of products and services and, even more importantly, into the design of the processes used to create these products and services. Regardless of what quality program one adopts for an organization, the issue of customer value is the single most important question. Lean thinking also recognizes the vital importance of first identifying the customer’s notion of value so that any activity that does not add value is ruthlessly eliminated. As one article put it, “Lean enterprise never misses an opportunity to capture information about customers.”Christer Karlsson and Pär Ahlstrom, “A Lean and Smaller Global Firm?,” International Journal of Operations and Production Management 17, no. 10 (1997): 940.
The linkages between quality management, lean thinking, and customer value, therefore, should be obvious. What is less obvious is the connection between customer value and topics such as creativity, time management, and running meetings effectively. Nonetheless, indirect connections do exist. Without creativity, there will not be any new product development, and there will be no innovations in design, packaging, promotion, or distribution that can be so vital to the enhancement of value.
Owners, managers, supervisors, and employees who cannot manage their time effectively or efficiently will be unable to provide appropriate attention to improving customer value. Poorly run meetings are inefficient and degrade morale; neither is a recipe for enhancing customer value.
Cash-Flow Implications
The old saying “time is money” may be shopworn, but it is an absolute truism. Wasting time inexorably turns into a waste of money. Poor time management means that time is wasted, which costs the individual and the organization.
In a depressed economy, both large and small firms attempt to preserve cash flow by adopting a program of cost cutting. This often begins with laying off employees. However, this presents a rather significant problem. As Nancy Koehn, a business historian at Harvard business School, points out, “If demand picks up, you can’t exploit it because you don’t have the resources.”Sarah E. Needleman, “Three Best Ways to Get Lean,” Wall Street Journal, March 25, 2000, accessed February 6, 2012, online.wsj.com/article/SB10001424052748704094104575143680597058528.html. Lean thinking offers an alternative to cost cutting by reducing staff. Lean thinking, a focus on more intelligent cost-cutting, and the efficient use of all business resources have produced significant results, such as an 80 percent to a 90 percent reduction in inventory investment, an 80 percent to a 90 percent reduction in manufacturing lead times, a 50 percent reduction in space requirements, and a 50 percent reduction in material handling equipment. Such results translate into tremendous cost savings. Lawrence P. Etkin, Farhard M. E. Raiszadeh, and Harold R. Hunt Jr., “Just-in-Time: A Timely Opportunity for Small Manufacturers,” Industrial Management 32, no. 1 (1990): 16.
Firms that have used the principles of the Toyota Production System have also found that they can achieve a 50 percent reduction in human effort and a 200 percent to a 500 percent improvement in quality. One small manufacturer, Gelman Sciences, adopted a lean approach to operations, and during a nine-month period, one section of the company saw inventory turns go from twenty to fifty-seven, inventory value dropped from \$86,000 to \$33,000, and lead time dropped from three to four weeks to one to three days. Matthew Zayko, Douglas Broughman, and Walter Hancock, “Lean Manufacturing Yields World-Class Improvements for Small Manufacturing,” IIE Solutions 29, no. 4 (1997): 36. Estee Bedding Company applied lean concepts to its operations and reduced its labor cost as a percentage of sales by one-half; Ameripay, a payroll service firm, saw sales increase from \$1.8 million to \$6 million in three years. John T. Slania, “Lean Firms Look to Ride Recovery,” Crain’s Chicago Business 27, no. 2 (2004): SB6. Some small businesses that are part of a larger supply change may find their movement toward lean thinking supported by firms that are further up the supply chain. In the 1990s, Pratt & Whitney initiated a program to assist smaller firms in its supply chain by requiring them to move to more of a lean focus. Mario Emiliani, “Supporting Small Businesses in Their Transition to Lean Production,” Supply Chain Management 5, no. 2 (2000): 66–71. Even small foreign firms are beginning to recognize the economic benefits from adopting lean methodologies. A polyvinyl chloride manufacturer in Thailand adopted a lean management program and saw its average production time per unit decline from forty-four minutes to twenty-three minutes while decreasing the number of operators from fifty to forty-one. Nanchanok Wongsamuth, “Nawaplastic Pushes Lean Management,” McClatchy Tribune Business News, July 31, 2010. The concepts behind lean thinking, with its focus on efficiencies, should dictate that a small business should automate as many processes—such as bookkeeping—as possible and rely on outsourcing when feasible. Matt Dotson and Brandon Kennington, “Eliminating Waste Using Lean Concepts for Small Business,” Automate My Small Business, November 9, 2009, accessed February 4, 2012, automatemysmallbusiness.com/eliminating-waste-using-lean-concepts-for -small-business.
One does not have to commit to major organizational programs, such as a quality management system or lean thinking, to find ways to save on cash flow. Earlier in this chapter we cited two studies. One said that better than one-third of executives believed that all meetings were a waste, while the second study said that two-thirds of all meetings were a waste. We split the difference between these two studies and arrive at a figure that one-half of all meetings are perceived as useless. This can have significant cash-flow implications, even for small firms.
Let us illustrate this through a simple example. The owner of a small hardware store believes it is important to have weekly meetings with the store’s supervisor and five employees. Let us assume that the owner values his or her time at \$70 per hour. The supervisor’s value is given at \$35 an hour, while each employee’s time is valued at \$10 per hour. Employees are expected to produce 2.5 times their pay. This means that a 1-hour meeting should be valued at \$282.50 [\$70/hour + 2.5 × (5 employees × \$10/hour) + 2.5 × (1 supervisor × \$35/hour)]. Assuming 52 meetings per year, the total opportunity cost for these meetings is \$14,690. If one-half of those meetings are a waste, then the business is losing nearly \$7,350 a year. There are many areas throughout a firm’s operations that can be evaluated to reduce wasteful activities and improve its cash-flow position.
Implications of Technology and the E-Environment
Time-management systems are available in a variety of paper-and-pencil and software formats. They generally allow for listing to-do tasks, setting due dates, identifying required resources, and prioritizing their importance. Some allow for a project format, where one can break down the project into smaller interrelated tasks. Many of them provide the capability to synchronize this information across several computers and smartphones. This would allow a person to have the time-management system available on an office computer, a home computer, and in the pocket (smartphone). One system is based on Covey’s fourth-generation approach to time management.
Multiple software packages are geared to assist individuals and groups who wish to improve their creativity. There are packages to help with brainstorming in its various forms. Numerous companies provide mind-mapping software in a variety of formats: computers, iPads, and even smartphones.
Quality management encompasses many tools and techniques, far more than could ever be covered in this chapter. There are packages geared just for statistical process control (SPC) models. Some can receive data from a process and then automatically inform the operator of a “drift” from conformance to standards. In addition to SPC models, other packages include tools that are used to improve quality. These packages range from less than \$100 to many thousands of dollars.
Web Resources
Achieve
A time-management system.
www.effexis.com/achieve/planner.htm
My Life Organized
A time-management system.
www.mylifeorganized.net
PlanPlus for Outlook v7
A time-management system (based on Covey’s fourth-generation time-management system).
franklincoveysoftware.com/individual/individual-products/planplus-for-outlook-v7
SciPlore
Mind-mapping software.
en.Wikipedia.org/wiki/SciPlore_MindMapping
MindManager
Mind-mapping software.
en.Wikipedia.org/wiki/MindManager
MindMaple
Mind-mapping software.
en.Wikipedia.org/wiki/MindMaple
MindMapper
Mind-mapping software.
en.Wikipedia.org/wiki/MindMapper
Creative Whack Pack
Brainstorming software app for the iPad.
itunes.apple.com/us/app/creative-whack-pack/id307306326?mt=8
Mind View 4
Brainstorming software.
www.matchware.com/mv3be_landing.php?gclid=CKyWyorEiasCFWUZQgodAQjG1Q
Sigma Magic
Quality management software plus lean components.
www.sigmamagic.com
Sigma XL
Quality management software
www.sigmaxl.com
SPC XL
Quality management software add-in for Excel.
www.sigmazone.com/spcxl.htm
Lean Tuppas Software
Quality management software.
www.tuppas.com/lean-manufacturing-software/lean-manufacturing-software.htm
KEY TAKEAWAYS
• Customer value can be enhanced not only through organizational programs such as quality management and lean thinking but also by increasing creativity, time-management skills, and meeting effectiveness.
• Quality management and lean programs can generate efficiencies that produce significant cost savings.
• Software exists that can assist with improving one’s own time management.
• Similar programs are available to improve the creativity of teams and support both quality and lean improvement programs.
EXERCISES
1. Evaluate several computerized time-management systems and write a report covering your selection process.
2. Evaluate several creativity packages and select one that you might buy. Write a one-page paper that talks about why you selected this package.
3. Assume you are a small manufacturer of hypodermic needles. You have sixty employees, and sales are \$23 million. You are nervous about overseas competitors, whose products are getting better. You want to further improve your quality and may be interested in applying lean thinking to your operations. Evaluate several software packages and write a report specifying why you support the acquisition of this package.
Disaster Watch
Successful small business owner often rapidly acquire a sixth sense—one that warns them of impending dangers. They begin to sense when there are changes in consumer preferences, when there is a need for an infusion of additional financial resources, or when closer attention needs to be paid to cash flow. These are fundamental issues, and the failure to recognize them will lead to disaster. Subtler issues associated with operations are sometimes missed, and just because they are less obvious does not mean that they cannot be as dangerous. Small businesses can die when they fail to focus on the necessity of being efficient. As said by one commentator, “As the economy grows leaner, this focus on efficiency is paramount to SMEs [small and midsized enterprises], and may indicate chances of business sustainability.”Renee O’Farrell, “Problems of Small Scale Industries,” eHow, accessed March 7, 2012, www.ehow.com/about_5368391_problems-small-scale-industries.html.
In Section 13.1 "Personal Efficiency and Effectiveness", time was identified as perhaps the most vital resource, since once lost it can never be recovered. This perspective may be particularly true for small businesses. Most small businesses are under tremendous financial pressures. They normally don’t have the luxury of having large staffs, and this means that much of the work falls on the shoulders of the owner. Those owners who cannot effectively manage their time are asking for problems in their business and personal lives.Richard Sandusky, “The Problems That Small Business Owners Face,” eHow, accessed March 7, 2012, www.ehow.com/list_6521178_problems-small-business-owners-face .html. Their businesses can suffer because the owners don’t have sufficient time to generate new business.Rod Kurtz, “Solving Time Management Problems,” BusinessWeek.com, accessed March 7, 2012, www.BusinessWeek.com/smallbiz/tips/archives/2007/01/solving_time _management_problems.html. Family life suffers because the owner’s inability to successfully manager his or her time translates into time inefficiently spent at work.
Small business is often touted, correctly, as the driving mechanism for innovation in this country. The implication is that innovation and creativity in small business is limited to the development of new products and services. This belief can be disastrous for any small business because it may preclude creative innovations in other areas, such as operations and marketing. Recognizing this as a possibility, IBM has begun to operate “boot camps” to instruct smaller business how to fully exploit social media to drive sales.Market Watch: Wall Street Journal, “IBM Launches Global Boot Camps to Help Small and Midsize Businesses Build Social Media Skills,” Wall Street Journal, accessed March 7, 2012.
A failure to maintain a clear focus on quality can have disastrous consequences. While quality in and of itself may not guarantee success, its absence, in the long run, will guarantee failure. Given the complexity of many quality programs and tools, small businesses should overcome a reticence to bring outside quality experts in-house.Diane Kulisek, “Top Three Small Business Quality Problems,” CAPAtrak (blog), accessed March 7, 2012, capatrak.wordpress.com/2009/12/21/top-three-small -business-quality-problems.
Lastly, businesses—large and small—can be slowly poisoned by an unending stream of poorly managed meetings. Those types of meetings waste managers’ and employees’ precious time and can wreck morale. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/13%3A_The_Search_for_Efficiency_and_Effectiveness/13.07%3A_The_Three_Threads.txt |
SoBe
Source: Used with permission from John Bello.
John Bello and Tom Schwalm founded SoBe Beverages in Norwalk, Connecticut, in 1996. The name is an abbreviation of South Beach, the well-known upscale area in Miami, Florida. John describes SoBe as playfully irreverent, having brand equity with meaning, a cult brand that resonates in the marketplace. He attributes the company’s success to some luck, missteps by the competition, being aggressive, and tapping into a cultural shift.
SoBe tapped into a cultural shift toward healthier living and wellness and the rise of companies like General Nutrition that focused on wellness products: vitamins, supplements, minerals, and herbs. Their first product, Black Tea 3G, contained ginseng, guarana, and ginkgo. Orange Carrot, another of SoBe’s first successful products, is a blend of orange and carrot juices enhanced with calcium, chromium picolinate, and carnitine. An extensive line of other flavors was added. All ingredients were linked to specific health benefits.
The first two years of operation saw SoBe losing money, but by the end of 1997, the company was on fire. In five years, the company went from \$0 to \$300 million in sales, and it became a national brand. SoBe was competing effectively at a premium price. Coca-Cola, Pepsi, Arizona, and other brands took notice. Within three years, Coca-Cola was talking to SoBe about a possible strategic partnership. There were fifteen meetings, only two of which were with marketing. The rest were with corporate lawyers (John calls them “sales preventers”) and regulators. At the end of 1999, Minute Maid presented the proposal to the Coca-Cola board. Surprisingly, it was rejected. Coca-Cola saw no reason to go beyond carbonated soft drinks, and there were also some leadership issues. Back to square one.
John and Tom started looking at liquidation because of pressure from investors who wanted their money. But there were other reasons they thought about selling. They were not interested in managing a disparate group of investors—bankers, investors, and private equity companies. With 250 employees, the company was growing into something they did not want it to be—and they were not having as much fun. In 2000, the market was flattening, so with a big brand image, it was a good time to get out. They also wanted to get into larger markets, such as schools and golf clubs, but only big companies could get them into a broader marketplace. They hired an investment bank and again went into negotiations with Coca-Cola as a strategic partner. The situation became very complicated and frustrating. Ultimately, a deal with Coca-Cola was again a no-go.
All was not lost. Pepsi (and others) had expressed an interest. John made a presentation to forty people at Pepsi—rather than the multiple presentations he had to make to Coca-Cola—and within two weeks, they had a deal. SoBe was sold in 2000 to Pepsi for an impressive \$370 million…a very nice return on an investment of \$7 million in cash and \$1 million in trade-out services. Part of the deal was that John would stay on at Pepsi for two years to manage the brand, but after one day, it was clear to him that he was not going to be managing anything. Things were moved into committee, and the corporate bureaucracy took over. John likened the experience to “Making Ho Chi Minh a general in the US Army,” that is, he had a very different way of doing things. He is independent, is unconventional, speaks his mind, and would rather do things and make them work—an approach that tends to be at odds with the culture in large corporations.
SoBe inspired a whole line of functional beverages that people like to buy to make them feel smarter, healthier, and sexier. The company helped to build careers that have lasted. John is very happy with his legacy…and with his piece of the \$370 million sale price.
Source: Interview with John Bello, cofounder of SoBe, August 23, 2011.
Most textbooks on small business and entrepreneurship emphasize, quite correctly, the benefits and joys of owning and operating one’s own business. However, they often neglect to cover many of the challenges of continuing to operate a business successfully—the icebergs that can sink a business. The first half of this chapter covers one of the biggest icebergs: a natural or a man-made disaster and the disaster planning that should precede it. Being able to anticipate a disaster will contribute significantly to its effective handling so that a business can survive.
Even if a small business survives a disaster or another kind of iceberg, the owner may still wish to walk away. If a business does not survive, the owner will have no choice but to walk away. There may be other reasons forcing the owner to walk away, or escape, as well. The second half of this chapter discusses the forced escape and the other end of the spectrum—when things go so well that the business owner is ready to move on to another phase of his or her life. In both cases, an exit strategy will be required. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/14%3A_Icebergs_and_Escapes/14.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Understand the kinds of disasters that can face a small business.
2. Understand why disaster planning is important to a small business.
3. Describe the process of disaster planning.
4. Describe the sources of disaster assistance for small businesses.
A natural or a man-made disaster is but the tip of the iceberg. Planning for the complexity of what lies below the tip is important for every small business. Small- to medium-sized businesses are the most vulnerable in the event of a disaster.“Planning Can Cut Disaster Recovery Time, Expense,” US Small Business Administration, accessed February 6, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_da_dprep_howtoprep.pdf. It has been estimated by the US Department of Labor that 40 percent of businesses never reopen following a disaster. At least 25 percent of the remaining companies will close within two years. The Association of Records Managers and Administrators estimated that over 60 percent of small businesses that experience a major disaster close by the end of two years. Darrell Zahorsky, “Disaster Recovery Decision Making for Small Business,” About.com, accessed February 6, 2012, sbinformation.about.com/od/disastermanagement/a/disasterrecover.htm.
Given these odds, planning for disaster recovery makes great sense—even if, in the end, walking away makes the most sense. If a small business owner decides to rebuild, the process can begin after human health and safety are restored, the electricity is back on, and transportation is up and running. Everyone will want life to return to normal following the destruction, but that may not be possible for every small business. The market may change. Conditions may change, and a business must change to succeed in disaster recovery. Darrell Zahorsky, “Disaster Recovery Decision Making for Small Business,” About.com, accessed February 6, 2012, sbinformation.about.com/od/disastermanagement/a/disasterrecover.htm.
Disaster Planning
In the film Apollo 13, astronauts and engineers went through seemingly endless simulations of what might go wrong on a flight to the moon. The astronauts complained that some of the scenarios were unrealistic and almost impossible to occur. But when a near disaster occurred on Apollo 13, the engineers and astronauts were confronted with a problem that had never been considered; however, because of their prior experience with disaster training, they were able to develop a solution.
Rather than being negative, anticipating what can go wrong can be profoundly positive through either prevention or quickly responding to a crisis. The wise small business owner should appreciate Murphy’s Law (“Anything that can go wrong will go wrong”) and Murphy’s first corollary (“And it will go wrong at the worst possible moment”). The most pragmatic small business owner will also realize that Murphy was an optimist.
The Federal Emergency Management Agency declared 741 natural disasters in the United States for the period 2000 to 2011. Of that number, 66 percent were declared across the following six states: Texas (#1), California, Oklahoma, New York, Florida, and Louisiana (#6). However, every state and territory was represented.“Declared Disasters by Year and State,” Federal Emergency Management Agency, accessed February 6, 2012, www.fema.gov/news/disaster_totals_annual.fema. Planning for the aftermath of severe storms, flooding (e.g., perhaps snow melts too fast), fire, a hurricane or a tornado, a terrorist attack, or—in some areas—an earthquake is the key to getting back to business with a minimum of disruption. Not all businesses will face the same likelihood of these disasters occurring, but everyone faces the possibility of fire, severe storms, and flooding. Every situation will be unique, with the complexity of issues depending on the particular industry, size, location, and scope of a business.“Planning Can Cut Disaster Recovery Time, Expense,” US Small Business Administration, accessed February 6, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_da_dprep_howtoprep.pdf. The widespread nature of a the typical disaster means that public services, such as police, fire fighters, and medical assistance, will be unable to reach everyone right away. A business might be going it alone for a while.F. John Reh, “Survive the Unthinkable through Crisis Planning,” About.com, accessed February 6, 2012, management.about.com/cs/communication/a/PlaceBlame1000.htm.
According to a recent poll conducted by the National Federation of Independent Business, man-made disasters affect 10 percent of small businesses, and natural disasters have impacted more than 30 percent of all small businesses in the United States.Darrell Zahorsky, “Disaster Recovery Decision Making for Small Business,” About.com, accessed February 6, 2012, sbinformation.about.com/od/disastermanagement/a/disasterrecover.htm. Man-made disasters are disastrous events caused directly and principally by one or more identifiable deliberate or negligent human actions.“Man-Made Disaster,” BusinessDictionary.com, accessed February 6, 2012, www.businessdictionary.com/definition/man-made-disaster.html. They include such things as arson, radiation contamination, terrorism, structural collapse due to engineering failures, civil disorder, and industrial hazards.“Anthropogenic Hazard,” Wikipedia, accessed February 6, 2012, en.Wikipedia.org/wiki/List_of_man-made_disasters. The better prepared a business is, the faster it will be able to recover and resume operations…if that is the decision. Having a disaster plan can mean the difference between being shut down for a few days and going out of business entirely.“Disaster Preparedness: FAQs,” US Small Business Administration, accessed February 6, 2012, sbaonline.sba.gov/services/disasterassistance/disasterpreparedness/serv_da _dprep_howcaniprep.html.
A Disaster Planning Success Story
Joe Bogner of Dodge City, Kansas, learned the importance of disaster planning firsthand. He owns Western Beverage, Inc., a beverage distribution company serving twenty-nine counties in western Kansas. In 2002, Western Beverage sustained millions of dollars in fire damage. Yet the company resumed deliveries after just three days. Bogner was named the Kansas City Small Businessperson of the Year for 2006, partially because of his company’s ability to respond to adversity. As his nomination package stated, “Setting up plans of action and following through are Joe’s way of life. He has proven and is continuing to prove that dreams can come true.”“Planning Can Cut Disaster Recovery Time, Expense,” US Small Business Administration, accessed February 6, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_da_dprep_howtoprep.pdf.
Four key facts about disaster planning must be kept in mind: (1) disasters will occur, (2) an owner must have a plan before the disaster occurs, (3) react with urgency but do not panic, and (4) ride it out.F. John Reh, “Survive the Unthinkable through Crisis Planning,” About.com, accessed February 6, 2012, management.about.com/cs/communication/a/PlaceBlame1000.htm. If an owner is committed to having a disaster plan for a business, the plan and process can be structured in a variety of ways. For this section, however, the recommendations on Ready.gov serve as the structure for our discussion. These recommendations reflect the Emergency Preparedness Business Continuity Standard (NFPA 1600) developed by the National Fire Protection Association and endorsed by the American National Standards Institute and the Department of Homeland Security.“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business. The recommendations are divided into three areas: plan to stay in business, talk to the people, and protect the investment. The topics discussed here are presented in Figure 14.1 "Disaster Planning". They have the greatest immediacy for a small business.
Figure 14.1 Disaster Planning
Source: http://www.ready.gov/business.
Plan to Stay in Business
A business owner has invested a tremendous amount of time, money, resources, and emotions into building a business, so he or she will want to be able to survive a natural or man-made disaster. This requires taking a proactive approach so that the chances of the business surviving are increased. Unfortunately, nothing can be done to guarantee the survival of a business because there is no way to know what kind of disaster may occur—or when. There is also no way to know what kind of business environment the owner will face after the disaster. There are, however, several things can be done to increase those chances of survival. Resist the temptation to put emergency planning on the back burner.
Be Informed
It is important to look realistically at the types of disasters that might affect a business internally and externally and prepare a risk assessment. Consider the natural disasters that are most common in the areas where the business operates and think about the business’s vulnerability to man-made disasters. Fires are the most common disasters in the United States, and they are extremely destructive to businesses,“Fires,” American Red Cross, accessed February 6, 2012, www.sdarc.org/HowWeHelp/DisasterPreparedness/Fire/tabid/81/Default.aspx. but an owner may not be aware that a community is very vulnerable to flooding from snow melt or that the proximity to a chemical plant makes a business vulnerable to the results of explosions. This is why it is important to prepare a risk assessment so that the business can plan accordingly.
Make a Continuity Plan
It is said that a business continuity plan is the least expensive insurance any business can have—especially a small business—because it costs virtually nothing to produce.“How to Create a Business Continuity Plan,” wikiHow, accessed February 6, 2012, www.wikihow.com/Create-a-Business-Continuity-Plan. The better the continuity planning is before a disaster, the greater the chances that a business will survive and recover. There are many things that can be done.“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business; “How to Create a Business Continuity Plan,” wikiHow, accessed February 6, 2012, www.wikihow.com/Create-a-Business-Continuity-Plan. The following is not an exhaustive list:
1. Carefully assess how the business functions. Document internal key personnel and backups (i.e., the personnel without whom a business absolutely cannot function). The list should be as large as necessary but as small as possible.
2. Identify suppliers, shippers, resources, and other businesses that are interacted with on a daily basis. Document these and other external contacts, such as bankers, attorneys, information technology (IT) consultants, utilities, and municipal and community offices (police, fire, etc.) that may be needed for assistance.
3. Identify people who can telecommute. Take steps to ensure that critical staff can telecommute if necessary.
4. Plan for payroll continuity.
5. Document critical equipment. Personal computers, fax machines, special printers and scanners, and software are critical to most businesses. An accurate inventory will help a business restore critical equipment.
6. Make sure that all data and critical documents are protected. Critical documents include articles of incorporation and other legal papers, utility bills, banking information, and human resources documents; all these will be required to start over again. The Small Business Administration (SBA) recommends that vital business records—information stored on paper and computer—should be copied and saved at an offsite location at least fifty miles away from the main business site.“Disaster Preparedness: FAQs,” US Small Business Administration, accessed June 1, 2012, archive.sba.gov/services/disa...paredness/serv _da_dprep_howcaniprep.html. Companies such as Carbonite can store records “on the cloud.”
7. Identify a contingency location where business can be conducted while the primary office is unavailable. Many hotels have well-equipped business facilities that can be used, but remember that other businesses may need to do the same thing. It is good to have a contingency plan for a contingency location.
8. Put all the information together. The continuity plan is an important document, a copy of which should be given to all key personnel. Do not distribute the plan to people who do not need to have it. The plan will contain sensitive and secure information that could be used by a disgruntled employee for inappropriate purposes.
9. Plan to change the plan. There will always be events that could not have been factored into the plan. For example, the contingency site is damaged beyond use or the business’s bank is in an area that will be without power for days. Situations such as these will require immediate changes to the plan.
10. Review and revise the plan.
Talk to People
Without good communication, the internal and external structure of a business—and its daily operations—will face challenges that may ultimately lead to its downfall.Kristie Lorette, “Importance of Good Communication in Business,” Chron.com, accessed February 6, 2012, smallbusiness.chron.com/importance-good -communication-business-1403.html. Strong communication skills are, therefore, a vital part of business success. When first starting out, the owner will need good communication skills to attract and keep new customers. As the business grows and new employees are required, these skills will be needed to hire, motivate, and retain good staff.Leslie Schwab, “Small Business: The Importance of Strong Communication Skills,” Helium, June 20, 2009, accessed February 6, 2012, www.helium.com/items/1486526-strong-communication-skills-are-required-for-success-in-small-business. It is for this reason that the employees of a business should play a central role in creating a disaster plan.
Involve Coworkers
Providing for the well-being of all employees is one of the best ways to ensure that a business will recover from a disaster. A business must be able to communicate with them before, during, and after a disaster. There are several recommendations for doing this, including the following:“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business.
• Employees from all levels in the organization should be involved.
• Internal communications tools, such as newsletters and intranets, should be used to communicate emergency plans and procedures.
• Set up procedures to warn people, being sure to plan how to warn employees who are hearing impaired, are otherwise disabled, or do not speak English.
• Encourage employees to find an alternate way of getting to and from work in case their usual way of transportation is interrupted.
• Keep a record of employee emergency contact information with other important documents.
Write a Crisis Communication Plan
The owner must decide how the business will contact suppliers, creditors, other employees, local authorities, customers, media, and utility companies during and after the disaster. One easy way to do this is to assign key employees to make designated contacts. Provide a list of these key employees and contacts to each affected employee and keep a copy with other protected contacts. Each key employee should also keep a copy of the list at home. In addition,“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business. do the following:
• Make sure that top executives have all the relevant information needed to protect employees, customers, vendors, and nearby facilities.
• Update customers on whether and when products will be received and services rendered.
• Let public officials know what the business is prepared to do to help in the recovery effort.
• Let public officials know whether the business will need emergency assistance to conduct essential business activity.
Support Employee Health—and the Owner’s Health
Disasters often result in business disorientation and environmental detachment, with the psychological trauma of key decision makers leading to company inflexibility (perhaps inability) to deal with the change required to move forward.Darrell Zahorsky, “Disaster Recovery Decision Making for Small Business,” About.com, accessed February 6, 2012, sbinformation.about.com/od/disastermanagement/a/disasterrecover.htm. If the owner or other key personnel experience posttraumatic stress disorder, it can cripple a business’s decision-making ability.
No matter the disaster, there will be psychological effects (e.g., fear, stress, depression, anxiety, and difficulty in making decisions) as well as—depending on the nature of the disaster—physical effects such as injuries, burns, exposure to toxins, and prolonged pain.John H. Ehrenreich, “Coping with Disasters: A Guidebook to Psychosocial Intervention,” Toolkit Sport for Development, October 2001, accessed February 6, 2012, www.toolkitsportdevelopment.org/html/resources/7B/7BB3B250-3EB8-44C6-AA8E -CC6592C53550/CopingWithDisaster.pdf. As a result, the owner and the employees may have special recovery needs. To support those needs, do the following:“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business.
• Provide for time at home to care for family needs, if necessary.
• Have an open-door policy that facilitates seeking care when needed.
• Reestablish routines as best as possible.
• Offer special counselors to help people address their fears and anxieties.
• Take care of yourself. Leaders tend to experience increased stress after a disaster. The leader’s own health and recovery are also important to both family and the business as a whole.
Protect the Investment
Last but certainly not least, take steps to protect the business and secure its physical assets. Among the things that can be done, having appropriate insurance coverage; securing facilities, buildings, and plants; and improving cybersecurity are at the top of the list.
Insurance Coverage
Having inadequate insurance coverage can leave a business vulnerable to a major financial loss if it is damaged, destroyed, or simply interrupted for a period of time. Because insurance policies vary, meet with an insurance agent who understands the needs of a particular business.“Insurance Coverage Review Worksheet,” Ready.gov, accessed February 6, 2012, www.ready.gov/sites/default/files/documents/files/InsuranceReview_Worksheet.pdf.
• Review coverage for things such as physical losses, flood coverage, and business interruption. Normal hazard insurance does not cover floods, so make sure the business has the right insurance.“Disaster Preparedness: FAQs,” US Small Business Administration, accessed June 1, 2012, archive.sba.gov/services/disa...paredness/serv _da_dprep_howcaniprep.html. Business interruption insurance protects a business in the event of a natural disaster, a fire, or other extenuating circumstances that affect the ability of a company to conduct business.“Business Interruption Insurance,” Entrepreneur, accessed February 6, 2012, www.entrepreneur.com/encyclopedia/term/82282.html. Small business owners should seriously consider this type of insurance because it can provide enough money to meet overhead and other expenses while out of commission. The premiums for these policies are based on a company’s income.“Business Interruption Insurance,” Entrepreneur, accessed February 6, 2012, www.entrepreneur.com/encyclopedia/term/82282.html.
• Understand what the insurance policy covers and what it does not cover.
• Add coverage as necessary.
• Understand the deductible and make adjustments as appropriate.
• Think about how creditors and employees will be paid.
• Plan how to pay yourself if the business is interrupted.
• Find out what records the insurance provider will require after an emergency and store them in a safe place. It would be a good idea to take pictures of your physical facilities, equipment, buildings, and plant so that insurance claims can be processed quickly. These pictures will also provide a good basis for putting the operation back into working order.
Secure Facilities, Buildings, and Plants
One cannot predict what will happen in the case of a disaster, but there are steps that can be taken in advance to help protect a business’s physical assets, including the following: “Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business.
• Fire extinguishers and smoke detectors should be installed in appropriate places.
• Building and site maps with critical utility and emergency routes clearly marked should be available in multiple locations—and they should be protected with other important documents.
• Think about whether automatic fire sprinklers, alarm systems, closed circuit television, access control, security guards, or other security measures would make sense.
• Secure the entrance and the exit for people, products, supplies, and anything else that comes into and leaves the business.
• Teach employees to quickly identify suspect packages and letters, for example, packages and letters with misspelled words, no return address, the excessive use of tape, and strange coloration or odor. Have a plan for how such packages and letters are to be handled.
Improve Cybersecurity
Many, perhaps most, small businesses will have data and IT systems that may require specialized expertise. They need to be protected. The industry, size, and scope of a business will determine the complexity of cybersecurity, but even the smallest business can be better prepared.“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business. Small businesses are the most vulnerable to cybersecurity breaches because they have the weakest security systems, thereby making them easier online targets.“CyberSecurity by Chubb,” Chubb Group of Insurance Companies, accessed February 6, 2012, www.chubb.com/businesses/csi/chubb822.html.
Video Clip 14.1
Cybersecurity
(click to see video)
An overview of cybersecurity.
Video Link 14.1
Chubb Group of Insurance Companies
The Chubb Group of Insurance Companies provides a very good video discussion of cybersecurity.
www.chubb.com/businesses/csi/chubb822.html
Every computer can be vulnerable to attack. The consequences can range from simple inconvenience to financial catastrophe.“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business. There are several things that can be done to protect a business, its customers, and its vendors, including the following:“Plan For and Protect Your Business,” Ready.gov, accessed February 29, 2012, www.ready.gov/business; “Cyber Security Liability Insurance,” Wall Street Journal, March 18, 2010, as cited in Robert Hess and Company Insurance Brokers, May 6, 2010, accessed February 6, 2012, robhessco.com/183/cyber-security-liability-insurance/; Eric Schwartzel, “Cybersecurity Insurance: Many Companies Continue to Ignore the Issue,” Pittsburg Post-Gazette, June 22, 2010, accessed February 6, 2012, www.post-gazette.com/pg/10173/1067262-96.stm.
• Explore cybersecurity liability insurance. This coverage is available at reasonable rates to protect against credit card identity theft, with limits up to \$5 million. This insurance will cover the loss of digital assets plus expenses for public relations, damages, and service interruption. It will also protect customers. The notification of customers whose credit was compromised is included plus any legal costs and a year of credit monitoring for each individual affected. Although other cybersecurity insurance policies can cover data loss, applicants must break down loss estimates on an hourly basis because most breaches are resolved in hours, not days. This is not an easy thing to do.
• Use antivirus software and keep it up to date. If an owner is not already doing this, he or she should probably have a mental examination.
• Do not open e-mail from unknown sources. Always be suspicious of unexpected e-mails that include attachments, whether or not they are from a known source. When in doubt, delete the file and the attachment—and then empty the computer’s deleted items file. This should be a procedure that all employees know about and follow. The owner must do it as well.
• Use hard-to-guess passwords. An application for cyberinsurance requires, among other things, answering the following question: “Are passwords required to be at least seven characters in length, alphanumeric, and free of consecutive characters?” (Check yes or no.) Whether or not a business plans to apply for cyberinsurance, instituting this kind of password policy is well worth consideration.
KEY TAKEAWAYS
• Small- to medium-sized businesses are the most vulnerable in the event of a disaster.
• Some estimates claim that over 60 percent of small businesses that experience a major disaster close by the end of the second year.
• Planning for disaster recovery makes great sense for protecting a business.
• Every state and territory has experienced disasters. Planning for the aftermath is the key to getting back to business with a minimum of disruption. However, every situation will be unique.
• Man-made disasters affect 10 percent of small businesses, while natural disasters have impacted more than 30 percent of all small businesses in the United States.
• A man-made disaster is a disastrous event caused directly and principally by one or more identifiable deliberate or negligent human actions—for example, arson, terrorism, and structural collapse.
• The better prepared a business is, the faster it will recover from a disaster and resume operations. Having a disaster plan can mean the difference between being shut down for a few days and going out of business entirely.
• Even the smallest business should have a disaster plan.
• The three main areas that an owner should focus on in a disaster plan are the plan to stay in business, talk to people, and protect the investment.
EXERCISE
Frank’s BarBeQue just missed being impacted by a tornado that ripped through southwestern Connecticut. Many small businesses were lost, never to reopen, while others sustained major physical and economic damage. Frank’s son, Robert, asked his father about whether he was prepared for something like that. Frank’s response was troubling. Although he kept some important documents in a safety deposit box at the bank, there was little planning or protection. Robert explained the importance of disaster planning, but Frank was overwhelmed by the prospect of the process.
Robert contacted a local university and arranged with its school of business for a team of five students to prepare a disaster plan for Frank’s BarBeQue. He presented the project idea to his father and was relieved that his dad was willing to participate. It was clearly understood that no proprietary or confidential information would be shared with the students.
1. Assume that you are the leader of the team. Describe the approach you will take and the recommendations that you will make. It is expected that you will go beyond the information provided in the text. Creativity is strongly encouraged. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/14%3A_Icebergs_and_Escapes/14.02%3A_Icebergs.txt |
Learning Objectives
1. Learn about the sources of disaster assistance for the physical and/or economic losses of small business.
Do not assume that all small businesses will qualify for disaster loan assistance or that insurance will cover the costs of all losses. A small business owner may have to depend on other forms of financial assistance—for example, savings, friends, and family.Darrell Zahorsky, “Disaster Recovery Decision Making for Small Business,” About.com, accessed February 6, 2012, sbinformation.about.com/od/disastermanagement/a/disasterrecover.htm. However, if a small business has sustained economic injury after a disaster, it may be eligible for financial assistance from the Small Business Administration (SBA). If a business is located in a declared disaster area, the owner may apply for a long-term, low-interest loan to repair or replace damaged property.“Disaster Assistance For Businesses of All Sizes,” US Small Business Administration, accessed February 28, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_da _dprep_factsheethome.pdf.
Physical and Economic Injury Disaster Loans
In the case of a physical disaster, a small business owner may apply for a low-interest SBA loan of up to \$2 million to repair or replace damaged real estate, equipment, inventory, and fixtures: “The loan may be increased by as much as 20 percent of the total amount of disaster damage to real estate and/or leasehold improvements, as verified by SBA, to protect property against future disasters of the same type. These loans will cover uninsured and or under-insured losses.”“Disaster Assistance For Businesses of All Sizes,” US Small Business Administration, accessed February 28, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_da _dprep_factsheethome.pdf. It is also possible that small business disaster relief loans may be available at the local, county, regional, or state level.See, for example, the small business loans that are available through the Union County Economic Development Corporation (Union, New Jersey) for disaster assistance: scotchplains.patch.com/articles/union-county-makes-small-business-loans -available.
The SBA can also help small businesses that were not damaged physically but have suffered economically.“Demand Grows for Disaster Loans,” Wall Street Journal, September 7, 2011, accessed February 6, 2012, blogs.wsj.com/in-charge/2011/09/07/demand-grows-for-disaster -loans/?mod=google_news_blog. An Economic Injury Disaster Loan of up to \$2 million can be granted to meet necessary financial obligations—expenses the business would have paid if the disaster had not occurred.
The interest rate on both Physical and Economic Injury Disaster Loans will not exceed 4 percent if you do not have credit available elsewhere. Repayment can be up to 30 years, but this will depend on the business’s ability to repay the loan. For businesses that may have credit available elsewhere, the interest rate will not exceed 8 percent. SBA determines whether the applicant has credit available elsewhere.“Disaster Assistance For Businesses of All Sizes,” US Small Business Administration, accessed February 28, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_da _dprep_factsheethome.pdf.
Disaster Assistance from the Internal Revenue Service
The Internal Revenue Service (IRS) provides some disaster assistance and emergency relief for businesses through special tax law provisions, especially when the federal government declares their location to be a major disaster area. The IRS may grant additional time to file returns and pay taxes. While doing disaster planning, check the latest special tax law provisions that may help a business recover financially from the impact of a major disaster.“Disaster Assistance and Emergency Relief for Individuals and Businesses,” Internal Revenue Service, accessed February 6, 2012, www.irs.gov/businesses/small/article/0,,id=156138,00.html. It would also be a good idea to check out what kind of record keeping the IRS requires so that a business will be fully prepared should it be necessary to take advantage of what the IRS offers.
SCORE Business Advice
Disaster recovery will push the limits of a small business…and then some. Locate the closest offices of SCORE (Service Corps of Retired Executives)—a nonprofit association dedicated to educating entrepreneurs and helping small businesses start, grow, and succeed nationwide—and enlist their support. SCORE provides confidential business counseling services at no charge.“About SCORE,” SCORE, accessed February 6, 2012, www.score.org/about-score.
Online Disaster Assistance
DisasterAssistance.gov is a one-stop web portal, self-described as access to disaster help and resources, that details over sixty different forms of assistance from seventeen US government agencies where a business owner can apply for SBA loans through online applications, receive referral information on forms of assistance that do not have online applications, or check the progress and status of online applications.“Disaster Assistance and Emergency Relief for Individuals and Businesses,” Internal Revenue Service, accessed February 6, 2012, www.irs.gov/businesses/small/article/0,,id=156138,00.html; “What Is DisasterAssistance.gov,” DisasterAssistance.gov, accessed February 6, 2012, www.disasterassistance.gov.
Benefits.gov wants to let survivors and disaster relief workers know about the many disaster relief programs that are available. There are questions for a small business owner who has suffered damage because of a natural disaster to answer to find out which government benefits the business may be eligible to receive. The site also provides a link to DisasterAssistance.gov.“Disaster Assistance and Emergency Relief for Individuals and Businesses,” Internal Revenue Service, accessed February 6, 2012, www.irs.gov/businesses/small/article/0,,id=156138,00.html; “Looking for Benefits?,” accessed February 6, 2012, www.benefits.gov.
KEY TAKEAWAYS
• Do not assume that a small business will qualify for disaster loan assistance or that insurance will cover the costs of all losses. A small business owner may have to depend on others for financial assistance—for example, friends, family, and savings.
• A small business owner may apply for a low-interest SBA loan of up to \$2 million to repair or replace damaged real estate. The interest rate on this loan will not exceed 4 percent if credit is not available elsewhere.
• The SBA also provides financial assistance to small businesses that were not damaged physically but suffered economic losses. The interest rate on this loan will also not exceed 4 percent if the business does not have credit available elsewhere.
• The IRS provides disaster assistance and emergency relief through special tax provisions.
• It would be worthwhile checking out SCORE for assistance.
• Online disaster assistance is available through two website portals: DisasterAssistance.gov and Benefits.gov.
EXERCISE
1. As part of the disaster management plan, Robert has asked the student team to prepare a specific plan for obtaining disaster assistance under the assumption that both physical and economic damages will occur. Review the various options and the material from the previous section in this chapter and then make specific recommendations. It is expected that you will go beyond the information presented in the text. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/14%3A_Icebergs_and_Escapes/14.03%3A_Disaster_Assistance.txt |
Learning Objectives
1. Identify the situations in which an owner may choose to get out of business.
2. Identify and understand the situations that may lead to being forced out of business.
3. Understand the resources that can help an owner make a decision.
There are many reasons why an owner might want to walk away from a business; the choice is oftentimes the owner’s. Perhaps the owner wants to sell the business before retirement. Perhaps someone has approached the owner with a terrific offer. Perhaps investors are pressuring the owner for their money. Perhaps no one in the owner’s family wants to take over the business. Perhaps it is no longer fun; the entrepreneurial spirit is gone, and the owner’s passion has changed. It could be that either the owner or the team is not committed to making things work.“Knowing When to Throw in the Towel,” Fox Business, May 2, 2011, accessed February 6, 2012, smallbusiness.foxbusiness.com/entrepreneurs/2011/05/02/knowing -throw-towel. Perhaps the owner would like to cash out the equity built in the business.Timothy Faley, “Making Your Exit,” Inc., March 1, 2006, accessed February 6, 2012, www.inc.com/resources/startup/articles/20060301/tfaley.html; “Knowing When to Throw in the Towel,” Fox Business, May 2, 2011, accessed February 6, 2012, smallbusiness.foxbusiness.com/entrepreneurs/2011/05/02/knowing-throw-towel. There are many other reasons as well:
• The owner is spending more time fixing nominal problems, it feels as if he or she is working backward, and no end seems in sight.
• Instead of being the most optimistic person on the team, the owner starts taking a negative view on most of the decisions the team is making about future prospects for growth.
• Continuing with the business may have serious, lasting personal repercussions, such as threatening one’s marriage, familial relationships, or health. The potential risk is no longer worth the reward.
• The owner sees the writing on the wall: no repeat or referral customers, no positive feedback from any source, or no demand for the business’s product or service. Positive feedback can take many forms: word of mouth, referrals, favorable press, favorable posts and reviews on Facebook and Twitter, and plenty of inquiries. If a business owner is not satisfying customers and attracting new ones, why be in business at all?
When Walking Away Is Not the Owner’s Choice
There will also be those times when walking away from a business may not be the owner’s choice.
• The owner wants no one else to run the business and is unwilling to give up equity. Every small business founder faces the founder’s dilemma—that is, the dilemma between making money and controlling the business.Dan Bigman, “On the Hunt,” Forbes 185, no. 2 (2009): 56–59. It is tough to do both because they tend to be incompatible goals. Founders often make decisions that conflict with maximizing wealth.Noam Wasserman, “The Founder’s Dilemma,” Harvard Business Review, February 2008, 1–8. If an owner wants to make a lot of money from a business, the owner will need to give up more equity (the money put into the business) to attract investors, which requires relinquishing control as equity is given away; investors may alter the board membership of a business.Noam Wasserman, “The Founder’s Dilemma,” Harvard Business Review, February 2008, 1–8. To retain control of a business, the owner will have to keep more equity, relying on his or her own capital instead of taking money from investors. The result will be less capital to increase a company’s value, but he or she will be able to run the company.Noam Wasserman, “The Founder’s Dilemma,” Harvard Business Review, February 2008, 1–8.
In a recent study of 212 new ventures, it was found that in three years, 50 percent of the founders were no longer the CEO, only 20 percent were still “in the corner office,” and fewer than 25 percent led their company’s initial public offering (IPO). Four out of five found themselves being forced to step down at some point.Dan Bigman, “On the Hunt,” Forbes 185, no. 2 (2009): 56–59; Noam Wasserman, “The Founder’s Dilemma,” Harvard Business Review, February 2008, 1–8. Although specific to new ventures, this information has a clear message for all small business founders/owners: wanting to make a lot of money while still controlling and running the business are not compatible goals. One must decide which goal is most important, understanding that the choice of letting someone else run the business will likely result in being forced to step down…and perhaps out of the business altogether.
• The owner is facing bankruptcy. One studyRichard Carter and Howard Van Auken, “Small Firm Bankruptcy,” Journal of Small Business Management 44, no. 4 (2006): 493–512. found that firms with less sophisticated owners or managers with respect to experience and training increases the likelihood of bankruptcy as do a deteriorating market and having less access to capital. There can be other reasons as well—for example, employee theft, fraud, or a consumer liability lawsuit that drains a company’s assets.
• The owner may be the cause. The owner could be killing the company or, at the very least, shooting himself or herself in the foot. There are several ways in which this could happen:Geoff Williams, “Dead Zone,” Entrepreneur, March 2007, accessed February 6, 2012, www.entrepreneur.com/magazine/entrepreneur/2007/march/174716.html. (1) micromanaging, which may lead to, for example, employees presenting problems or issues but no solutions, unusually high turnover, and never receiving a project that the owner does not change; (2) spending money in the wrong places—for example, spending money on items not needed, such as a fancier location, hiring more staff than needed, and attending costly trade shows with limited or no return on investment; (3) chasing after every customer instead of focusing on the ideal and regular customers that should be reached; (4) the owner is not on top of the numbers, perhaps because he or she is not financially minded and has not taken the time to become financially minded or hire someone as the finance person; and (5) the owner is not a people person, perhaps being a “my way or the highway” kind of person who invests no emotion or warmth when dealing with employees and colleagues, or is an egomaniac.
• The owner is seriously ill. Being ill will raise doubts about a company’s future, and new businesses are the most vulnerable.Leigh Buchanan, “A Fight for Survival: When the Boss Gets Cancer,” Inc., July/August 2009, 106, 108. If there is no one in the owner’s family who is interested in or willing to take over the business, this can add additional stress to the situation.
• The industry dies or implodes. Sometimes the demand for a service or a product just dies—for example, web-consulting companies during the dot-com bust in 2000 and 2001.Joel Spolsky, “The Day My Industry Died,” Inc., July/August 2009, 37–38. Henrybuilt Corporation, a Seattle firm that specialized in designing kitchens from \$30,000 to \$100,000, saw its sales come to a standstill in 2008. Everyone was cancelling projects. The company modified its product and was able to survive.Sarah E. Needleman, Vanessa O’Connell, Emily Maltby, and Angus Loten, “And the Most Innovative Entrepreneur Is…,” Wall Street Journal, November 14, 2011, accessed February 6, 2012, online.wsj.com/article/SB10001424052970203716204577013501641346794.html.
Resources to Help Make a Decision
The decision to walk away from a business—whether that decision is voluntary or forced—is not an easy one to make. Consult with an appropriate mix of individuals; a partner or partners if applicable, your spouse, your family, an attorney, an accountant, and perhaps someone from SCORE. Each individual can offer a different perspective and different counsel. Ultimately, however, the decision is the owner’s.
One thing is for certain. Whether the escape is voluntary or forced, there should be an exit strategy.
KEY TAKEAWAYS
• Escaping from a business is the owner’s choice when, for example, he or she wants to sell the business before retirement, someone has approached the owner with a terrific offer, investors are pressuring the owner for their money, no family member wants to take over the business, or it is not fun anymore.
• An escape may be forced when, for example, an owner wants no one else to run the business and is unwilling to give up equity or is facing bankruptcy or is seriously ill.
• The owner should consult with a mix of resources before making a decision.
EXERCISE
1. You are the twenty-eight-year-old founder of a very successful, five-year-old software company. For the last three years, sales have doubled in each year. Last year’s sales were \$75 million. A major high-tech firm wants to buy your company. They will offer cash and will sweeten the offer by allowing you the option of being CEO for at least two years. How much would the firm have to offer you to take this deal? How would you know if it was a fair offer? Would you exercise the option to act as CEO for the two years? If you took the offer, what would be your life plans? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/14%3A_Icebergs_and_Escapes/14.04%3A_Getting_Out_of_the_Business.txt |
Learning Objectives
1. Understand the importance of an exit strategy.
2. Explain the exit strategies that a small business can consider.
The most emotional topic a small business owner will face while building a business—and the hardest decision to make—is when and how to exit the business. This very personal decision should be considered while building the business because this decision will impact many other decisions made along the way.Timothy Faley, “Making Your Exit,” Inc., March 1, 2006, accessed February 6, 2012, www.inc.com/resources/startup/articles/20060301/tfaley.html. Ultimately, however, an exit strategy must be developed whether or not it is considered along the way. The strategy should be developed early in the business, and it should be reviewed and changed periodically because conditions change. Unfortunately, many small business owners have no exit strategy. This will make an already very emotional decision and process even more difficult.
There are many exit strategies that a small business owner can consider. Liquidation or walk away, family succession, selling the business, bankruptcy, and taking the company public are discussed here. Selecting an exit strategy is important because the way in which an owner exits can affect the following:“Consider Your Exit Strategy When Starting Up: Why You Need an Exit Strategy,” Business Link, accessed February 6, 2012, www.businesslink.gov.uk/bdotg/action/detail?itemId=1073792644&type=RESOURCES.
• The value that the owner and/or shareholders (if any) can realize from a business
• Whether a cash deal, deferred payments, or staged payments are received
• The future success of the business and its products or services (unless one is closing the business)
• Whether the owner wants to retain any involvement in or control of the business
• Tax liabilities
Figure 14.4 Possible Exit Strategies
The best exit strategy (see Figure 14.4 "Possible Exit Strategies") is the one that is the best match to a small business and the owner’s personal and professional goals. The owner must first decide what he or she wants to walk away with—for example, money, management control, or intellectual property. If interested only in money, selling the business on the open market or to another business may be the best choice. If, on the other hand, one’s legacy and seeing the small business continue are important, family succession or selling the business to the employees might be a better solution.Susan Ward, “Exit Strategies for Your Small Business,” About.com, accessed June 1, 2012, sbinfocanada.about.com/od/businessplanning/a/exitstrategies.htm.
Liquidation or Walkaway
There are times when a small business owner may decide that enough is enough, so he or she simply calls it quits, closes the business doors, and calls it a day.Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512. This happens all the time, to hundreds of businesses every day—for example, a small shop, a restaurant, a small construction company, a shoe store, a gift shop, a consignment shop, a nail salon, a bakery, or a video store.Andrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies-for-Small -Business-Owners-By-Andrew-Clarke. This closing of the business involves liquidation, the selling of all assets. If all debts are paid, it can also be referred to as a walkaway.
To make any money with the liquidation exit strategy, a business must have valuable assets to sell—for example, land or expensive equipment. The name of the business may have some value, so it could be purchased by someone for pennies on the dollar and restarted with different owners. There is also a possibility that there may be a substantial amount of goodwill or even badwill if a business has been around for a long time. Goodwill is an intangible asset that reflects the value of intangible assets, such as a strong brand name, good customer relationships, good employee relationships, patents, intellectual property, size and quality of the customer list, and market penetration.“Goodwill,” Investopedia, accessed February 6, 2012, www.investopedia.com/terms/g/goodwill.asp. However, if a business is simply closed, the value of the goodwill will drop, and the selling price will be lower than it would have been prior to the business being closed.Andrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies-for-Small -Business-Owners-By-Andrew-Clarke.
Badwill is the negative effect felt by a company when it is found out that a company has done something not in accord with good business practices. Although badwill is typically not expressed in a dollar amount, it can result in such things as decreased revenue; the loss of clients, customers, and suppliers; the loss of market share; the loss of credit; federal or state indictments for crimes committed, and censure by the community.“Badwill,” Investopedia, accessed February 6, 2012, www.investopedia.com/terms/b/badwill.asp. For the small business owner who wants to close under these circumstances, there will be nothing much to sell but tangible assets because the business will have very little, if any, market value.
In all instances of liquidation, the proceeds from the sale of assets must first be used to repay creditors. The remaining money is divided among the shareholders (if any), the partners (if any), and the owner.Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512. In an ideal walkaway situation, the following occurs:Jerome A. Katz and Richard P. Green, Entrepreneurial Small Business (New York: McGraw-Hill Irwin, 2009), 663.
• All bills are paid off (or scheduled).
• All taxes are paid, and the various levels of government are informed of the closure.
• Contracts, leases, and the like are fulfilled or formally terminated.
• Employees are let go to find other jobs.
• Assets or inventory is depleted.
• No lawsuits are consuming money and time.
• Customers are placed so that they get needed goods or services.
• If needed, insurance is continued to cover unexpected claims after the firm closes.
The walkaway is the cleanest and best way to exit, but it is not always possible for all businesses that decide to close their doors. There will, of course, always be those instances in which the owner closes the business and takes off, leaving a mess behind.
Any small business owner thinking about liquidation should consider the pros and cons, which are as follows:Andrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies-for-Small -Business-Owners-By-Andrew-Clarke; Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
• Pros
• It is easy and natural. Everything comes to an end.
• No negotiations are involved.
• There are no worries about the transfer of control.
• Cons
• Get real! It is a waste. At most, the owner will get the market value of the company’s assets.
• Things such as client lists, the owner’s reputation, and business relationships may be very valuable. Liquidation destroys them without an opportunity to recover their value.
• Other shareholders, if any, may be less than thrilled about how much is left on the table.
• If a company’s brand has any value, there is a loyal or sizeable customer base, or there is a stable core of employees, an owner would be significantly better off selling the company.
Family Succession
Many small business owners dream of passing the business to a family member. Keeping the business in the family allows the owner’s legacy to live on, which is clearly an attractive option. Family succession as an exit strategy also allows the owner an opportunity to groom the successor; the owner might even retain some influence and involvement in the business if desired.Susan Ward, “Exit Strategies for Your Small Business,” About.com, accessed February 6, 2012, sbinfocanada.about.com/od/businessplanning/a/exitstrategies.htm. However, given that very few family firms survive beyond the first generation and even fewer survive into the third generation,Sue Birley, “Succession in the Family Firm: The Inheritor’s View,” Journal of Small Business Management 24, no. 3 (1986): 36–43; Manfred F. R. Kets de Vries, “The Dynamics of Family Controlled Firms: The Good News and the Bad News,” Organizational Dynamics 21, no. 3 (1993), 59–68; Michael H. Morris, Roy O. Williams, Jeffrey A. Allen, and Ramon A. Avila, “Correlates of Success in Family Business Transitions,” Journal of Business Venturing 12 (1997): 385–401. succession is the most critical issue facing family firms.Wendy C. Handler, “Succession in Family Business: A Review of the Literature,” Family Business Review 7, no. 2 (1994): 133–57. Succession is the transference of leadership from one generation to the next to ensure continuity of family ownership of the business.Stanley M. Davis, “Entrepreneurial Succession,” Administrative Science Quarterly 13 (1968): 402–16, as cited in A. Bakr Ibrahim, Khaled Soufani, Panikkos Poutziouris, and Jose Lam, “Qualities of an Effective Successor: The Role of Education and Training,” Education and Training 46, no. 8/9 (2004): 474–80.
A sudden decision to hand over the business to a family member is unwise. The owner will be burdened with problems that will likely lead to business failure. Succession in family firms is a multistage, complex process that should begin even before the heirs enter the business, and effects extend beyond the point in time when they are named as successors. Many factors are involved, and the succession should evolve over a long period of time.A. Bakr Ibrahim, Khaled Soufani, Panikkos Poutziouris, and Jose Lam, “Qualities of an Effective Successor: The Role of Education and Training,” Education and Training 46, no. 8/9 (2004): 474–80; Katiuska Cabrera-Suarez, “Leadership Transfer and the Successor’s Development in the Family Firm,” The Leadership Quarterly 16 (2005): 71–96. Further, because succession is usually followed by changes in the organization, particularly the change in the top position, it is thought to be an indicator of the future of the business. The better prepared and committed the successor is, the greater the likelihood of a successful succession process and business.Katiuska Cabrera-Suarez, “Leadership Transfer and the Successor’s Development in the Family Firm,” The Leadership Quarterly 16 (2005): 71–96. The quality of interpersonal relationships, successors’ expectations, and the role of the predecessor are also relevant to success.Katiuska Cabrera-Suarez, “Leadership Transfer and the Successor’s Development in the Family Firm,” The Leadership Quarterly 16 (2005): 71–96.
The ideal is for the family business to have engaged in formal succession planning: planning for the family business to be transferred to a family member or members. The failure to plan for succession is seen as a fundamental human resource problem as well as the primary cause for the poor survival rate of family businesses.A. Bakr Ibrahim, Khaled Soufani, Panikkos Poutziouris, and Jose Lam, “Qualities of an Effective Successor: The Role of Education and Training,” Education and Training 46, no. 8/9 (2004): 474–80. Unfortunately, a very small percentage of family businesses plan appropriately for succession, and those that do frequently have mental, not written, plans.Stephan van der Merwe, Elmarie Venter, and Suria M. Ellis, “An Exploratory Study of Some of the Determinants of Management Succession Planning in Family Businesses,” Management Dynamics 18, no. 4 (2009): 2–17. A discussion of succession planning is in Chapter 3 "Family Businesses".
Video Clip 14.2
How to Pass On a Family Business
(click to see video)
The owner of the Casanova Restaurant in Carmel, California, talks about his business and his hopes of passing it on to his children.
Bankruptcy
Feeling the need to file for bankruptcy is a tough pill for any small business owner to swallow. Bankruptcy is an extreme form of business termination that uses a legal method for closing a business and paying off creditors when the business is failing and the debts are substantially greater than the assets.Jerome A. Katz and Richard P. Green, Entrepreneurial Small Business (New York: McGraw-Hill Irwin, 2009), 663. Because bankruptcy is a complicated legal process, it is important to get an attorney involved as soon as possible. There may be options other than bankruptcy, and consulting with an attorney will help. The owner must understand how bankruptcy works and the options that are available. It is also good to know that not all bankruptcies are voluntary; creditors can petition the court for a business to declare bankruptcy.“Bankruptcy,” US Small Business Administration, accessed February 6, 2012, www.sba.gov/content/bankruptcy.
Chapter 7 small business bankruptcy, more commonly referred to as liquidation, is appropriate when a business is failing, has no future, and has no substantial assets. This form of bankruptcy makes sense only if the owner wants to walk away. It is particularly suited to sole proprietorships and other small businesses in which the business is essentially an extension of its owner’s skills.Caron Beesley, “Bankruptcy Options for the Small Business Owner,” AllBusiness.com, February 5, 2009, accessed February 6, 2012, www.allbusiness.com/company-activities-management/company-structures-ownership/11772426-1.html; “Small Business Bankruptcy…You Have Choices,” Daniel B. James Group, accessed February 6, 2012, www.small-business-bankruptcy.com. Under Chapter 7 bankruptcy law, a trustee will take a business apart, selling assets to satisfy outstanding debts and discharging debts that cannot be satisfied with the assets that are available.Caron Beesley, “Bankruptcy Options for the Small Business Owner,” AllBusiness.com, February 5, 2009, accessed February 6, 2012, www.allbusiness.com/company-activities-management/company-structures-ownership/11772426-1.html; “Small Business Bankruptcy…You Have Choices,” Daniel B. James Group, accessed February 6, 2012, www.small-business-bankruptcy.com.
Chapter 11 small business bankruptcy allows an owner to run a business with court oversight. The owner loses control of the firm, but it continues to operate. The owner is protected from creditors in the short term because the court orders an automatic stay that prevents the creditors from seizing your assets. Unfortunately, the outcome is not pleasant. The owner is out as manager, and the creditors end up owning the business. If the owner cannot pay the \$75,000+ in legal fees, the judge will probably order liquidation, so the result is the same as a Chapter 7.“Small Business Bankruptcy…You Have Choices,” Daniel B. James Group, accessed February 6, 2012, www.small-business-bankruptcy.com. This form of bankruptcy applies to sole proprietorships, corporations, and partnerships.Caron Beesley, “Bankruptcy Options for the Small Business Owner,” AllBusiness.com, February 5, 2009, www.allbusiness.com/company-activities-management/company-structures-ownership/11772426-1.html.
The amount that creditors can collect will depend on how a business is structured. If a business is a sole proprietorship, the owner’s personal assets may be used to pay off business debts, depending on the chosen bankruptcy option. If a business is a corporation, a limited liability company, or some form of a partnership, the owner’s personal assets are protected and cannot be used to pay off business debts.“Bankruptcy,” US Small Business Administration, accessed February 6, 2012, www.sba.gov/content/bankruptcy.
Alternatives to Bankruptcy
Instead of going the bankruptcy route, a small business owner could do the following things:“Small Business Bankruptcy…You Have Choices,” Daniel B. James Group, accessed February 6, 2012, www.small-business-bankruptcy.com.
• Negotiate debt. This involves trying to reorganize a business’s finances outside a legal proceeding. The owner can work with the creditors to renegotiate the terms of payment and the amount owed to each creditor. If a business is basically profitable but the debt situation is due to an unusual circumstance, such as a lawsuit or a temporary industry slowdown, this could be a successful solution.
• Improve operations. If the owner is in a position to fix the cash problem by fixing the underlying problems in the business, it may not be necessary to declare bankruptcy. An owner should look at cash-flow controls; eliminate unprofitable products, services, and divisions; and restructure into a leaner and meaner organization.
• Turn around and restructure the business. This alternative combines debt negotiation and operational improvement—perhaps the best choice. By doing both things at the same time, an owner will be in an even stronger position to improve the balance sheet, cash flow, and profitability—and avoid insolvency.
Taking a Company Public
An initial public offering (IPO) is a stock offering in which the owner or owners of equity in a formerly private company have their private holdings transferred into issues tradable in public markets, such as the New York Stock Exchange (NYSE).Timothy Faley, “Making Your Exit,” Inc., March 1, 2006, accessed February 6, 2012, www.inc.com/resources/startup/articles/20060301/tfaley.html. From the initial owners’ perspective, an IPO is often seen as liquidation, but it is also a money event for a company. For this reason, an IPO makes sense only if a small business can benefit from a substantial infusion of cash.Timothy Faley, “Making Your Exit,” Inc., March 1, 2006, accessed February 6, 2012, www.inc.com/resources/startup/articles/20060301/tfaley.html.
IPOs receive lots of press, even though they are really very rare. In a typical year, there may be 200 IPOs, perhaps even less. Consider the following data:“IPOs in 2011,” Upcoming-IPOs.com, August 23, 2011, accessed February 6, 2012, upcoming-ipos.com/ipos-in-2011; Trent Tillman, “2010 Year-End U.S. IPO Review and 2011 Outlook,” Syndicate Trader, March 4, 2011, accessed February 6, 2012, syndicatetrader.wordpress.com/2011/03/04/2010-year-end-u-s-ipo-review-and-2011 -outlook.
• 2008: 32 IPOs
• 2009: 63 IPOs
• 2010: 157 IPOs
• 2011: 159 IPOsDouglas W. Campbell, “2011 IPO Review & 2012 Outlook,” Triad Securities, January 6, 2012, accessed February 28, 2012, www.triadsecurities.com/ipo_review/20120106.
Why are the numbers so small?Andrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies-for-Small -Business-Owners-By-Andrew-Clarke. The IPO process is costly, labor intensive, and usually requires an up-front investment of more than \$100,000. Detailed reports are required on a business’s financials, staffing, marketing, operations, management, and so forth. Preparing these reports typically costs hundreds of thousands of dollars, sometimes millions, every year. The Sarbanes-Oxley Act alone, a product of the Enron scandal, costs even the smallest companies several hundred thousands of dollars in consulting fees. Lastly, many companies are not valued very highly on the stock market.
When thinking about an IPO, consider the following pros and cons:Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
• Pros
• The owner will be on the cover of Newsweek.
• The stock will be worth in the tens—or even hundreds—of millions of dollars.
• Venture capitalists will finally stop bugging the owner as they frantically try to ensure their shares will retain value.
• Cons
• Only a very few number of small businesses actually have this option available to them because there are so few IPOs in the United States each year.
• A business needs financial and accounting rigor from day one that is way beyond what many small business owners put in place.
• The owner will spend most of his or her time selling the company, not running it.
• Investment bankers take 6 percent off the top, and the transaction costs of an IPO can run into the millions.
Stever Robbins of Entrepreneur paints an amusing but very dismal picture of what is actually involved in an IPO.Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
You start by spending millions just preparing for the road show, where you grovel to convince investors your stock should be worth as much as possible…Unlike an acquisition, where you craft a good fit with a single suitor, here you are romancing hundreds of Wall Street analysts. If the romance fails, you’ve blown millions. And if you succeed, you end up married to the analysts. You call that a life?
Once public, you bow and scrape to the analysts. These earnest 28-year-olds—who haven’t produced anything of value since winning their fifth grade limerick contest—will study your every move, soberly declaring your utter incompetence at running the business you’ve built over decades. It’s one thing to receive this treatment from your loving spouse. It’s quite another to receive it from Smith Barney.
We won’t even talk about the need to conform to Sarbanes-Oxley, or the 6 percent underwriting fees you’ll pay to investment bankers, or lockout periods, or how markets can tank your wealth despite having a healthy business, or how IPO-raised funds distort your income statement, or…
In short, IPOs are not only rare, they’re a pain in the backside. They make the headlines in the very, very rare cases that they produce 20-year-old billionaires. But when you’re founding [and running] your company, consider them just one of many exit strategies. Realize that there are a lot of ways to skin a cat, and just as many ways to get value out of your company. Think ahead, surely, but do it with sanity and gravitas. And if you find yourself tempted to start looking for more office space in preparation for your IPO in 18 months, call me first. I’ll talk you down until the paramedic arrives.
For some small businesses, although not many, an IPO might make sense—and may even be necessary. For most, however, an IPO is clearly not a viable exit strategy.
Selling the Business
Another possible exit strategy is selling the business. Although the sale of a business is sometimes described as the end of entrepreneurship or as failure or defeat,J. G. Pellegrin, “Toward a Model of Making and Executing the Decision to Sell: An Exploratory Study of the Sale of Family Owned Companies” (PhD diss.), Lausanne Business School, Switzerland, 1999, as cited in Christian Niedermeyer, Peter Jaskiewicz, and Sabine B. Klein, “’Can’t Get to Satisfaction?’ Evaluating the Sale of the Family Business from the Family’s Perspective and Driving Implications for New Venture Activities,” Entrepreneurship & Regional Development 22, no. 3–4 (2010): 293–320. selling the business can also be a relief and the beginning of the next phase of the owner’s personal and professional life. As in the case of SoBe (highlighted at the beginning of this chapter), the owners sold the business because, among other things, it was becoming something they did not want it to be—and it was no longer fun. Whatever the reason, an owner can sell a business only once, so be sure that it is the right exit strategy. The owner should address the following questions:Barbara Taylor, “How to Sell Your Business,” New York Times, January 7, 2010, accessed February 6, 2012, www.nytimes.com/2010/01/07/business/smallbusiness/07guide.html; Anthony Tjan, “The Founder’s Dilemma: To Sell or Not to Sell?,” Harvard Business Review, February 18, 2011, accessed February 6, 2012, blogs.hbr.org/tjan/2011/02/the-founders-dilemma-to-sell-o.html.
1. Can the business be sold? There are many things that make a business attractive to buyers: a solid history of profitability, a large and loyal base of customers, a good reputation, a competitive advantage (e.g., intellectual property rights, patents, long-term contracts with clients, and exclusive distributorships), opportunities for growth, a desirable location, a skilled workforce, and a loyal workforce. If a business does not have at least some of these things or others of equal value, it will not likely generate much interest in the market.
2. Is the owner ready to sell or does the owner need to sell? Selling a business, when it is a choice, requires emotional and financial readiness. The owner must think about what life will be like after the business is sold. What will be a source of income? How will time be spent? Has the owner “sold out” or could more have been done with the business? Does the owner love what he or she is doing? Many small business owners suffer real remorse after handing their businesses over to a new owner. Selling the business because the owner is forced to will engender very different emotional and financial challenges.
3. What is the business worth? The owner may have no idea. For example, the owner of a small professional services firm felt the firm was worth more than \$1 million. After a lengthy search, however, the owner received less than one-half that amount from the buyer. On the other side of the coin, the owner of an information technology (IT) company planned to sell the company to an employee for \$200,000. However, after advertising the business for sale nationwide, the owner sold it for one dollar shy of \$1 million.
It is recommended that an owner start planning for a sale at least three to four years in advance. Sometimes, even five years is not long enough. It is very easy to become overly attached to a business, so it will be difficult to see how the business really looks to an outsider.Andrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies-for-Small -Business-Owners-By-Andrew-Clarke. Selling a business is an art and a science. If the asking price is too high, this may signal to potential buyers that the owner is not really interested in selling. Because there are several methods used to value a business, it is a good idea to hire a professional.Barbara Taylor, “How to Sell Your Business,” New York Times, January 7, 2010, accessed February 6, 2012, www.nytimes.com/2010/01/07/business/smallbusiness/07guide.html.
There are different ways to sell a business (see Figure 14.5 "Four Ways to Sell a Small Business"). Acquisition, friendly buyout, selling to the employees, and selling on the open market are discussed here. Be aware, however, that if a business is floundering and it is well known that the business is having major problems paying bills, vulture capitalists might start circling. A vulture capitalist is a venture capitalist who invests in floundering firms in the hope that they will turn around.“Vulture Capitalist,” Investopedia, accessed February 6, 2012, www.investopedia.com/terms/v/vulturecapitalist.asp; “Vulture Capitalist,” Urban Dictionary, November 12, 2009, accessed February 6, 2012, www.urbandictionary.com/define.php ?term=Vulture%20Capitalist. A venture capitalist is an investor who either provides capital to start-up ventures or supports small companies to expand but does not have access to public funding. Venture capitalists typically expect higher returns because they are taking additional risks.“Venture Capitalist,” Investopedia, accessed February 6, 2012, www.investopedia.com/terms/v/venturecapitalist.asp.
Figure 14.5 Four Ways to Sell a Small Business
Acquisition
When one business buys another business, as in the case of Pepsi buying SoBe, it is called an acquisition. Businesses buy other businesses for all kinds of reasons—for example, as a quick path to expansion or diversification or to get rid of the competition. When Pepsi was considering acquiring SoBe, their first thought was to kill the brand. But the bottlers convinced them otherwise, saying that it was a very strong brand.Interview with John Bello, cofounder of SoBe, August 23, 2011.
Acquisition is one of the most common exit strategies for a small business. One key to success is to target the potential acquirer(s) in advance, position the business accordingly, and convince the acquirer that the small business is worth the asking price.Susan Ward, “Exit Strategies for Your Small Business,” About.com, accessed February 6, 2012, sbinfocanada.about.com/od/businessplanning/a/exitstrategies.htm. Another way to become the target of an acquisition is to be successful in the marketplace. This happened with SoBe. Coca-Cola, Pepsi, Arizona, and Campbell’s all expressed an interest after SoBe became a national brand. Pepsi ended up being the acquirer in the end.Interview with John Bello, cofounder of SoBe, August 23, 2011.
In an acquisition, the owner negotiates the price—a good thing because public markets value a business relative to its industry, which limits the value of a business. In an acquisition, however, there is no limit on the perceived value of a company. Why? The person making the acquisition decision is rarely the owner of the acquiring company, so there is no problem with the checkbook. It is someone else’s money.
When thinking about an acquisition, consider the following pros and cons:
• Pros Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
• If a business has strategic value to an acquirer, it may pay far more than the business is worth to anyone else.
• If multiple acquirers are in a bidding war, the owner can raise the price “to the stratosphere.”
• Cons Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
• If the owner organizes the business around a specific acquirer, the business may be unattractive to other buyers.
• Acquisitions are messy and often difficult when cultures and systems clash in the merged company. Although not a small business example, the Warner-AOL combination was a failure largely due to a major culture clash.
• Acquisitions are frequently accompanied by noncompete agreements and other strings that, while making the owner rich, can make life unpleasant for a while. Noncompete agreements are enforceable, but their enforcement depends on the applicable facts and circumstances—including which state’s law governs. George W. Keeley, “Non-Compete Agreements: Are They Enforceable?,” KK&R, accessed February 29, 2012, www.kkrlaw.com/articles/noncomp.htm.
Friendly Buyout
A friendly buyout occurs when ownership is transferred to family members, customers, employees, current managers, children, or friends. It is still considered selling the business, but the terms and nature of the transaction are usually very different. No matter who the “friendly” buyer may be, figure on starting to plan early—and engage a professional before, during, and after the sale.Andrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies-for-Small -Business-Owners-By-Andrew-Clarke; Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
When thinking about friendly buyout, consider the following pros and cons:
• ProsAndrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies -for-Small-Business-Owners-By-Andrew-Clarke; Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
• The owner knows much more about the buyer, and the buyer knows the owner. There is less due diligence required.
• The buyer will most likely preserve what is important about the business.
• If management buys the business, it has a commitment to make it work.
• ConsAndrew Clarke, “Exit Strategies for Small Business Owners,” Experts.com, 2006, accessed February 6, 2012, www.experts.com/Articles/Exit-Strategies-for -Small-Business-Owners-By-Andrew-Clarke; Stever Robbins, “Exit Strategies for Your Business,” Entrepreneur, June 27, 2005, accessed February 6, 2012, www.entrepreneur.com/article/78512.
• The owner will be less objective about the buyer and more likely to let his or her guard down in negotiations and planning. The owner leaves too much money on the table.
• If the owner sells to a friend, the friend will be less than thrilled when discovering, for example, decades’ worth of unpaid taxes.
• Selling to family can tear a company apart with jealousies and promotions that put emotion ahead of business needs.
Selling to Employees
Selling the business to employees and/or managers is another option to consider. “Arranging an employee buyout can be a win-win situation as they get an established business they know a great deal about already and you get enthusiastic buyers that want to see your business continue to thrive.”Susan Ward, “Exit Strategies for Your Small Business,” About.com, accessed February 6, 2012, sbinfocanada.about.com/od/businessplanning/a/exitstrategies.htm. The owner can accomplish this process by setting up an employee stock option plan (ESOP), a stock equity plan that lets employees buy ownership in the business. However, because the owner is giving control of the business to the employees, a transition plan is critical to make sure that they are ready to carry on the business after the owner leaves. It is a good idea to hire an ESOP specialist. Keep in mind, though, that only corporations are eligible to form an ESOP. An ESOP is expensive to set up and maintain, so this might not be the best choice.Monica Mehta, “Alternative Exits for Business Owners,” Bloomberg BusinessWeek, July 27, 2010, accessed February 6, 2012, www.BusinessWeek.com/smallbiz/content/jul2010/sb20100727_564778.htm.
If an ESOP is not appealing or the business is not eligible to have an ESOP, selling the business could be as simple as having a current employee take it over. The owner could also consider a worker-owned cooperative, in which interested employees become members of a cooperative that buys the business.Barbara Taylor, “A Creative Way to Sell Your Business,” New York Times, October 29, 2010, accessed February 6, 2012, boss.blogs.nytimes.com/2010/10/29/a -creative-way-to-sell-your-business. In the case of Select Machine of Brimfield, Ohio, “[the owners] sold 30 percent of their stock to the co-op in the first of several installments. The co-op took out loans in the amount of \$324,000, which were personally guaranteed by the sellers. The loans were paid off out of company profits over three years; subsequent installments have been owner-financed. Today the co-op owns 59 percent of the company’s stock, and sale of an additional 10 percent is now on the table.”Barbara Taylor, “A Creative Way to Sell Your Business,” New York Times, October 29, 2010, accessed February 6, 2012, boss.blogs.nytimes.com/2010/10/29/a -creative-way-to-sell-your-business.
For a worker-owned cooperative to work, the business owner(s) must be totally committed to the sale of the business to the employees. It is a good option if the business is small (fewer than twenty-five employees), profitable, relatively debt free, already has a culture of participatory management, and the owners are willing to stay on throughout the transition.Barbara Taylor, “A Creative Way to Sell Your Business,” New York Times, October 29, 2010, accessed February 6, 2012, boss.blogs.nytimes.com/2010/10/29/a -creative-way-to-sell-your-business.
Selling on the Open Market
Selling a business on the open market is the most popular exit strategy for small businesses.Susan Ward, “Exit Strategies for Your Small Business,” About.com, accessed February 6, 2012, sbinfocanada.about.com/od/businessplanning/a/exitstrategies.htm. Unfortunately, it has been estimated that 75 percent of US businesses do not sell, Harvey Zemmel, “Top 7 Ways to Maximize Your Exit Strategy for Maximum Profit,” About.com, accessed February 6, 2012, sbinfocanada.about.com/od/sellingabusiness/a/exitstrategyhz.htm. so if this is how the owner wants to sell the business, it must be marketed in a way that maximizes its value in the eyes of a potential buyer.
An owner also needs to spread the word. Most savvy business buyers use the Internet to research available businesses for sale, so post the sale notice on the two largest websites:Barbara Taylor, “A Creative Way to Sell Your Business,” New York Times, October 29, 2010, accessed February 6, 2012, boss.blogs.nytimes.com/2010/10/29/a-creative-way-to-sell-your-business. BizBuySell.com, self-described as the “Internet’s Largest Business for Sale Marketplace,” and BizQuest.com, self-described as the “Original Business for Sale Website.”
KEY TAKEAWAYS
• The most emotional topic an owner will face when building a business—and the hardest decision he or she will probably have to make—is when and how to exit.
• An exit strategy should be planned while running the business. Unfortunately, many small businesses do not have an exit plan.
• There are many exit strategies that a small business owner can consider, including liquidation or walkaway, family succession, selling the business, bankruptcy, and taking a company public.
• The best exit strategy is the one that best matches the small business and the owner’s personal and professional goals.
• Liquidation is the selling of all assets. If all debts are paid, it can also be referred to as a walkaway. Walking away is the cleanest and best way to exit a business.
• Family succession is the transference of leadership from one generation to the next to ensure continuity of family ownership in the business. It is a critical issue in family businesses because few family firms survive beyond the first generation and even fewer survive into the third generation.
• The failure to plan for succession is seen as a basic human resource problem as well as the primary cause for the poor survival rate of family businesses.
• Bankruptcy is an extreme exit strategy that uses a legal method for closing a business and paying off creditors when a business is failing and the debts are substantially greater than the assets.
• Debt negotiations, operational improvements, or business turnaround and restructuring are alternatives to bankruptcy.
• An IPO is a stock offering in which the owner or owners of equity in a business have their private holdings transferred into issues tradable in public markets, such as the NYSE.
• There are several options for selling a business: acquisition, friendly buyout, selling to the employees, and selling in the open market.
• An acquisition is when another business buys a business. In an acquisition, there is no limit on the perceived value of the business.
• A friendly buyout is the transfer of ownership to family members, customers, employees, current managers, children, or friends—but it is still a sale.
• Selling to the employees can be a win-win situation because they get an established business that they know a great deal about already, and the owner gets enthusiastic buyers who want to see a business continue to thrive.
• Selling in the open market is the most popular exit strategy for small businesses.
• It has been estimated that 75 percent of small businesses do not sell, so a business must market in a way that maximizes its value in the eyes of the potential buyer.
EXERCISE
1. Two executives of a regional food company are regular customers and big fans of Frank’s All-American BarBeQue. They recently learned that Frank has been selling his sauces in local grocery stores and have been a big hit. The executives bought jars of each flavor, took them back to their company, and talked to the people who would decide about adding products to their line. Everyone loved the sauces, and there was definite interest in acquiring the sauce-making side of Frank’s business. It would fill a hole in their product line that they had been looking to fill.
The company contacted Frank about its interest, and Frank—with some urging from his son, Robert—is thinking about it. It would provide Frank with a nice retirement (when he decides to do that), money for his son and daughter, and a legacy. How should Frank proceed? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/14%3A_Icebergs_and_Escapes/14.05%3A_Exit_Strategies.txt |
Center Rock Inc.
Source: Reprinted with permission from Center Rock, Inc.
Brandon Fisher, the founder of Center Rock Inc., is shown on the left side in the picture The man to his right is Richard Soppe, the senior drilling application engineer. The number 33 is the number of Chilean miners who were rescued in 2010. Brandon and his company, now at seventy-five employees, are true American heroes.
Center Rock manufactures and distributes a complete line of air drilling tools and products. At its state-of-the-art manufacturing facility in Pennsylvania, they build stock and made-to-order products that are used by leading drilling, oil and gas, foundation, construction, roadway, and mining contractors across North America, Europe, Asia, Russia, and Australia. Fisher entered the global market four years ago as a way to expand the business. He was able to finance the expansion internally, so financing was not an issue.
Center Rock Inc., founded in 1998 by then twenty-six-year-old Brandon Fisher, began as a drilling company. He designed and built his own horizontal drilling rig and, shortly thereafter, began focusing on making Center Rock an air and rock drilling supplier and manufacturer. He recognized the need for a manufacturing company that was reactive to customer needs, with innovative products and 24/7 customer service and support. Working with his high-tech engineering and design team, Fisher created a company different from its competitors with its unique products and service capabilities.
“I love what I do,” says Fisher. “There is always a challenge in this industry to find new ways to drill into the earth, and the challenge feeds the excitement.”“About Us,” Center Rock Inc., accessed February 7, 2012, www.centerrock.com/content/about-us; e-mail correspondence with Brandon Fisher, July 28, 2011.
15.02: US Small Business in the Global Environment
Learning Objectives
1. Understand and appreciate the role of small businesses in the global environment.
2. Learn about the global growth opportunities for small businesses.
3. Understand the advantages and the disadvantages of a small business going global.
Although small businesses make up a disproportionately large share of the number of companies that export and import, this represents only about 1 percent of the total number of small businesses. Thus many small businesses have yet to compete globally. The opportunities are there. “So much of what America makes is in great demand,” said US Commerce Secretary Gary Locke in an interview, adding further that the growth potential for small companies is outside the United States. Dale Hayes, vice president of US marketing for UPS concurs, observing that the demand for high-quality American products is huge.Paul Davidson, “Small Businesses Look Across Borders to Add Markets,” USA Today, April 12, 2011, accessed February 7, 2012, www.usatoday.com/money/economy/2011-04-06-small-businesses-go-international.htm; Rieva Lesonsky, “Increased Opportunities for Small-Business Exports,” Small Business Trends, June 27, 2010, accessed February 7, 2012, smallbiztrends.com/2010/06/opportunities-small-business -exports.html. It may be that a small business is already competing globally because foreign-owned companies are competing in our own backyards.“Breaking into the Trade Game: A Small Business Guide to Exporting,” US Small Business Administration, 2005, accessed February 7, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_entire.pdf.
Yet the global marketplace is not relevant to most small businesses. Given that 99 percent of the small businesses in the United States are not operating globally—preferring to grow (if they want to) locally, regionally, and perhaps nationally—it is reasonable to conclude that going global will interest only a few. Those few, however, must undertake careful analyses before jumping into the global arena.
The Small Business Global Presence
It may seem to many that the global market is the domain of the large corporations, but the statistics tell a very different story. Small businesses actually account for close to 97.6 percent of US exporters and 32.8 percent of the value of US exports as well as 97.1 percent of all identified importers and 31.9 percent of the known import value.“Profile of U.S. Importing and Exporting Companies, 2008–2009 Highlights,” US Census Bureau, April 12, 2011, accessed February 7, 2012, www.census.gov/foreign-trade/Press-Release/edb/2009/2009Highlights.pdf. Consider the following additional facts:“Profile of U.S. Importing and Exporting Companies, 2008–2009 Highlights,” US Census Bureau, April 12, 2011, accessed February 7, 2012, www.census.gov/foreign-trade/Press-Release/edb/2009/2009Highlights.pdf.
• Small businesses account for 96.4 percent of all manufacturing exporters, which is 17.2 percent of the sector’s \$562 billion in exports.
• Nearly 100 percent (99.2 percent) of exporting wholesalers were small businesses, which is 61.1 percent of the sector’s \$218 billion in exports.
• Of other companies with exports, 96.9 percent were small businesses. These companies include manufacturing companies of prepackaged software and books, freight forwarders and other transportation service firms, business services, engineering and management services, gas and oil extraction companies, coal mining companies, and communication services, to name a few.
• Small businesses account for 93.6 percent of all manufacturing importers, which is 12.9 percent of the sector’s \$602 billion in imports.
• Nearly 100 percent (99.2 percent) of wholesaler importers were small businesses, contributing 56.8 percent of the sector’s \$451 billion in imports.
• Small businesses accounted for 94.3 percent of the companies that both exported and imported, accounting for 29 percent of the export value and 27 percent of the import value.
This tells us that small businesses are very active in the global marketplace, and small business success in international markets is extremely important to the welfare of the United States.“Breaking into the Trade Game: A Small Business Guide to Exporting,” US Small Business Administration, 2005, accessed February 7, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_entire.pdf. Although it is true that small businesses are major users of imported goods, the focus of this chapter is on small business exporting because exporting can be an effective way to diversify the customer base, manage market fluctuations, grow, and become more competitive.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), i.
Small businesses are limited in the products and the services that they export. Small business exports are concentrated in four main product categories: computers and electronic products, chemicals, machinery, and transportation equipment. However, the leading product categories in terms of market share were wood products, apparel and accessories, tobacco products, beverages, and leather products.“Small and Medium-Sized Enterprises: Overview of Participation in U.S. Exports,” US International Trade Commission, January 2010, accessed February 7, 2012, www.usitc.gov/publications/332/pub4125.pdf.
Although the United States is one of the world’s largest participants in global services trade, very little information exists with respect to services exports by small businesses. What is known is that it is increasingly common for most US services firms to establish a foreign affiliate—a branch or a subsidiary of the parent company established outside the national boundaries of the parent company’s home market—because most services are better supplied in close proximity to the principal or final customers.“Small and Medium-Sized Enterprises: Overview of Participation in U.S. Exports,” US International Trade Commission, January 2010, accessed February 7, 2012, www.usitc.gov/publications/332/pub4125.pdf. Additionally, in some business sectors, foreign regulations may restrict the delivery of some services to affiliates only. For example, to comply with domestic solvency requirements, some countries require that personal lines of insurance be carried out only by affiliates. Another example is the protection of intellectual property rights. This is often accomplished through the services of affiliates, thus intellectual property is kept in-house.“Small and Medium-Sized Enterprises: Overview of Participation in U.S. Exports,” US International Trade Commission, January 2010, accessed February 7, 2012, www.usitc.gov/publications/332/pub4125.pdf.
What is particularly interesting is that most of the service exporting occurs in businesses with 0–19 employees, with the least service exporting done by small businesses with 300–499 employees. This may be the exact opposite of what you would expect.
The Advantages of Going Global
The flexibility of a smaller company may make it possible to meet the demands of global markets and redefine a company’s programs more quickly than might occur in the larger multinational corporation.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 312. A multinational corporation is a company that operates on a worldwide scale without ties to any specific nation or region; it is organized under the laws of its own country.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2007), 94. This flexibility of the smaller company is particularly true of the micromultinationals, a relatively new category of tiny companies that operate globally, having a presence and people in multiple countries.Anita Campbell, “The Trend of the Micro-Multinationals,” Small Business Trends, February 20, 2007, accessed February 7, 2012, smallbiztrends.com/2007/02/the-trend-of-the-micro-multinationals.html; Bernard Lunn, “Introducing the Tales of Micro-Nationals,” Small Business Trends, July 7, 2010, accessed February 7, 2012, smallbiztrends.com/2010/07/introducing-the-tales-of-micro-multinationals.html.
These micromultinationals outsource virtually everything to specialists all over the world and sell to people all over the world through the Internet.Bernard Lunn, “Introducing the Tales of Micro-Nationals,” Small Business Trends, July 7, 2010, accessed February 7, 2012, smallbiztrends.com/2010/07/introducing -the-tales-of-micro-multinationals.html. The Internet is inexpensive technology, and the services designed to help small businesses make it possible for the small company to operate across borders with the same effectiveness and efficiencies as large businesses.Anita Campbell, “Preparing Your Business to Go Global,” Small Business Trends, November 19, 2010, accessed February 7, 2012, smallbiztrends.com/2010/11/preparing-your-business-to-go-global.html.
Micromultinationals
Generation Alliance is a branding and design firm that provides services to clients all over the world. They have core employees in Australia and specialist contractors in New Zealand, the United Kingdom, Germany, Switzerland, Jamaica, Dubai, and Singapore. One of their more interesting projects was to rebrand the country of Botswana for the global market.Bernard Lunn, “Tales of Micro-Multinationals: Generation Alliance,” Small Business Trends, July 7, 2010, accessed February 7, 2012, smallbiztrends.com/2010/07/tales-of-micro-multinationals-generation-alliance.html.
Jadience sells a line of health and skincare products that has its roots in traditional oriental medicine. Their physical products are sent to customers, mostly spas, in the United States, Canada, and Mexico.Bernard Lunn, “Tales of Micro-Multinationals: Jadience,” Small Business Trends, July 15, 2010, accessed February 7, 2012, smallbiztrends.com/2010/07/tales -of-micro-multinationals-jadience.html.
Worketc operates in the large and competitive business software market. Their focus is small businesses, selling web-based customer relationship management (CRM), project management, billing, shared calendars, help desk, and document management software. The company is headquartered in Sydney, Australia, and it claims happy customers in sixteen countries. The United States accounts for 86 percent of its customers.Bernard Lunn, “Tales of Micro-Multinationals: Worketc,” Small Business Trends, July 21, 2010, accessed February 7, 2012, smallbiztrends.com/2010/07/micro -multinationals-worketc.html; “The Why of What We’re About,” Worketc, accessed February 7, 2012, www.worketc.com/about_us.
There are many reasons why small businesses should consider going global:“Benefits of Exporting,” Export.gov, March 31, 2011, accessed February 7, 2012, export.gov/about/eg_main_016807.asp; Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding -your-business.html; Steve Strauss, “Globalization Is Good for (Small) Business,” USA Today, May 17, 2004, accessed February 7, 2012, www.usatoday.com/money/smallbusiness/columnist/strauss/2004-05-17-globalization_x.htm; “Breaking into the Trade Game: A Small Business Guide to Exporting,” US Small Business Administration, 2005, accessed February 7, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_entire.pdf.
• A small business that thinks and sells only domestically may be reaching only a small share of its potential customers because 95 percent of the world’s consumers live outside the United States.
• Exporting enables companies to diversify their portfolios and weather changes in the domestic economy. This stabilizes seasonal and cyclical market fluctuations.
• Exporting helps small businesses grow and become more competitive in all their markets, which reduces the dependence on existing markets.
• Exporting increases sales and profits, also extending the sales potential of existing products. Research has shown that exporting can expand total sales 0.6 percent to 1.3 percent faster than would otherwise be the case.
• Exporting companies are able to sell excess production capacity.
• Exporting companies are nearly 8.5 percent less likely to go out of business.
• There are higher worker earnings as well, which contributes to the betterment of the community.
According to the US Small Business Administration (SBA),“Breaking into the Trade Game: A Small Business Guide to Exporting,” US Small Business Administration, 2005, accessed February 7, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_entire.pdf. US exporting businesses experience faster annual employment growth by 2 to 4 percentage points over their nonexporting counterparts. Workers employed in exporting companies have better paying jobs and better opportunities for advancement. Research has estimated that blue-collar worker earnings in firms that export are 13 percent higher than those in nonexporting plants, 23 percent higher when comparing large plants, and 9 percent higher when comparing small plants. White-collar employees also benefit from higher salaries, 18 percent more than their nonexporting counterparts. Less skilled workers also earn more at companies that export. Lastly, the benefits that all workers receive at exporting plants are 37 percent higher and include improved medical insurance and paid leave.
Video Link 15.1
Why Export?
Why small businesses should consider entering the global marketplace.
www.inc.com/exporting/whyexport.htm
The Disadvantages of Going Global
There is no question that the benefits of going global are considerable. However, disadvantages or barriers must also be considered. For example, a small business will incur additional costs, such as modifying its product or its packaging (perhaps even changing the name of its product so that it does not convey negative meanings outside the United States), developing new promotional materials, administrative costs (such as hiring staff to launch the export expansion and dedicating personnel for traveling), traveling to foreign locations (very important), and shipping.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html; Strategic Name Development, Inc., “Global Linguistic Analysis” (2011), accessed February 7, 2012, www.namedevelopment.com/global-linguistic-analysis.html. It may also be necessary for the owner to subordinate short-term profits to long-term gains, wait longer for payments, apply for additional financing, and obtain special export licenses.“Breaking into the Trade Game: A Small Business Guide to Exporting,” US Small Business Administration, 2005, accessed February 7, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_entire.pdf. There will be differences in consumer needs, wants, and usage patterns for products; differences in consumer response to the elements of the marketing mix and differences in the legal environment may conflict with those of the United States.“Global Marketing,” SmallBusiness.com, accessed February 7, 2012, smallbusiness.com/wiki/Global_marketing. Then, of course, there are cultural and language issues along with the all-too-familiar fear of the unknown.Rieva Lesonsky, “Increased Opportunities for Small-Business Exports,” Small Business Trends, June 27, 2010, accessed February 7, 2012, smallbiztrends.com/2010/06/opportunities-small-business-exports.html. A recent survey of exporting and nonexporting members of the National Small Business Association (NSBA) and the Small Business Exporters Association (SBEA) reported the following main barriers to small businesses selling their goods and/or services to foreign customers:“2010 Small Business Exporting Survey,” NSBA and SBEA, March 11, 2010, accessed February 7, 2012, www.nsba.biz/docs/2010_small_business_exporting_survey _001.pdf.
• I do not have goods and/or services that are exportable: 49 percent.
• I do not know much about it and am not sure where to start: 38 percent.
• I would worry too much about getting paid: 29 percent.
• It is too costly: 27 percent.
• It would take too much time away from my regular, domestic sales: 17 percent.
• I cannot obtain financing to offer products or services to foreign customers: 7 percent.
Three things were identified as the single largest challenge: worrying about getting paid (26 percent), feeling that exporting is confusing and difficult to do (24 percent), and having limited goods and/or services that are exportable (18 percent).
Richard Ginsburg in the SBA’s Office of International Trade has commented that most US small businesses simply do not understand the value of taking their business global, further noting that “the number-one barrier to trade is the psychological acceptance that global business is necessary.”Kevin Morris, “Small Business Owner Takes His Green Energy Business Global,” AllBusiness.com, April 22, 2011, accessed February 7, 2012, www.allbusiness.com/small-green-energy-business/15572754-1.html.
Small businesses also face some resource constraints that reduce their ability to export. For example, small businesses are more likely than larger firms to face scarcities of financial and human resources that limit their ability to take advantage of global opportunities. Limited personnel, the inability to meet quality standards, the lack of financial backing, and insufficient knowledge of foreign markets are important constraints affecting the ability of small businesses to export.“Breaking into the Trade Game: A Small Business Guide to Exporting,” US Small Business Administration, 2005, accessed February 7, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_entire.pdf. Fortunately, being proactive, innovative, and willing to take risks have helped small businesses overcome export impediments and improve export performance.“Breaking into the Trade Game: A Small Business Guide to Exporting,” US Small Business Administration, 2005, accessed February 7, 2012, archive.sba.gov/idc/groups/public/documents/sba_homepage/serv_entire.pdf.
The disadvantages of going global may warrant a go-slow approach, but they should not be viewed as knockout factors. If a business’s financial situation is weak, the timing may not be right for becoming an exporter…but perhaps exporting makes sense in the future. In any case, very careful thinking should precede the decision to export.
2010 Winner of the Growth through Global Trade Award
Source: SteelMaster Buildings. Reprinted with permission.
The UPS Growth through Global Trade Award recognizes businesses with fewer than five hundred employees that are excelling in international trade. The inaugural winner was SteelMaster Buildings LLC, in Virginia Beach, Virginia, a manufacturer, designer, and supplier. The UPS award was followed up by two other national awards and four regional awards related to SteelMaster’s increases in global trade plus a mention in a September 2010 speech by the former US Secretary of Commerce, Gary Locke, at a trade conference. The company earned first place in the 2011 Export Video Contest cosponsored by the SBA and VISA.
Building Beyond Our Borders
(click to see video)
Video contest winning entry.
SBA Exporting Video Contest
(click to see video)
Video contest finalist entries.
SteelMaster employs fifty people, excluding distributors. It exports to more than forty countries and has distributorship relationships in more than fifty international markets (e.g., South Korea, Romania, Mexico, Angola, Chile, Peru, Slovakia, South Sudan, and Australia). This distributor network has provided an important source of market differentiation. Since the company began exporting in 2006, in response to the very competitive and saturated US market, the company’s revenue has quadrupled, and exporting now represents over 20 percent of its total revenue. In addition,
• The SteelMaster website is user-friendly and offers a bilingual choice for Spanish-speaking viewers. Live chat is also available. In addition, various parts of the website have been translated to other languages (i.e., Korean, French, Romanian, Portuguese, and Arabic) to serve the company’s international customers in their own languages.
• SteelMaster buildings are environmentally friendly and can be recycled. Green buildings are offered that protect against nonuniform weathering and reduce energy loads on buildings due to a long-term, bright service that helps heat reflectivity.
• SteelMaster’s Galvalume Plus coated steel has been approved by the ENERGY STAR program for both low-slope and high-slope applications.
• The SteelMaster product can be easily used in the wake of natural disasters, such as earthquakes, flooding, or hurricanes. The company has participated in humanitarian relief efforts, specifically in Haiti.Shannon Coursey, “Has Your Small Business Taken Big Steps to Grow Globally?,” UPS Upside, January 10, 2011, accessed February 7, 2012, blog.ups.com/2011/01/10/has-your-small-business-taken-big-steps-to-grow-globally/; Laurel Delaney, “And the Winner for the Growth through Global Trade Award Goes To…,” The Global Small Business Blog, January 24, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/and-winner-for-growth-through-global.html; interview with Michelle Wickum, director of marketing, SteelMaster Buildings, January 5, 2012; SteelMaster company materials provided by Michelle Wickum, Director of Marketing, January 5, 2012. The company stands ready to provide safe and reliable construction solutions to people in need around the world.
KEY TAKEAWAYS
• Small businesses make up a disproportionately large share of the number of companies that export and import. However, this is only about 1 percent of the total number of small businesses.
• The growth potential for small companies outside the United States is huge because of the demand for high-quality American products.
• Small businesses account for close to 98 percent of US exporters and 33 percent of the value of US exports.
• Small business success in international trade is extremely important to the welfare of the United States.
• There are many advantages and disadvantages of a small business going global. These must be analyzed very carefully before deciding to enter the global marketplace.
• A recent survey of small business owners revealed that the number one barrier to exporting was the feeling that their businesses did not have exportable goods and/or services. The number one challenge was worrying about getting paid.
EXERCISE
1. Go to www.trade.gov/mas/ian/statereports. Select your state and prepare a profile of small business exporting. Review additional sites as well, for example, websites sponsored by your state’s commerce and/or economic development departments. When looking at government sites, you may see the term small- and medium-sized businesses or something similar. They are simply referring to businesses with fewer than five hundred employees. This is the small business group for your purposes. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/15%3A_Going_Global_-_Yes_or_No/15.01%3A_Chapter_Introduction.txt |
Learning Objectives
1. Learn about the different ways that a business can export.
2. Understand the importance of an industry analysis.
3. Understand that it is important to carefully assess a business.
4. Learn about the marketing decisions that must be made.
5. Learn about the kinds of legal and political issues that will affect the exporting activities of a business.
6. Understand why the currency exchange rate is important to determining price.
7. Learn about the different sources of financing.
Although expanding into global markets offers many important benefits, not the least of which is increased profits, it will also introduce new complexities into the operations of a small business. There are several key decisions (see Figure 15.1 "Factors Affecting the Decision to Go Global") that will need to be made, including the following:Adapted from David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 121.
• Determine which foreign market(s) to enter.
• Analyze the expenditures required to enter a new market and determine the source(s) of financing.
• Determine the best way to organize the overseas operation in concert with the US organization.
• Determine the extent to which, if any, the marketing mix will need to be adapted to the needs of the foreign market(s).
• Figure out the best way for the business to get paid.
These decisions, and others, will be based on an assessment of the ways to export, an analysis of the industry and the business, marketing and cultural factors, legal and political conditions, currency exchange issues, and sources of financing.
Video Link 15.2
A Family Business Goes Global
A small business specializing in leather-care products gets a lesson in expanding beyond its old fashioned clientele.
money.cnn.com/video/fsb/2008/09/10/fsb.pecard.makeover.fsb
Figure 15.1 Factors Affecting the Decision to Go Global
Ways to Export
Small businesses can choose from two basic ways to export: directly or indirectly.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html. There are advantages and disadvantages of each that should be understood before making a choice.
Direct Exporting
In direct exporting, a small business exports directly to a customer who is interested in buying a particular product. The small business owner makes all the arrangements for shipping and distributing the product overseas, is responsible for the marketing research, and collects payment. This approach gives the owner greater control over the entire transaction and entitles him or her to higher profits—although these higher profits are accompanied by the need to invest significantly more resources and efforts (see Table 15.1 "Advantages and Disadvantages of Direct Exporting"). It also requires a significantly changed internal organizational structure, which entails more risk.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html; Laurel Delaney, “Direct Exporting: Advantages and Disadvantages to Direct Exporting,” About.com, accessed February 7, 2012, importexport.about.com/od/DevelopingSalesAndDistribution/a/Direct-Exporting-Advantages-And -Disadvantages-To-Direct-Exporting.htm; “The Advantages of Direct Exporting,” vcShipping.com, accessed February 7, 2012, www.vcshipping.com/export/the-advantages-of-direct-exporting.html.
Table 15.1 Advantages and Disadvantages of Direct Exporting
Advantages Disadvantages
Potential profits are greater because intermediaries are eliminated. It takes more time, energy, and money than an owner may be able to afford.
The owner has a greater degree of control over all aspects of the transaction. It requires more “people power” to cultivate a customer base.
The owner knows customers, and the customers know the owner. Customers feel more secure in doing business directly with the owner. Servicing the business will demand more responsibility from every level in the organization. The owner is held accountable for whatever happens. There is no buffer zone.
Business trips are much more efficient and effective because an owner can meet directly with the customer responsible for selling the product. The owner may not be able to respond to customer communications as quickly as a local agent can.
The owner knows whom to contact if something is not working. The owner gets slightly better protection for trademarks, patents, and copyrights. The owner must handle all the logistics of the transaction. If it is a technological product, the owner must be prepared to respond to technical questions and provide on-site start-up training and ongoing support services.
The owner is presented as fully committed and engaged in the export process and develops a better understanding of the marketplace. As a business develops in the foreign market, the owner has greater flexibility to improve or redirect marketing efforts.
Source: Laurel Delaney, “Direct Exporting: Advantages and Disadvantages to Direct Exporting,” About.com, accessed February 7, 2012, http://importexport.about.com/od/Dev...-Exporting.htm.
Indirect Exporting
Indirect exporting involves entering “into an agreement with an agent, distributor, or a traditional exporting house for the purpose of selling (or marketing and selling) the products in the target market.”Team Canada Inc., “10 Steps to Successful Exporting,” About.com, accessed February 7, 2012, sbinfocanada.about.com/od/canadaexport/a/10exportsteps.htm. Many small businesses choose this option, at least at the outset. It is the simplest approach, particularly when a business does not have the necessary human and financial resources to promote products in foreign markets in any other way (see Table 15.2 "Advantages and Disadvantages of Indirect Exporting").CBS Investment, “Advantages and Disadvantages of Direct and Indirect Exports,” CBS Investment, accessed February 7, 2012, www.cbsinvestment.com/advantages-and-disadvantages-of-direct-and-indirect-exports/; Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html. The easiest way to export indirectly is to sell to an intermediary in the United States because the business will normally not be responsible for collecting payment from the overseas customer or coordinating the shipping logistics.Laurel Delaney, Start and Run a Profitable Exporting Business (Vancouver, BC: Self-Counsel Press, 1998): chapter 8.
Table 15.2 Advantages and Disadvantages of Indirect Exporting
Advantages Disadvantages
Does not require a lot of organizational effort or staff workers. Not all types of goods lend themselves to indirect exporting (e.g., technically complex goods and services).
The producer of the goods is subject to only small dangers and risk (e.g., a short-term drop in the exchange rate). The profits of a business will be lower, and control over foreign sales is lost.
It is an almost risk-free way to begin. It demands minimal involvement in the export process. It allows the owner to continue to concentrate on its domestic business. A business very rarely knows who its customers are, thus losing the opportunity to tailor its offerings to their evolving needs.
The business has limited liability for product marketing problems. There is always someone else at which to point the finger. When an owner visits, he or she is a step removed from the actual transaction and feels out of the loop.
The owner learns on the fly about international marketing. Depending on the type of intermediary with which the owner is dealing, the owner does not have to be concerned with shipment and other logistics. The intermediary might be offering products similar to a particular business’s products, including directly competitive products, to the same customers instead of providing exclusive representation.
A business can field-test its products for export potential. In some instances, the local agent can field technical questions and provide necessary product support. The long-term outlook and goals for an export program can change rapidly, and if a business has put its product in someone else’s hands, it is hard to redirect efforts accordingly.
Source: CBS Investment, “Advantages and Disadvantages of Direct and Indirect Exports,” CBS Investment, accessed February 7, 2012, http://www.cbsinvestment.com/advanta...irect-exports/; Laurel Delaney, Start and Run a Profitable Exporting Business (Vancouver, BC: Self-Counsel Press, 1998), chapter 8.
Industry Analysis
Before jumping into the global pond, it is a good idea to identify where an industry currently is and then look at the trends and directions that are predicted over the next three years. This will be true whether a business is only on the ground, only online, or both brick and click.
A business should try to determine how competitive an industry is in the global market.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html. Try to get as good a picture of the market as possible because the better informed a business is, the better its chances of a successful global entry. Learn a product’s potential in a given market, where the best prospects for success seem to be, and common business practices.“6 Steps to Begin Exporting,” US Small Business Administration, accessed February 7, 2012, www.sba.gov/content/6-steps-begin-exporting.
A small business owner may be reticent about conducting market research before going global, particularly if domestic research efforts have been limited or nonexistent. However, the global market is a very different animal compared to the domestic market. It is even more important to conduct thorough market research to help identify possible risks in advance so that the appropriate steps can be taken to avoid mistakes. This ultimately portrays the business as forward-thinking, trustworthy, and credible.Tricia Phillips, “Biz Bureau Gives Top Tips on Going Global with Your Business,” Mirror, January 26, 2011, accessed February 7, 2012, www.mirror.co.uk/advice/money/2011/01/26/biz-bureau-gives-top-tips-on-going-global-with-your-business-115875 -22875517.
• Several resources should be consulted. However, the best guide to exporting for the small business comes from the US government.“A Small Business Guide to Exporting: Part 1—Getting Started,” AllBusiness.com, accessed February 7, 2012, www.allbusiness.com/economy-economic-indicators/money-currencies/11790828-1.html.
• The SBA is a great place to start to find information to help a business break into the global game. The information on exporting and importing is comprehensive and easily understood.
• The US government portal Export.gov provides online trade resources and one-on-one assistance for global businesses. Export.gov provides particularly helpful information on regulations, licenses, and trade data and analysis. Trade data can help a business identify the best countries to target for exports. A business can gauge the size of the market for a product or a service and develop a pricing strategy to become competitive.“Trade Data and Analysis,” Export.gov, March 3, 2011, accessed February 7, 2012, export.gov/tradedata/index.asp.
• The US International Trade Commission offers market information, trade leads, and overseas business contacts. Trade professionals are available to help a business every step of the way with information counseling that can reduce costs, risks, and the mystery of exporting.“Session 11: Global Expansion,” My Own Business, accessed February 7, 2012, www.myownbusiness.org/global_expansion/index.html.
• The US Department of Commerce provides trade opportunities for US business, export-related assistance, and market information.“Session 11: Global Expansion,” My Own Business, accessed February 7, 2012, www.myownbusiness.org/global_expansion/index.html.
• Information about protecting intellectual property abroad can be found at http://www.stopfakes.gov. This is important because counterfeiting and piracy cost the world economy approximately \$650 billion per year.“Session 11: Global Expansion,” My Own Business, accessed February 7, 2012, www.myownbusiness.org/global_expansion/index.html.
Other sources to be consulted include people in the same business or industry, industry-specific magazines, trade fairs, seminars,Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html. and export training and technical assistance that is available to small businesses through the states and the federal government. The Federation of International Trade Associations is a global trade portal that provides trade leads, market research, links to eight thousand import/export websites, and even travel services. WorldBid.com describes itself as the largest network of international trade marketplaces in the world, providing trade leads and new business contacts.“Session 11: Global Expansion,” My Own Business, accessed February 7, 2012, www.myownbusiness.org/global_expansion/index.html.
The Internet makes it possible to gather and view tremendous amounts of information. If a business is thinking seriously about going global, there is no better time to take advantage of this quick-and-easy access than now.
Video Link 15.3
Knowing the Export Environment
Government experts identify challenges and debunk some myths.
www.inc.com/exporting/exportsuccess.htm
Business Assessment: Are You Ready?
It is important to honestly self-evaluate a business to determine whether it is really ready to go global or not…or at least not yet.“Is Your Small Business Ready to Go Global?,” Small Business CEO, February 7, 2011, accessed February 7, 2012, www.smbceo.com/2011/02/07/global-business-2. If a business is thinking about expanding globally, it is probably already doing something right to have reached this point. However, that does not preclude the importance of assessing its strengths and its weaknesses to determine the approach that should be taken in the global market.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html. This will be true no matter what role e-commerce plays in a business. Even a micromultinational business should assess its strengths and its weaknesses, although its instantaneous presence as a global business means that the assessment must be done at start-up and then must continue as products and services move from country to country.
There are several issues that should be addressed. The following are some of the questions that should be asked:Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html; “Starting an Export Business,” Gaebler.com, May 19, 2011, accessed February 7, 2012, www.gaebler.com/Starting-an-Export-Business.htm; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 96; “Is Your Small Business Ready to Go Global?,” Small Business CEO, February 7, 2011, accessed February 7, 2012, www.smbceo.com/2011/02/07/global-business-2.
• Why is a business successful in the domestic market? What is its growth rate? What are its strengths?
• What products have export potential? Do the products fill a niche that is exclusive to the US market? Are they packaged in a way that can be understood by non-English-speaking consumers? Do they violate any cultural taboos or contain ingredients that will prohibit their sale in a foreign market? Identify the key selling features of the products, identify the needs that they satisfy, and identify any selling constraints.
• What are the competitive advantages of a particular business’s products over other domestic and international businesses?
• What competitive products are sold abroad and by whom?
• Does the product require complementary goods and technologies? If so, who will provide them?
• How will the business provide customer service?
• Can production handle a wider demographic? Can the business increase output without sacrificing quality?
• Does the business have the money to market globally?
• Is the entire business (including all staff) committed to a global effort?
If a product is an industrial good, a business will want to know things such as what firms will likely use it, whether its use or life might be affected by climate, and whether geography will present transportation problems that will affect purchase. In the case of a consumer good, a business will want to know who will consume it; how frequently it will be purchased; whether it will be restricted abroad; whether climate or geography will negatively impact accessibility for purchase; and—perhaps most importantly—whether it conflicts with traditions, taboos, habits, or the beliefs of customers abroad.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html.
A helpful tool to assess readiness is the export questionnaire available at www.export.gov/begin/assessment.asp. This questionnaire highlights characteristics common to successful exporters and identifies areas that need to be strengthened to improve export activities.
Video Link 15.4
Where Will Your Next Customer Come From?
Small businesses looking to grow should look beyond US borders to find new customers.
www.sba.gov/content/where-will-your-next-customer-come
Marketing
Just as it is necessary to offer a different marketing mix (see Figure 15.2 "The Marketing Mix") for different target markets, it will generally be necessary to adapt the marketing mix to the global market in general and different countries in particular. A business’s unique value proposition (the set of benefits offered to customers to satisfy their needs and wants consisting of some combination of products, services, information, and experiences)Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 13. is what will differentiate one marketplace offering from the competition. Given the more diversified competition in the global marketplace, identifying the value proposition is even more critical—and most likely more difficult—than in the domestic market.Jennifer LeClaire, “How to Take Your Small Business Global,” E-Commerce Times, June 20, 2006, accessed February 7, 2012, www.ecommercetimes.com/story/50910.html%20?wlc=1305842348.
Figure 15.2 The Marketing Mix
Product
The ideal situation is when a product developed for the US market can be sold in a foreign country without any changes. Although some kinds of products can be introduced with no changes (e.g., cameras, consumer electronics, and many machine tools),Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 611. most products usually have to be altered in some way to meet conditions in a foreign market.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 49. From a small business perspective, the owner will want to market products that do not require drastic changes to be accepted. Relatively minor packaging changes, such as size or the language on the package, can be made inexpensively, but more drastic changes should be avoided. If a product must be changed drastically to market it globally, conduct an in-depth cost analysis to determine whether the additional costs will outweigh the anticipated benefits.“All About Global Marketing,” BusinessKnowledgeSource.com, accessed February 7, 2012, www.businessknowledgesource.com/marketing/all_about_global_marketing _032164.html. If a product is a food or a beverage, for example, is the business prepared to make the changes necessary to appeal to widely varying tastes?Arundhati Parmar, “Dependent Variables: Sound Global Strategies Rely on Certain Factors,” Marketing News, September 2002, 2.
Products need to be adapted for many reasons, including the following:Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 341, 351, 353; “Global Linguistic Analysis,” Strategic Name Development, accessed February 7, 2012, www.namedevelopment.com/global-linguistic -analysis.html.
• Different physical or mandated requirements must be met (e.g., electrical goods will need to be rewired for different voltage systems).
• The legal, economic, political, technological, and climatic requirements of the local marketplace vary (e.g., varying laws will set specific packaging sizes and safety and quality standards).
• The product or the company name must translate flawlessly to the new target market so that it does not convey an unintended, perhaps very negative, meaning. One of the most well-known examples of a translation blunder is the Chevy Nova. In Spanish, “nova” means “no go.”
• The package label may need to be changed. Imagine the horror of a well-known baby food producer that introduced small jars of baby food in Africa when it found out that the consumers inferred from the baby picture on the jars that the jars contained ground-up babies. This shows us that even big companies can make big mistakes.
• A change in flavor or fragrance may be necessary to bring a product in line with what is expected in a culture. The pine and hints of ammonia or chlorine scents that are popular in the United States were flops in Japan because many Japanese sleep on the floor on futons. With their heads so close to the floor, a citrus scent is more pleasing.
The less economically developed a market happens to be, the greater may be the need for product adaptation. Research has found that only one in ten products can be marketed in developing countries without some kind of product adaptation.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 341.
Cultural Differences
It is important to know that cultural and social differences are intertwined with the perceived value and importance that a market places on a product.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 343. “A product is more than a physical item: It is a bundle of satisfactions (or utilities) that the buyer receives. These include its form, taste, color, odor, and texture; how it functions in use; the package; the label; the warranty; the manufacturer’s and retailer’s servicing; the confidence or prestige enjoyed by the brand; the manufacturer’s reputation; the country of origin; and any other symbolic utility received from the possession or use of the goods. In short, the market relates to more than a product’s physical form and primary function.”C. K. Prahalad, The Fortune at the Bottom of the Pyramid (Philadelphia: Wharton School Publishing, 2005), as cited in Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 343.
The values, customs, rituals, language, and taboos within a culture will determine the acceptability of a product or a service. Cultural sensitivity is particularly important in cyberspace. Website visitors may come from anywhere in the world. Icons and gestures that seem friendly to US visitors may shock people from other cultures. For example, a high-five hand gesture would be insulting to a visitor from Greece.David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 109. Knives and scissors should not be given as gifts in South America because they symbolize the severing of a friendship.David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 109.
The psychological attributes of a product (features that have little to do with the primary function of the product but add value to customer satisfaction, e.g., color, size, design, brand name, and price)Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 343. can also vary across cultures, and the meaning and the value assigned to those attributes can be positive or negative. It may be necessary to adapt the nonphysical features of the product to maximize the positive meanings and eliminate the negative ones.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 343. When Coca-Cola, the number one global brand, introduced Diet Coke to Japan, it found that Japanese women do not like to admit to dieting. Further, the idea of diet was associated with medicine and sickness. Coca-Cola ended up changing the name to Coke Light.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 343. This happened in Europe as well, so if a product is associated with weight loss, a business must be very careful with its marketing.
The Package
The package for a product includes its design, colors, labeling, trademarks, brand name, size, product information, and the actual packaging materials. There are many reasons why a package may have to be adapted for a particular country. There may be laws that stipulate a specific type of bottle or can, package sizes, measurement units, extraheavy packaging, and the use of particular words on the label.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 352. In some cases, the expense of package adaptation may be cost prohibitive for entering a market. Consider the following examples:Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 352–53.
• In Japan, a poorly packaged product is seen as an indicator of product quality.
• Prices are required to be printed on the labels in Venezuela, but putting prices on labels or in any way suggesting the retail price in Chile is illegal.
• A soft-drink company from the United States incorporated six-point stars as decoration on its package labels. But it had inadvertently offended some of its Arab customers who interpreted the stars as symbolizing pro-Israeli sentiment.
• Soft drinks are sold in smaller sizes in Japan to accommodate the smaller Japanese hand.
• Descriptive words such as giant or jumbo on a package or a label may be illegal in some countries.
The message here is clear. Before going global with a product, examine the packaging so that each element is in compliance with appropriate laws and regulations so that nothing will offend prospective customers.
Global Packaging
Canada’s oldest candymaker, Ganong Brothers, is located about one mile from Maine. The company chairman, David Ganong, can see the US border from his office window. You would think it would be easy for Ganong Brothers to sell to the US market. Not so. In Canada, nutritional labels read 5 mg, with a space between the number and the unit of measurement. Ganong’s jellybeans cannot get into America unless the label reads 5mg, without the space. This difference, as well as differences in Canada’s nutritional guidelines, means that Ganong must produce and package its US products separately, which reduces its efficiency. Small differences can and do have a significant effect on cross-border trade. This may be the reason why there is not as much trade between the United States and Canada as you would think.Ryan Underwood, “Creating a Smart Export Strategy,” Inc., May 3, 2011, accessed February 7, 2012, www.inc.com/magazine/20110501/author-pankaj-ghemawat -on-global-expansion-for-small-exporters.html. This notwithstanding, however, Canada remains the number one exporting destination for US small businesses.“Small and Medium-Sized Enterprises: Overview of Participation in U.S. Exports,” US International Trade Commission, January 2010, accessed February 7, 2012, www.usitc.gov/publications/332/pub4125.pdf.
The Business Website
As part of product preparations, a business will need to make its website ready for international business. Remember that the website is a very cost-effective way to sell a product or a service across borders. Here are four ways to ready the website:Anita Campbell, “How to Make Your Website Ready for International Business,” Small Business Trends, October 29, 2010, accessed February 7, 2012, smallbiztrends.com/2010/10/website-ready-international-business.html.
1. Internationalize website content. A business must account for language differences, and cultural differences may require different graphics and different colors. One way to deal with the additional costs is to translate text or provide country-specific sites only for the country or countries where the most products are sold. One organization that provides resources to help businesses localize their products and resources is the Globalization and Localization Association.
2. Calculate the buyer’s costs and estimate shipping. Shipping internationally will take longer, is more complicated, and will be more expensive than shipping domestically. Fortunately, there are shipping management software packages available that will automatically figure the costs and delivery times for overseas orders, giving a close estimate. Large shipping carriers, such as UPS and FedEx, offer such software; other companies include E4X Inc., eCustoms, and Kewill Systems Plc.Paul Demery, “Anchors Aweigh,” Internet Retailer, January 31, 2008, accessed February 7, 2012, www.internetretailer.com/2008/01/31/anchors-aweigh.
3. Optimize site and search marketing for international web visitors. With the increase in cross-border selling, websites can be optimized for visitors from specific countries, and techniques can be used to attract international visitors through search engines and search ads. This is a growing specialty among search marketers. A business should definitely check out the cost of hiring such a marketer as a consultant. It would be well worth the investment.
4. Comply with government export regulations. A business does not need government approval to sell most goods and services across international borders. There are, of course, notable exceptions. For example, the US government restricts defense or military goods, and agricultural, plant, and food items may have restrictions or special labeling requirements. Such restrictions should be addressed on the website. It may be necessary to restrict the sale of certain products to certain countries only.
Video Link 15.5
Finding Your First Customer
To find the first customer, visit the selected country.
www.inc.com/exporting/findingfirst.htm
Translation Blunders in Global Marketing
We often hear it said that something was lost in the translation. Here are some global marketing examples of translation blunders. Something important to note is that most of these blunders were committed by the “big guys,” companies that are extremely marketing-savvy—proof positive that no one is immune from this kind of error.
• When Coca-Cola was first translated phonetically into Chinese, the result was a phrase that meant “bite the wax tadpole.” When Coca-Cola discovered the error, the company was able to find a close phonetic equivalent that could be loosely translated as “happiness in the mouth.”“Translation Problems in Global Marketing,” My Opera, November 14, 2006, accessed February 7, 2012, my.opera.com/kitkreuger/blog/2006/11/14/translation -problems-in-global-marketing.
• When Pope John Paul II visited Miami in 1987, an ambitious entrepreneur wanted to sell t-shirts with the logo, “I saw the Pope” in Spanish. The entrepreneur forgot that the definite article in Spanish has two genders. Instead of printing “El Papa” (“the Pope”), he printed “La Papa” (“the potato”). Needless to say, there was no market for t-shirts that read “I saw the potato.”“Translation Problems in Global Marketing,” My Opera, November 14, 2006, accessed February 7, 2012, my.opera.com/kitkreuger/blog/2006/11/14/translation -problems-in-global-marketing.
• Sunbeam got into trouble when it did not change the name of its Mist-Stick curling iron when marketing it in Germany. As it turned out, “mist” is German slang for manure. Not surprisingly, German women did not want to use a manure stick in their hair.Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 613.
• A proposed new soap called “Dainty” in English came out as “aloof” in Flemish (Belgium), “dimwitted” in Farsi (Iran), and “crazy person” in Korean. The product was dropped. The company either did not have the resources to research a new name or did not want to take the time and incur the costs to do so.
• Kellogg’s Bran Buds sounded like “burned farmer” in Swedish.John Freivalds, “What’s in a Name?,” Business Library, April 1996, accessed February 7, 2012, findarticles.com/p/articles/mi_m4422/is_n4_v13/ai_18512264.
Given that misunderstanding foreign languages can destroy a brand, it is worth the investment to hire someone who is proficient in the native language in the intended market—including the use of slang. This will help a small business avoid a fatal mistake because it does not have the resources of the big companies to fix the mistakes.Jeffrey Gangemi, “Avoiding Faux Pas When Exporting,” Bloomberg BusinessWeek, June 27, 2007, accessed February 7, 2012, www.BusinessWeek.com/smallbiz/content/jun2007/sb20070627_897013.htm?campaign_id=rss_smlbz. This concern must be extended to the web presence as well because the website is an integral part of the product.
Price
Pricing for the global market is not an easy thing to do. Many factors must be taken into account, the first of which are traditional price considerations: fixed and variable costs, competition, company objectives, proposed positioning strategies, the target group, and willingness to pay.“The International Marketing Mix,” Learn Marketing, accessed February 7, 2012, www.learnmarketing.net/internationalmarketingmix.htm. Add to these factors things such as the additional costs that are incurred due to taxes, tariffs, transportation, retailer margin, and currency fluctuation risks;John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 40; Philip Kotler and Kevin Lane Keller, Marketing Management (Upper Saddle River, NJ: Pearson Prentice Hall, 2009), 616. the nature of the product or industry, the location of production facility, and the distribution system;Eric Mitchell, “The Pricing Advisor,” The Pricing Advisor Newsletter, accessed February 7, 2012, members.pricingsociety.com/articles/Pricing-for-Global-Markets.pdf. the psychological effects of price; the rest of the marketing mix; and the price transparency created by the Internet“The International Marketing Mix,” Learn Marketing, accessed February 7, 2012, www.learnmarketing.net/internationalmarketingmix.htm. and a business can begin to appreciate the challenges of global price setting. About the only thing that can be seen as a certainty is that a small business should expect the price of its product or service to be different, usually higher, in a foreign market.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 50. The specifics of that difference need to be worked out carefully, with thorough analysis.
Setting the right price for a product or a service is critical to success. It will be a challenge to navigate the pricing waters of each different country—to learn why, for example, a product sells for \$16 in the United States but \$23 in Britain.
Place
As challenging as distribution may be for a small business in the domestic market, it is even more so for the global market. No matter the product, it has to go through a distribution process—the physical handling and distribution of goods, the passage of ownership or title, and the buying and selling negotiations between producers and middlemen and middlemen and customers.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 396. It would make sense to be able to take advantage of existing transportation systems, retailers, and suppliers to sell goods and provide services. Unfortunately, adequate distribution systems do not exist in all countries, so a business will need to develop ways to get products to customers in as cost-effective a manner as possible.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 50.
Video Link 15.6
Getting Your Product from Here to There
Small businesses rely on freight forwarding and shipping experts to move products around the world.
www.inc.com/exporting/heretothere.htm
Before deciding on a channel or channels of distribution, a business needs information. The following are some basic questions as a starting point:
• Is the selected market dominated by major retailers or is the retail sector made up of small independent retailers?“The International Marketing Mix,” Learn Marketing, accessed February 7, 2012, www.learnmarketing.net/internationalmarketingmix.htm.
• How many intermediaries will be involved? In Japan, for example, a product must go through approximately five different types of wholesalers before it reaches the final consumer.“The International Marketing Mix,” Learn Marketing, accessed February 7, 2012, www.learnmarketing.net/internationalmarketingmix.htm.
• Can we use the manufacturer, wholesaler, retailer, or consumer channel or can we export directly to a retailer?
• Should we work with a foreign partner? Unless a business plans to establish a retail operation on foreign soil, it will need to establish business-to-business (B2B) sales relationships. Then products can be sold directly to foreign retailers or foreign distributors who will sell to those retailers. A foreign partner can provide valuable insights about local import regulations, product marketability, and local customs. The US Department of Commerce website contains directories of foreign buyers.Ryan Underwood, “Creating a Smart Export Strategy,” Inc., May 3, 2011, accessed February 7, 2012, www.inc.com/magazine/20110501/author-pankaj-ghemawat -on-global-expansion-for-small-exporters.html. Small businesses excel at forming strategic partnerships.Laurel Delaney, “Global Guru: Shaking Things Up. Making Things Happen,” Change This, October 2004, accessed February 7, 2012, changethis.com/manifesto/6.03.GlobalGuru/pdf/6.03.GlobalGuru.pdf.
• Where can we attend a trade show or a trade mission? Going to these events can help a business find distribution channels.
• Is the Internet commonly used to distribute my product?
Video Link 15.7
Understanding Partnerships and Distributors
Partnerships help many thriving US businesses overseas.
www.inc.com/exporting/partnerships.htm
Video Link 15.8
Identifying Marketing Channels/Activities
How research and planning inform business growth.
www.inc.com/exporting/marketingchannels.htm
In the final analysis, the behavior of distribution channel members will be the result of the interaction between cultural, economic, political, legal, and marketing environments. A small business that is looking to go global—or is already there—will encounter channel structures that range from a minimally developed marketing infrastructure, such as in emerging markets, to highly complex, multilayered systems, such as in Japan.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 396.
When deciding to enter the global marketplace, a determination must be made as to whether the current channel structure in the selected country (or countries) will meet the business’s needs or whether some additional arrangements will be needed. The means of distribution will necessarily be a country-by-country decision. No matter the arrangement, however, figure on the costs being greater than in the United States.
Promotion
It is understandable that a small business owner may want to use the same integrated marketing communications (IMC) programs used in the home market to inform customers in foreign markets and persuade them to buy. This “one voice” approach offers the advantage of enabling a business or a product to gain broader recognition in the global marketplace; it also helps reduce costs, minimize redundancies in personnel, and maximize the speed of implementation.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 50; “Global Marketing,” SmallBusiness.com, accessed February 7, 2012, smallbusiness.com/wiki/Global_marketing. However, things are not that easy. Cultural, social, language, and legal differences from country to country will usually make it necessary to modify IMC messages to not offend current or prospective customers. Modification is more of a challenge for the small business because the resources needed to make the changes are more limited.
A business communicates with its customers through some combination of its website, advertising, publicity, public relations, sales promotion, sales personnel, e-mail, and social media. The actual mix will be a function of the selected country or countries. For example, in some less-developed countries, the major portion of the promotional effort in rural and less-accessible parts of the market is sales promotion; in other markets, product sampling works especially well when the product concept is new or has a very small market share.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 468. In Saudi Arabia, there is an appreciation for fancy packaging, and point-of-sale advertising elicits the best reaction.Marian Katz, “No Women, No Alcohol; Learn Saudi Taboos before Placing Ads,” Abstracts, Business International, 1986, accessed June 1, 2012, www.faqs.org/abstracts /Business-international/No-women-no-alcohol-learn-Saudi-taboos-before-placing-ads.html. However, the appropriateness of IMC activities for a small business will depend on the product being marketed, the industry in which it is competing, and the country in which it hopes to sell the product.
Of all the four Ps, decisions involving advertising are thought to be those most often affected by cultural differences in foreign markets. Consumers respond in terms of their culture, style, feelings, value systems, attitudes, beliefs, and perceptions. Because advertising’s function is to interpret or translate the qualities of products and services in terms of consumer needs, wants, desires, and aspirations, emotional appeals, symbols, persuasive approaches, and other characteristics in an advertisement must coincide with cultural norms if the ad is to be effective.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 473.
Examples abound of international advertising mistakes that have offended different cultures. Three are presented here. Although they are linked to large corporations, there are lessons to be learned by small businesses. No business is immune from making mistakes from time to time.
• Burger King ran in-store ads for three restaurants in Spain that depicted the Hindu goddess Lakshami on top of a ham sandwich. The caption read, “a snack that is sacred.” Many Hindus are vegetarian and were offended by the ad. Burger King pulled it.Emily Bryson York, “Burger King’s MO: Offend, Earn Media, Apologize, Repeat,” Ad Age Global, July 8, 2009, accessed February 7, 2012, adage.com/article/global-news/advertising-burger-king-draws-ire-hindus-ad/137801.
• Burger King ran a campaign in Europe for the Texican Whopper that featured a lanky American cowboy; a short, round Mexican draped in a cape resembling Mexico’s flag; and the caption, “the taste of Texas with a little spicy Mexican.” There was an immediate uproar, with the Mexican ambassador to Spain objecting publicly.Shaun Rein, “Learn from Burger King’s Advertising Fiasco,” Forbes, April 20, 2009, accessed February 7, 2012, www.forbes.com/2009/04/20/advertising-global-mistakes -leadership-managing-marketing.html.
• During a time when Fiat was trying to take advantage of auto sales growth in China, it released an ad in Italy in which actor Richard Gere drove a Lancia Delta from Hollywood to Tibet. The ad did not air in China, but it caused an online uproar nonetheless. Richard Gere is hated in China because he is an outspoken supporter of the Dalai Lama. His selection as the Fiat spokesperson was a major faux pas by Fiat.Shaun Rein, “Learn from Burger King’s Advertising Fiasco,” Forbes, April 20, 2009, accessed February 7, 2012, www.forbes.com/2009/04/20/advertising-global-mistakes -leadership-managing-marketing.html.
The reality of international advertising is that its cost and the effort required to prepare and place the ads correctly may be prohibitive for most small businesses, therefore pushing the emphasis on other elements of the IMC mix. However, a business will not know that for sure until it does the proper research before making a decision. Consider the characteristics of the target market, how the market uses media in that country, and which media are actually available. Some countries do not have commercial television, and some do not have advertising in newspapers. There will be newspaper and magazine circulation differences from country to country; in countries with a low literacy rate, radio and television advertising (if available) will be more effective than print media.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 50.
Fortunately, small businesses that want to go global can look to social media for assistance. The social web is a low-cost way to catapult a small business brand into the global arena.Susan Gunelius, “Building Your Brand with Social Media,” Reuters, January 4, 2011, accessed February 7, 2012, www.reuters.com/article/2011/01/05/idUS16245956220110105. Facebook, the most popular social networking site in the world, has developed a self-serve advertising tool that has created the greatest interest among small businesses that might not have had the means to launch a global advertising campaign before. This would be a good place to start—along with a map of the world’s most popular media applications country by country and culture by culture, which is available at www.appappeal.com/the-most-popular-app-per-country/social-networking.
No matter the mix of the IMC program, and no matter whether a business is business-to-consumer (B2C) or B2B, the way a business communicates internationally will be a major determinant of success. Each IMC component is a communication channel in its own right. A business must consider the appropriateness of each message in each channel. For example, is the message adequate? Does it contain correct cultural interpretations? Are the colors and graphics right? In the case of advertising, have the media been chosen that match the behavior of the intended audience? Have you correctly assessed the needs and wants or the thinking processes of the target market?Adapted from Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 479.
Careful consideration of these and other communication issues will not guarantee success, but it should help reduce the chances of making a major marketing blunder.
Legal and Political Issues
It is impossible for any small business to know all the laws that pertain to exporting from the United States. Thus it is important to consult an attorney who is knowledgeable about the legal implications of globalization: international trade laws, tax laws, local regulations,“Small Business Globalization: Should You Pursue Global Markets?,” more-for-small business.com, accessed February 7, 2012, www.more-for-small-business.com/small-business-globalization-should-you-pursue-global-markets.html. international border restrictions, customs rules, and duties and taxes.Paul Demery, “Anchors Aweigh,” Internet Retailer, January 31, 2008, accessed February 7, 2012, www.internetretailer.com/2008/01/31/anchors-aweigh.
To varying degrees, each small business must be concerned with the following. However, this list is not exhaustive; it is a sampling only.
• The Foreign Corrupt Practices Act makes it illegal for companies to pay bribes to foreign officials, candidates, or political parties. The challenge for all US businesses is that bribery is a common business practice in many countries, even though it is illegal.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 203. Interestingly, private business bribes are tax deductible in Germany as long as the German businessperson discloses both his or her identity and the recipient of the bribe(s). Although it is supposedly rarely used, it is available.Joshua Ritchie, “The 5 Most Bizarre Tax Deductions around the World,” Mint Software Inc., December 15, 2009, accessed June 1, 2012, http://www.mint.com/blog/trends/the-...und-the-world/.
• Specific licenses and permits are required or additional paperwork must be completed if the following specific products are exported or imported: agricultural products, automobiles (not a likely product for a small business), chemicals, defense products, food and beverage products, industrial goods, and pharmaceutical and biotechnology products.“Exporting/Importing Specific Products,” US Small Business Administration, accessed February 7, 2012, www.sba.gov/content/exportingimporting-specific-products.
• There is heightened sensitivity since September 11, 2011, about exporting products that could even remotely be used in a military or a terrorist capacity.“For Entrepreneurs: Starting an Export Business,” Gaebler.com, May 19, 2011, accessed February 7, 2012, www.gaebler.com/Starting-an-Export-Business.htm.
• Brand names, trademarks, products, processes, designs, and formulas are among the more valuable assets a small business can possess. These need to be protected—domestically and internationally. US officials estimate that \$300 billion of intellectual property assets are ripped off every year.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 193.
• There are commercial laws within countries related to marketing, environmental issues, and antitrust.
Video Link 15.9
Understanding Legal Considerations
Important legal considerations for small businesses that want to go global.
www.inc.com/exporting/legal.htm
In addition to legal considerations, no small business can conduct global business without understanding the influence of the political environments in which it will be operating.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 158. Every nation has the sovereign right to grant or withhold permission to do business within its political boundaries and control where its citizens do business, so the political environment of countries is necessarily a critical concern to any small business.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 158. Political issues include the stability of government policies (a stable and friendly government being the ideal), the forms of government (with some being more open to foreign commerce than others), political parties and their influence on economic policy, the degree of nationalism (the greater the nationalism, the greater the bias against foreign business and investments may be), fear and/or animosity that is targeted toward a specific country, and trade disputes.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 159-165. One or all these things create political risk that must be assessed. The most severe political risk is confiscation, the seizing of a company’s assets without payment.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 166.
Currency Exchange Issues
The exchange rate is the rate at which one country’s currency can be exchanged for the currency of another country.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 39. For example, assume that on a particular day, \$1 exchanged for 0.75643 euros and 49.795 Indian rupees.“Euro,” X-rates.com, accessed March 5, 2012, www.x-rates.com/d/EUR/table.html;%20X-rates.com; “Indian Rupee,” X-Rates, accessed March 5, 2012, www.x-rates.com/d/INR/table.html. These exchange rates then changed the next day, when \$1 exchanged for 0.6891 euros and 49.845 Indian rupees, meaning that the value of the US dollar increased in value with respect to the euro and decreased in value against the Indian rupee. Currency exchange rates change daily, and they are important because currency fluctuations can present additional problems for the small business looking to go global. The appreciation and depreciation of a currency will have an effect on the prices of goods and services. For example, as the dollar declines in value against the euro, the price of goods and services from the European Union for US customers will increase, likely reducing their purchases.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 39. The following are other implications of exchange rate fluctuations:Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 537; David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 113.
• Inattention to exchange rates in long-term contracts could result in large unintended discounts.
• Rapid and unexpected currency fluctuations can make pricing in local currencies very difficult.
• Shifts in exchange rates can influence the attractiveness of various business decisions, not the least of which is whether doing business in a particular country is worthwhile.
Different strategies may be needed when the dollar is weak versus when it is strong. For example, when the US dollar is weak, a business should stress price benefits. When the dollar is strong, a business can engage in nonprice competition by improving quality, delivery, and after-sale services.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 538. To navigate these challenging currency exchange waters, it will be necessary to tap into accounting and finance expertise.
Sources of Financing
How a business finances an export project is often a critical factor in its success. Financing decisions extend to working capital and export transactions. Working capital is needed to finance operations before and after a sale, and money is needed to sustain a business until it is paid for the goods and services that have been provided (export transactions). The International Trade Association in the US Department of Commerce identifies the following factors as important to consider when making financing decisions.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 193–94.
• The need for financing to make the sale. Offering favorable payment terms can make a product more competitive.
• The length of time the product is being financed. The term of the loan required determines how long a business will have to wait before the buyer pays for the product, which will influence the choice of how to finance the transaction.
• The cost of different methods of financing. Interest rates and fees will vary, and a business should probably expect to assume some of the financing costs. Before providing an invoice to the buyer, a business must understand how these costs will affect price and profit.
• The risks associated with financing the transaction. The riskier the transaction, the more difficult and costly it will be for a business to finance it because there will likely be a higher chance for default. The level of risk will be influenced by several things, not the least of which is the political and economic stability of the buyer’s country. In risky situations, the financing provider may require the most secure method of payment—a letter of credit or export credit insurance.
• The need for preshipment financing and postshipment working capital. Working capital could experience unexpected and severe strains with the production of an unusually large order or a surge of orders. Inadequate working capital can limit exporting growth—even during normal periods.
Where to Go
Small businesses have reported that problems with access to financing for their exporting operations are a major barrier to exporting. The difficulties they experience in obtaining both trade finance and working capital often prevent small businesses from financing purchases by foreign buyers. This encourages foreign buyers to choose suppliers that are able to extend credit. Small businesses must also face the perception of lending institutions that they are a higher risk than larger companies coupled with a lack of familiarity with exporting by community banks.“Small and Medium-Sized Enterprises: Overview of Participation in U.S. Exports,” US International Trade Commission, January 2010, accessed February 7, 2012, www.usitc.gov/publications/332/pub4125.pdf.
Despite any anticipated difficulties, small businesses need to find export financing. They can look for financing in several places. The first place to look is internally. Does it already have the funds to finance global efforts? If the answer is yes, then all is well. This was the case for Center Rock, the small business featured at the beginning of this chapter. If the answer is no, which will most likely be the case, it will be necessary to look for external financing. A range of options is available for small businesses to consider (see Table 15.3 "Sources of Export Financing for the Small Business"). As you will see, most financing sources are available from the government. A small business must become familiar with the financing, insurance, and grant programs that are available to help it finance transactions and carry out export operations.“6 Steps to Begin Exporting,” US Small Business Administration, accessed February 7, 2012, www.sba.gov/content/6-steps-begin-exporting.
Table 15.3 Sources of Export Financing for the Small Business
Source Information
Extending credit to foreign buyers working with commercial banks Liberal financing can enhance export competitiveness, but extending credit must be weighed carefully. Some commercial bank services used to finance domestic business, including revolving lines of credit for working capital, are often needed to finance export sales until payment is received. However, commercial banks prefer to establish an ongoing business relationship instead of financing solely on the basis of an individual order. Most US banks do not lend against export orders, export receivables, or letters of credit.
Export Express 7(a) Loan Programs Offered by the SBA, this streamlined program helps small businesses develop or expand their export markets. A business may be able to obtain SBA-backed financing for loans and lines of credit up to \$500,000.
Export Working Capital Program (EWCP) 7(a) Loan Programs This SBA loan program targets small businesses that are able to generate export sales but need additional working capital to support these sales. The SBA provides lenders guarantees of up to 90 percent on export loans to ensure that qualified exporters do not lose viable export sales due to a lack of working capital.
International Trade Loan Program 7(a) Loan Programs Loans are available for businesses that plan to start or continue exporting or have been adversely affected by competition from imports. The loan proceeds must enable the borrower to be in a better position to compete. The program offers borrowers a maximum SBA-guaranteed portion of \$1.75 million.
Export-Import Bank An independent federal agency that provides working capital loan guarantees, export-credit insurance, and other forms of financing for US exporters of all sizes. The funds are aimed at offsetting the added risks of doing business abroad, from complex trade rules to unpaid bills.
Using export intermediaries Many export intermediaries, for example, trading companies and export management companies, can help finance export sales. The intermediaries may provide short-term financing or may purchase the goods to be exported directly from the manufacturer, thus eliminating any risks to the manufacturer that are associated with the export transaction as well as the need for financing.
Source: “Export Financing,” US Small Business Administration, accessed February 7, 2012, www.sba.gov/content/export-financing-0; US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 194, 197; “More Small Businesses Seek Export Financing,” Wall Street Journal, May 20, 2011, accessed February 7, 2012, http://blogs.wsj.com/in-charge/2011/...port-financing.
Video Link 15.10
Financing
Some of the ways small businesses can finance their exporting projects.
www.inc.com/exporting/financing.htm
KEY TAKEAWAYS
• Expanding into global markets introduces new complexities into small business operations.
• The decision to go global should be based on an assessment of the ways to export, an analysis of the industry and a particular company, marketing and cultural factors, legal and political conditions, currency exchange rates, and sources of financing.
• There are two basic ways to export: direct or indirect. In direct exporting, a small business exports directly to a customer who is interested in buying the product. Indirect exporting involves using a middleman for marketing and selling the product in the target market.
• Industry analysis involves looking at where an industry currently is and the trends and directions predicted over the next three years so that a business can try to determine how competitive an industry is in the global market.
• It is important to honestly self-evaluate a business to determine whether it is ready to go global or not.
• It will generally be necessary to adapt the marketing mix to the global market in general and different countries in particular.
• Legal issues include international trade laws, tax laws, and local regulations.
• No small business can conduct global business without understanding the influence of the political environments in which it will be operating.
• Currency exchange rates are important because currency fluctuations can present additional problems for a small business that is looking to go global. In particular, the appreciation and depreciation of a currency will have an effect on the prices of goods and services.
• How a business finances an export project is often a critical factor in its success.
• Working capital is needed before and after the sale, and money is needed until the goods and services that have been provided have been paid for.
• Many—perhaps most—of the sources for small business exporting activity are governmental.
EXERCISES
1. Comment on the following: a small business owner firmly believes that because a product is successful in Chicago, Illinois, it will be successful in Tokyo or Berlin.Adapted from Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 367. Be as specific as you can in your comments.
2. There has been tremendous growth in online business, which has introduced new elements to the legal climate of global business. Patents, brand names, copyrights, and trademarks are difficult to monitor because there are no boundaries with the Internet. What steps could a small business take to protect its trademarks and brands in this environment? Prepare at least five suggestions.David L. Kurtz, Contemporary Business (Hoboken, NJ: John Wiley & Sons, 2011), 133.
3. Find a local small business that exports its products. Talk to the owner about his or her experiences. Ask questions such as the following: What convinced you to export? How did you decide on the product(s) to export? Did you have to adapt your product(s) in any way? What were the greatest barriers you had to face? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/15%3A_Going_Global_-_Yes_or_No/15.03%3A_What_You_Should_Know_Before_Going_Global.txt |
Learning Objectives
1. Understand the organizational support that will be needed for exporting activities.
2. Understand the need to select the best market to entry.
3. Identify and describe each possible market entry strategy.
4. Learn about the different approaches to getting paid.
5. Appreciate the importance of business etiquette when traveling to visit customers.
6. Understand the importance of an export plan.
After a business decides to jump into the global pond, several key management decisions must be made (Figure 15.3 "Management Decisions"). Among them are organization for the global project, selecting the best market to enter, the level of involvement desired, and how to get paid. There should also be consideration of global etiquette and travel.
Figure 15.3 Management Decisions
Several important questions about the global venture should be answered before making any management decisions or considerations.“Management Issues Involved in the Export Decision,” Export.gov, March 31, 2011, accessed February 7, 2012, export.gov/exportbasics/eg_main_017455.asp. Less than satisfactory answers to these questions may put the global venture in jeopardy.
1. Do the company’s reasons for pursuing export markets include solid objectives, such as increasing sales volume or developing a broader, more stable customer base, or are the reasons frivolous, such as the owner wants an excuse to travel?
2. How committed is top management to the export effort? Is it viewed as a quick fix for a slump in domestic sales? Will the company neglect its export customers if domestic sales pick up?
3. What are management’s expectations for the export effort? Will they expect export operations to become self-sustaining quickly? If so, how quickly?
4. What level of return on investment is expected from the export project?
Organization for the Global Project
It will be important to have some kind of structure or team within the business to handle the global side of the business. It does not have to be large, but it should be dedicated to ensuring that export sales are adequately serviced, and there should be a clear indication of who will be responsible for the organization and staffing.“Management Issues Involved in the Export Decision,” Export.gov, March 31, 2011, accessed February 7, 2012, export.gov/exportbasics/eg_main_017455.asp. Having the right resources for the global effort is critical, so a business should make the most of skills already held by staff members, for example, languages or familiarity with a range of foreign currencies. If these and other needed skills are not already available on staff, a small business should seek assistance from external experts.Tricia Phillips, “Biz Bureau Gives Top Tips on Going Global with Your Business,” Mirror, January 26, 2011, accessed February 7, 2012, www.mirror.co.uk/advice/money/2011/01/26/biz-bureau-gives-top-tips-on-going-global-with-your-business-115875 -22875517.
Other organizational issues that small businesses must address before going abroad include the following:Denise O’Berry, “Is Now the Time to Expand to Global Markets?,” AllBusiness.com, April 14, 2008, accessed February 7, 2012, www.allbusiness.com/company-activities-management/company-strategy/8518731-1.html; Anita Campbell, “Smaller and Younger Companies Get Overseas Presence,” Small Business Trends, December 7, 2007, accessed February 7, 2012, smallbiztrends.com/2007/12/smaller-and-younger-companies-get-overseas-presence.html; “Management Issues Involved in the Export Decision,” Export.gov, March 31, 2011, accessed February 7, 2012, export.gov/exportbasics/eg_main_017455.asp.
• Getting internal buy-in. Because going overseas to do business is a larger undertaking than many businesses realize, make sure that senior management and the people who are responsible for implementing and supporting the overseas effort know what the goals are and what is expected of them with respect to oversight and management. Knowing how much senior management time should be and could be allocated is an important part of getting internal buy-in. Look for support from people in all functions of the business.
• Making sure that the full costs of overseas hiring are understood. If people from overseas will be hired, employment regulations and practices are very different. For example, outside the United States, employment benefits often represent a larger percentage of an employee’s salary than in the United States; in the European Union, for example, a full-blown employment contract is needed, not just an offer letter. This tilts the balance of power to the employee at the expense of the company, making termination very difficult. Understanding the full ramifications of hiring people outside the United States has significant implications for a company’s financial success.
• Thinking about how the business will manage overseas employees’ expectations. Different time zones and countries wreak havoc with keeping employees on the same page. Employees hired locally may have very different ideas about what is considered acceptable than a US employee does. Unless expectations and responsibilities are clearly conveyed at the beginning, problems will undoubtedly arise. They may anyway, but perhaps they will not be as serious.
Market Selection
A business must select the best market(s) to enter. The three largest markets for US products are Canada, Japan, and Mexico, but these countries may not be the largest or best markets for a particular product.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html. If a business is not sure where the best place for doing global business is, one good approach is to find out where domestic competitors have been expanding internationally. Although moving into the same market(s) may make good sense, a good strategy might also be to go somewhere else. Three key US government databases that can identify the countries that represent significant export potential for a product are as follows:Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html.
1. The SBA’s Automated Trade Locator Assistance System
2. Foreign Trade Report FT925
3. The US Department of Commerce’s National Trade Data Bank
After identifying the country or countries that may offer the best market potential for a product, serious market research should be conducted. A business should look at all the following factors: demographic, geographic, political, economic, social, cultural, market access, distribution, production, and the existence or absence of tariffs and nontariff trade barriers. Tariffs are taxes imposed on imported goods so that the price of imported goods increases to the level of domestic goods. Tariffs can be particularly critical in selecting a particular country because the tariff may make it impossible for a US small business to profitably sell its products in a particular country.
Nontariff trade barriers are laws or regulations enacted by a country to protect its domestic industries against foreign competition.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html. These barriers include such things as import licensing requirements; fees; government procurement policies; border taxes; and packaging, labeling, and marking standards.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 40.
Market Entry Strategies
A small business must decide how it wants to enter the selected foreign market(s). Several choices might look attractive for a business (see Figure 15.4 "Examples of Export Market Entry Strategies"). Direct and indirect exporting, strategic alliances, joint ventures, and direct foreign investment are discussed in this section. The benefits and risks associated with each strategy depend on many factors. Among them are the type of product or service being produced; the need for product or service support; and the foreign economic, political, business, and cultural environment to be penetrated. A firm’s level of resources and commitment and the degree of risk it is willing to incur will help determine the strategy that the business thinks will work best.“Exporting Basics,” SmallBusiness.com, February 6, 2010, accessed February 7, 2012, smallbusiness.com/wiki/Exporting_basics.
Figure 15.4 Examples of Export Market Entry Strategies
Direct exporting and indirect exporting are discussed in Section 15.2 "What You Should Know Before Going Global".
• A joint venture (JV) is a partnership with a foreign firm formed to achieve a specific goal or operate for a specific period of time. A legal entity is created, with the partners agreeing to share in the management of the JV, and each partner holds an equity position. Each company retains its separate identity. Among the benefits are immediate market knowledge and access, reduced risk, and control over product attributes. On the negative side, JV agreements across national borders can be extremely complex, which requires a very high level of commitment by all parties.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 329; William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 93; “Joint Ventures and Strategic Alliances,” Fukuda Law Firm, accessed February 7, 2012. Because some countries have restrictions on the foreign ownership of corporations, a JV may be the only way a small business can purchase facilities in another country.John M. Ivancevich and Thomas N. Duening, Business: Principles, Guidelines, and Practices (Mason, OH: Atomic Dog Publishing, 2007), 47.
• A strategic alliance is very similar to a JV in that it is a partnership formed to create competitive advantage on a worldwide basis.William M. Pride, Robert J. Hughes, and Jack R. Kapoor, Business (Boston: Houghton Mifflin, 2008), 93). An agreement is signed between two corporations, but a separate business entity is not created.“Joint Ventures and Strategic Alliances,” Fukuda Law Firm, accessed February 7, 2012. The business relationship is based on cooperation out of mutual need, and there is shared risk in achieving a common objective. Growing at a rate of about 20 percent per year, strategic alliances are created for many reasons (e.g., opportunities for rapid expansion into new markets, reduced marketing costs, and strategic competitive moves).Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 327. “Small businesses excel at forming strategic partnerships and alliances which make them look bigger than they are and offer their customers a global reach.”Laurel Delaney, “Global Guru: Shaking Things Up. Making Things Happen,” Change This, October 19, 2004, accessed February 7, 2012, changethis.com/manifesto/6.03.GlobalGuru/pdf/6.03.GlobalGuru.pdf.
• Direct foreign investment is exactly what it sounds like: investment in a foreign country. If a business is interested in manufacturing locally to take advantage of low-cost labor, gain access to raw materials, reduce the high costs of transportation to market, or gain market entry, direct foreign investment is something to be considered. However, the complicated mix of considerations and risks—for example, the growing complexity and contingencies of contracts and degree of product differentiation—makes decisions about foreign investments increasingly difficult.Philip R. Cateora and John L. Graham, International Marketing (New York: McGraw-Hill Irwin, 2007), 332.
Getting Paid
Being paid in full and on time is of obvious importance to a business, so the level of risk that it is willing to assume in extending credit to customers is a major consideration.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 177. The credit of a buyer will always be a concern, but potentially more worrisome is the lessened recourse a business will have when it comes to collecting unpaid international debts. Extra caution must be exercised. Both the business owner and the buyer must agree on the terms of the sale in advance.Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html.
The primary methods of payment for international transactions are payment in advance (the most secure), letters of credit, documentary collection (drafts), consignment, and open account (the least secure), which are described as follows:Laurel Delaney, “A How-To on Expanding Your Business Globally,” The Global Small Business Blog, January 11, 2011, accessed February 7, 2012, borderbuster.blogspot.com/2011/01/how-to-on-expanding-your-business.html; US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 178–80, 182–83.
• Cash in advance. This is the ideal method of payment because a company is relieved of collection problems and has immediate use of the money. Unfortunately, it tends to be an option only when the manufacturing process is specialized, lengthy, or capital intensive and requires partial or progress payments. Wire transfers are commonly used, and many exporters accept credit cards.
• Documentary letter of credit. This is an internationally recognized instrument issued by a bank on behalf of its client, the purchaser. A letter of credit represents the bank’s guarantee to pay the seller, provided that the conditions specified in the letter are fulfilled.
• Documentary collection or draft. This involves the use of a draft, drawn by the seller on the buyer. It requires the buyer to pay the face amount either on sight (sight draft) or on a specified date in the future (time draft). The draft is an unconditional order to make payment in accordance with its terms, which specify the documents needed before title to the goods will be passed. All terms of payment should be clearly specified so that confusion and delay are avoided.
• Open account. With an open account, the exporter bills the customer, who is then expected to pay under agreed-on terms at a future date after the goods are manufactured and delivered (usually with fifteen, thirty, or sixty days). This payment method works well if the buyer is well established, has a long and favorable payment record, or has been thoroughly checked for being creditworthy. This approach is considered risky in international business because a business has limited recourse if debts are unpaid. Small businesses considering this option must examine the political, economic, and commercial risks very thoroughly.
• Consignment sales. Goods are shipped to a foreign distributor, which sells them on behalf of the exporter. Title to the goods remains with the exporter until they are sold, at which point payment is sent to the exporter. The exporter has the greatest risk and least control over the goods with this method, and payment may take a while. Risk insurance should be seriously considered with consignment sales.
When buyers default on their payments, it can be time-consuming, difficult, and expensive to obtain payments. A business should contact the buyer and try to negotiate payment. If negotiation fails and the amount of the debt is large enough to make a difference in that business, obtain the assistance and advice of the business’s bank, legal counsel, and the US Commercial Service, an organization that can resolve payment problems informally. If arbitration becomes necessary, the International Chamber of Commerce is the place to go. It handles most international arbitrations and is usually acceptable to foreign companies because it is not affiliated with any single country.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 184.
Business Etiquette and Travel
Having a successful global business requires getting to know the history, the culture, and the customs of the country or countries in which a business hopes to expand. Each country is different from another and the United States in some ways. Some of these differences have been discussed earlier in this chapter. Among the cultural differences to be faced are business styles, attitudes toward business relationships and punctuality, negotiating styles, gift-giving customers, greetings, the significance of gestures, the meanings of colors and numbers, and customs regarding titles. For example, engaging in small talk before conducting business is standard practice in Saudi Arabia, and gift giving is an important part of doing business in Japan.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 211.
Before traveling to the chosen country or countries, knowing any and all cultural differences is critical. It is also important to educate stateside employees who will be working with international customers.
Being successful in global operations will depend on the relationships that are built. The best way to build them is by traveling to the selected country. Travel there…but do so with the cultural knowledge and understanding that will allow the conduct of business without inadvertently offending a potential customer.
Video Link 15.11
Meet Your Customers: Traveling There
Building relationships for success in exporting businesses.
www.inc.com/exporting/travelingthere.htm
The Export Plan
After deciding to sell products or services abroad, a carefully researched export plan is a source of direction. An export plan helps a business act on—rather than react to—the challenges and risks encountered in global business. The plan will also help a business obtain financial assistance and find investors, strategic partners, and JV partners that may be needed for success.“10 Steps to Successful Exporting,” About.com, accessed February 7, 2012, sbinfocanada.about.com/od/canadaexport/a/10exportsteps.htm.
There are many elements of an export plan, including a description of the company; its market and industry; its objectives; information on its products or services; an analysis of the target market and industry, including trends and forecasts; an examination of competitors and their strengths and weaknesses; international marketing strategies, including customer profiling and the development of sales and distribution channels; employment and training issues; after-sales and customer service, and financial requirements and forecasts.“10 Steps to Successful Exporting,” About.com, accessed February 7, 2012, sbinfocanada.about.com/od/canadaexport/a/10exportsteps.htm. “Many companies launch their export activities haphazardly and are unsuccessful in their early efforts because of poor or no planning, which often leads them to abandon exporting altogether.”US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 18.
Video Link 15.12
Providing Good Customer Service
Small business owners talk about what they have learned by serving international customers.
www.inc.com/exporting/customerservice.htm
A business’s first export plan should be simple, only a few pages because important market data and planning elements may not be easily available or completely unavailable. The plan should be written and seen as a flexible management document, not a static document that sits on a shelf somewhere gathering dust. Objectives need to be compared against actual results, just as a business would do with its marketing plan and its overall business plan. A business should be open to revising the plan as necessary as new information becomes available and experience is gained.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 18.
Video Link 15.13
Creating an Export Business Plan
Small business owners agree that developing a strategic plan is the first step toward exporting success.
www.inc.com/exporting/businessplan.htm
KEY TAKEAWAYS
• Before taking a business global, desire to pursue export markets for good rather than frivolous reasons.
• Management commitment must be present for successful global operations.
• A business must decide on some kind of structure to handle its global side. It should be dedicated to ensuring that export sales are adequately serviced.
• Getting internal buy-in is critical.
• A business will need to select the best market(s) to enter. Although Canada, Japan, and Mexico are the largest markets for US products, these countries may not be the best markets for specific products or services.
• Tariffs and nontariff trade barriers can pose serious constraints.
• A business must decide how to enter a foreign market. For example, it can choose direct and indirect exporting, strategic alliances, JVs, and direct foreign investment.
• Being paid in full and on time is of obvious importance, especially considering the difficulties a business will encounter in collecting an unpaid international debt. The most secure method of payment is cash in advance. The least secure is an open account.
• Learning and understanding the business etiquette of the country or countries to which a business is exporting is a very important part of building business relationships.
• A carefully researched export plan is a source of direction, and it will help a business act on—rather than react to—the challenges and risks it will encounter in global business.
EXERCISE
1. Go to the Coca-Cola website (www.coca-cola.com/en/index.html) and select one website from each of the following geographic areas: Latin America, Europe, Eurasia, Africa, and Asia Pacific. Compare the home pages of these sites to the US home page—even though you will not understand the language (unless you are bilingual). Look at the graphics, layout, and uses of color. What are the similarities? What are the differences? To what would you attribute the differences? How would these similarities and differences inform the design of a small business website for conducting global business? | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/15%3A_Going_Global_-_Yes_or_No/15.04%3A_Key_Management_Decisions_and_Considerations.txt |
Learning Objectives
1. Understand how to contribute to customer value in exporting activities.
2. Explain how exporting can impact cash flow.
3. Explain how technology and the e-environment impact exporting.
Customer Value Implications
Always remember that customers make the decision about whether the appropriate value is present, and that value will always be as they perceive it. Carefully adapting a product to the targeted country for an exporting venture is an important first step in providing customer value. This means knowing about the sources of value in a product or a service and then acting on them. It can mean a minor product adaptation—for example, serving beer in McDonald’s in Germany or wine in McDonald’s in France and Italy—or a new twist on distribution—for example, Procter & Gamble selling shampoo in single-use tubes in newsstands in India. Although these are large-company examples, the experiences can be easily translated into small business exporting practice.
Another important source of customer value is the company website. Whether the website is the only selling platform of a business or is part of a brick-and-click exporting business, foreign buyers are much more likely to buy if a business’s website is in their language. Although translation and country-specific sites can be a costly proposition, the text, graphics, and colors of the website can either enhance or detract from an exporting business. A small business owner should find out what organizational services and website designers can provide assistance. It may be possible to link the website to the Google translation tool to get a rough translation in seconds.Anita Campbell, “How to Make Your Website Ready for International Business,” Small Business Trends, October 29, 2010, accessed February 7, 2012, smallbiztrends.com/2010/10/website-ready-international-business.html.
Once a sale is made, do not make the mistake of thinking that it is the end of the relationship between the business and an overseas customer. Providing after-sale service must be an integral part of a company’s export strategy from the very beginning.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 219. This service should include regular thank-yous for their business; a plan for regular communication; and offering customers 24/7 availability via some combination of fax, Twitter, e-mail alerts, a wiki, a Skype account, and telephone voicemail services where messages can be retrieved around the clock. This level of access will be of great value to foreign customers because it lets them know that you are reliable, dependable, ready to serve, and willing to minimize risk. It is this proper care and feeding of customers that will keep them coming back because the business provides value that makes it worth their while.Laurel Delaney, “Building Global Bonds One Customer at a Time,” Small Business Trends, June 27, 2008, accessed February 7, 2012, smallbiztrends.com/2008/06/global-customer-bonds.html.
There is something else to consider as well. Research has shown that global online shoppers demand live customer service, with this service being more important than price.“Webinar: Online Retail and the ROI of Live Help—Why Global Online Shoppers Demand Live Customer Service,” accessed February 7, 2012, www.retailcustomerexperience.com/whitepapers/2508/Webinar-Online-Retail-and -the-ROI-of-Live-Help-Why-Global-Online-Shoppers-Demand-Live-Customer-Service. This has implications not only for how customer service is designed for the targeted country for exports but for buyers from other countries as well.
Cash-Flow Implications
A small business exporter will face the same cash-flow challenges that affect any small business, but being an exporter presents additional cash-flow challenges that are unique to selling products overseas. One of these challenges comes from the value-added tax (VAT) in Europe. Having the proper VAT registration can be key because all non–European Union businesses must collect and remit the VAT on applicable transactions. A business is required to charge the VAT, and compliance requires periodic VAT filings, which means keeping VAT records on file and available for inspection by local tax authorities and anyone else who has reason and authority to inspect them. A failure to comply can result in significant penalties and cash-flow problems.Denise O’Berry, “Is Now the Time to Expand to Global Markets?,” AllBusiness.com, April 14, 2008, accessed February 7, 2012, www.allbusiness.com/company-activities-managements/company-strategy/8518731-1.html.
Shipping costs pose another threat to cash flow. Shipping products overseas is very expensive, with the fees sometimes being as high as the cost of shipping the merchandise itself. Add to that the differences in currencies and taxes, and a business is faced with the possibility of having to pay all or most of the shipping costs up front. While waiting for customers to pay, paying these costs will have a negative impact on cash flow.Anita Campbell, “How to Make Your Website Ready for International Business,” Small Business Trends, October 29, 2010, accessed February 7, 2012, smallbiztrends.com/2010/10/website-ready-international-business.html. Fortunately, there are cost-cutting approaches available. For example, Michael Katz, a small business owner who ships portfolio and art cases overseas, was able to reduce the extra expenses by negotiating a discount with UPS, cutting his shipping costs to 50 percent of the list rate.Elise Craig, “How to Get Your Small Business into the Export Game,” CBS Money Watch, March 3, 2011, accessed February 7, 2012, www.cbsnews.com/8301-505143_162-46540438/how-to-get-your-small-business-into-the-export-game.
Implications of Technology and the E-Environment
Inexpensive technology and the Internet have made it possible for small businesses to operate internationally with some of the same efficiencies as larger companies.Anita Campbell, “Preparing Your Business to Go Global,” Small Business Trends, November 19, 2010, accessed February 7, 2012, smallbiztrends.com/2010/11/preparing-your-business-to-go-global.html. The global reach of the Internet makes it cost-effective for small businesses to sell products and services overseas. Small businesses can broaden their presence internationally by adopting e-commerce and e-business practices that are user-friendly for non-English-speaking countries.US Department of Commerce, A Basic Guide to Exporting, 10th ed. (Washington, DC: International Trade Association, 2008), 219.
The small business owner can also look to several other sources of assistance for global endeavors. Consider the following three examples:
1. The self-service advertising product developed by Facebook gives small businesses an opportunity to reach a global audience.“Small Business News: The Global View,” Small Business Trends, January 18, 2011, accessed February 7, 2012, smallbiztrends.com/2011/01/small-business-news-the -global-view.html.
2. Shipping management software packages will automatically figure the costs and the delivery times for overseas orders, giving a close estimate. They also convert the currency for the buyer. Integrating this software into the website of a small business will provide a seamless experience for the customer, making an important contribution to customer value.Anita Campbell, “How to Make Your Website Ready for International Business,” Small Business Trends, October 29, 2010, accessed February 7, 2012, smallbiztrends.com/2010/10/website-ready-international-business.html.
3. The Internet and mobile devices lower information and communication costs, providing new channels of distribution and permitting 24/7 global reach through Twitter, wikis, e-mail alerts, and Skype.
KEY TAKEAWAYS
• A small business can offer customer value in its global activities by carefully adapting its products to the targeted country, having a website that caters to the language and culture of the buyers, and providing excellent after-sale service.
• The small business faces potential cash-flow problems from the VAT and shipping costs.
• Inexpensive technology and the Internet have made it possible for small businesses to operate internationally with some of the same efficiencies as larger companies.
EXERCISES
1. How can mobile devices be used to help the exporting operations of a small business?
2. How does the advertising product developed by Facebook work? How can it help increase the global reach of a small business? What are the costs for a small business?
Disaster Watch
Michael has been very successful with his exporting business. Instead of choosing Canada, Japan, or Mexico, the top three countries for small business exporting, he decided on Babalacala, a small country in the Middle East that has a history of political stability even though it has been ruled by one man for more than thirty-five years. The risk has been worth it so far. Michael identified the demand for his product, and he was right on target with his marketing research.
Michael has a small manufacturing plant that employs 150 locals and 5 people from the United States. He has successfully adapted his product to the local cultural, legal, and economic environments. His prices and promotion strategy are good fits, and his distribution structure—with some minor tweaking—is proving to be very efficient and effective. Needless to say, Michael and his investors are very happy campers.
But not for much longer.
Michael awakened one morning to a large-scale revolt against the current governor of Babalacala. The streets of the capital city were filled with protestors. Things were peaceful at first, but violence erupted in the afternoon. Many of Michael’s local workers left the factory to protest or because they were afraid. Telecommunications were out, transportation was spotty, and there was only intermittent power. Most of the local stores closed. The word on the street was that the protestors were in for the long haul. They planned to keep protesting until the current governor resigned or left the country.
What should Michael do? He has a lot of money, time, and passion invested in his exporting business, and there are investors to think about. He does not want to leave Babalacala, but this is a serious situation. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/15%3A_Going_Global_-_Yes_or_No/15.05%3A_The_Three_Threads.txt |
The following business plan for Frank’s All-American BarBeQue was built using Business Plan Pro software. It is for the purpose of illustration and does not represent the full capabilities of the software.
Frank’s All-American BarBeQue has operated for decades in the southern Connecticut shore region. With a tradition of superlative food at fair prices served in a family-friendly atmosphere, the owners now believe it is time to open a second restaurant and expand the production and the distribution of Frank’s signature barbecue sauces. This second restaurant will be in Darien, Connecticut, and will be nearly twice as large, in terms of seating capacity, as the current Fairfield restaurant. The company also plans to ramp up production of its sauces and increase their sales fourfold in the next three years.
Objectives
The owners of Frank’s All-American BarBeQue and other investors plan to put \$160,000 of their own money into the second restaurant and expand the production of the signature sauces. They seek to raise an addition \$175,000 from a bank loan that will be repaid in two years.
Vision Statement
To produce the best barbecue food in New England.
Mission Statement
The mission of Frank’s All-American BarBeQue is to provide the southern Connecticut shore region with the finest barbecue food in four major regional styles at affordable prices in a family-friendly setting. As we grow, we will never forget and remain faithful to those factors that have made us a success.
Keys to Success
Frank’s All-American BarBeQue has been in business for nearly forty years. It has weathered good times and bad times through all types of economic conditions. We have survived because Frank’s has remained committed to several principles.
• The only objective of a restaurant is to serve the finest food it can prepare. Good food—not more gimmicks or advertising—brings in customers and, more importantly, keeps customers.
• Preparing the finest foods means a commitment to excellence, which means obtaining the best ingredients and a dedication to cooking barbecue properly, which means cooking carefully and slowly.
• In addition to providing the finest food, we remain committed to providing excellent service. To us, this means friendly and knowledgeable staff members who make the customers feel like they are dining with family.
• We provide the right atmosphere. Our goal is to have a setting that says “barbecue.” We do not provide a fancy setting; our basic setting complements the food we serve.
Company Summary
Frank’s All-American BarBeQue has been a highly successful restaurant in Fairfield, Connecticut, for nearly forty years. It was started and is still managed by Frank Rainsford. Its food and sauces have won awards at both regional and national barbecue cook-offs. In addition, Frank’s has been voted the best barbecue establishment in Connecticut numerous times by many local newspapers and magazines.
The management team of Frank’s All-American BarBeQue has decided that now is the time to expand to an additional location. After careful analysis, a second Frank’s All-American BarBeQue can and should be opened in Darien, Connecticut. This restaurant will be larger and geared to better tap into the growing premade, take-home dinner market.
In the last few years, Frank’s has been selling its four signature barbecue sauces—Texan, Memphis, Kansas City, and Carolina—in local supermarkets. Although this represents a small portion of overall revenues, sales have been growing at a remarkable pace. This market must be exploited. Preliminary market research indicates that this segment of the business will grow at 20 percent per year for the next five years.
Company Ownership
Presently, Frank’s All-American BarBeQue is a limited liability partnership with Frank Rainsford and his wife Betty as owners. Each has a 50 percent share in the business.
The plans for expansion will bring in capital from three other investors: Robert Rainsford, Susan Rainsford Rogers, and Alice Jacobs. Robert Rainsford and Susan Rainsford Rogers are the son and daughter of Frank and Betty. Both have extensive work experience at Frank’s. Alice Jacobs has been the restaurant’s accountant for over twenty years.
To assist the financing of the expansion, Robert Rainsford and Susan Rainsford Rogers will each invest \$50,000, while Alice Jacobs will invest \$60,000.
The new limited liability partnership will result in the investors holding the following equity percentages:
Frank Rainsford 40.00%
Betty Rainsford 40.00%
Robert Rainsford 6.25%
Susan Rainsford Rogers 6.25%
Alice Jacobs 7.50%
Company History
Frank’s All-American BarBeQue was founded in 1972 by Frank Rainsford. Although a native New Englander, Frank learned about cooking barbecue while serving in the US Air Force. During his twelve years of service, he traveled across the country and learned about the four major styles of American barbecue—Texas, Memphis, Kansas City, and Carolina. His plan was to introduce people in southern Connecticut to real barbecue that entailed high-quality meats properly cooked and smoked over an appropriate length of time.
In the beginning, Frank’s All-American BarBeQue was a small facility; it could seat about thirty people. It was located near the Fairfield railroad station and was the first full-service barbecue restaurant in Fairfield. Frank’s placed an emphasis on featuring the food; it had a highly simplified decor where the tables were covered with butcher paper, not linen tablecloths. The restaurant was an immediate hit, received considerable local press, and won several food awards. This success enabled Frank’s to move to a larger facility in Fairfield on the town’s main thoroughfare—Boston Post Road. The new location was a midsize restaurant of about eighty seats. Frank has built this location into a relatively successful and locally well-known enterprise. It has been at the present location since the early 1980s. It shares a parking lot with several other stores in the small mall in which it is located.
Frank’s has won many awards at regional and national barbecue cook-offs (for both the food and the sauces), which is unusual for a barbecue business in New England. The restaurant has been written up, repeatedly, in the local and New York papers for the quality of its food and its four signature barbecue sauces. In the last few years, Frank’s has sold small lots of these sauces in local supermarkets. They have been distributed because of Frank’s personal connections with the store managers. Frank Rainsford has been approached by a major regional supermarket to sell his sauces. The supermarket is willing to find a facility that could produce Frank’s sauces in significantly larger volumes, which would represent a substantial increase in the sales of sauces. Table \(1\) provides a summary of key financial figures for the last three years—2008 to 2010. Table \(1\) illustrates these key numbers for that period of time.
Table \(1\): Past Performance of Frank’s All-American BarBeQue
Past Performance 2008 2009 2010
Sales \$1,637,610 \$1,696,564 \$1,793,268
Gross margin \$851,557 \$909,358 \$943,259
Gross margin % 52.00% 53.60% 52.60%
Operating expenses \$542,080 \$577,315 \$600,408
Inventory turnover 13.20 12.10 12.90
Balance Sheet
Current Assets
Cash \$102,665 \$125,172 \$102,665
Inventory \$391,238 \$331,045 \$345,678
Other current assets \$278,372 \$230,074 \$278,372
Total current assets \$772,275 \$686,291 \$726,715
Long-Term Assets
Long-term assets \$504,580 \$388,820 \$423,675
Accumulated depreciation \$180,856 \$135,739 \$145,765
Total long-term assets \$323,724 \$253,081 \$277,910
Total assets \$1,095,999 \$939,372 \$1,004,625
Current Liabilities
Accounts payable \$155,534 \$132,206 \$145,321
Current borrowing \$170,000 \$150,000 \$135,000
Other current liabilities (interest free) \$81,888 \$63,972 \$74,329
Total current liabilities \$407,422 \$346,178 \$354,650
Long-term liabilities \$220,000 \$190,000 \$175,000
Total liabilities \$627,422 \$536,178 \$529,650
Paid-in capital \$75,000 \$75,000 \$75,000
Retained earnings \$281,838 \$234,377 \$287,114
Earnings \$111,739 \$93,817 \$112,861
Total capital \$468,577 \$403,194 \$474,975
Total capital and liabilities \$1,095,999 \$939,372 \$1,004,625
Other Inputs
Payment Days 30 30 30
Company Locations and Facilities
Frank’s All-American BarBeQue has been in Fairfield, Connecticut, for decades. It has a reputation throughout the southern Connecticut shore region for excellent food and has received numerous awards. The management team determined that a second location could tap into this local name recognition. Several towns in the region were evaluated for total population, population density, family income, and home value. These factors were considered because of their impact on generating traffic and consumers being able to pay for meals that are priced slightly higher than typical fast-food outlets. In addition, the average family size and the percentage of family households were considered because Frank’s is a family restaurant. Lastly, data were gathered on the average travel time to and from work for residents and the real estate tax rate. Because the new location of Frank’s will emphasize prepared meals, we felt that individuals with longer commutes would be more likely to order meals and pick them up at Frank’s. A summary of these data is provided in Table 1\(2\)".
After thorough analysis, it was concluded that Darien, Connecticut, would be the best location for the new branch of Frank’s All-American BarBeQue. It has a high-income population and a high population density, and a large percentage of its inhabitants are members of family households. They have longer commuting times, which increase the potential need for prepared meals.
Table \(2\): Demographic Data for Selected Connecticut Towns—Part 1
Item Fairfield Westport Easton Darien Norwalk
Population 57,578 25.884 7,383 19,375 83,802
Population density 1,917 1,293 269 1,508 3,675
Income \$108,209 \$155,322 \$162,688 \$180,474 \$79,693
House value \$589,179 \$1,169,081 \$868,622 \$1,430,589 \$504,100
Percentage of family households 72.6% 74.6% 84.3% 81.7% 64.1%
Travel time (minutes) 31.3 39.4 34.8 36.4 25.4
Real estate tax rate 1.3% 0.9% 1.3% 0.8% 1.1%
Family size 3.07 2.70 3.0 3.0 2.50
Table \(3\): Demographic Data for Selected Connecticut Towns—Part 2
Item Stamford Weston Wilton Trumbull State of Connecticut
Population 121,026 10,199 17,771 34,422 3,574,097
Population density 3,206 515 659 478 739/sq. mile
Income \$81,206 \$190,080 \$183,252 \$103,019 \$68,595
House value \$612,900 \$1,198,615 \$1,044,316 \$492,623 \$306,000
Percentage of family households 63.8% 84.9% 82.3% 81.5% 67.7%
Travel time (minutes) 24.0 41.6 39.2 27.1
Real estate tax rate 0.7% 1.1% 1.2% 1.5% 1.8%
Family size 2.50 3.0 3.25 2.80
A specific location has been identified in Darien for the second Frank’s All-American BarBeQue. It is in a small mall and is large enough to have a seating capacity of 150–160 plus takeout facilities. The mall has more than adequate parking for future customers. The mall is located three blocks from the Metro-North Darien railroad station and is four blocks from the I-95 exit. It is therefore well positioned to attract traffic from both car and rail commuters. The lease fee for a three-year contract is very reasonable for a property of this size.
Products and Services
Frank’s All-American BarBeQue specializes in the finest barbecue served in a family-friendly format. It uses the finest cuts of meats that are free of any growth hormones. It is known for a variety of slow-smoked and slow-cooked meats, such as ribs, beef, pulled pork, and chicken. These are served with Frank’s famous and award-winning sauce varieties, which represent the four major styles of barbecue cooking. Frank’s is also noted for its side dishes and desserts.
Our goal is to expand operations to a second location in Darien, Connecticut. This outlet will be significantly larger and will have a section devoted to takeout meals.
Competitive Comparison
There are approximately forty specialty barbecue restaurants in Connecticut. They are spread throughout the state, but only four (including Frank’s All-American BarBeQue) are in the southern shore region. The three competitors are smaller operations. None of the barbecue restaurants in Connecticut have the history, reputation, acclaim, or awards that match Frank’s All-American BarBeQue. It is not an exaggeration to say that Frank’s is the preeminent barbecue restaurant in Connecticut. It has a loyal following that reaches as far as New York City.
Frank’s is the only barbecue restaurant in Connecticut where supermarkets are vying for the right to market Frank’s signature barbecue sauces. This sideline business promises to be extremely profitable and support the overall marketing efforts for both locations of Frank’s All-American BarBeQue.
Fulfillment
Frank’s All-American BarBeQue has always been committed to providing the absolute best in barbecue food. This has meant assuring the highest quality ingredients in food preparation. Frank has established a decades-long relationship with suppliers in the New York and Connecticut areas. He selects nothing but the choicest selections of beef, pork, and chicken. He has always made sure that his meats come from suppliers who are committed to quality ingredients and who never use growth hormones. This long-term relationship with a variety of key suppliers enables Frank to secure the best cuts at reasonable prices. Frank is equally careful in using the finest spices for his barbecue sauces. The same is true for all the side dishes that Frank’s All-American BarBeQue offers its customers.
This commitment to quality is not limited to the selection of meats and ingredients. Frank and his staff recognize that top-quality barbecue food requires a knowledgeable and deep commitment to cooking the food properly. All meats must be cooked and smoked slowly. This requires time, effort, expense, and commitment, but the results are spectacular. Some cuts of meat at Frank’s may require as many as eleven hours of preparation and cooking. Excellence is not achieved without a commitment to effort. This effort has been recognized with numerous awards at national barbecue cook-offs. Frank has clearly recognized that the meal is clearly a function of the quality of the meat, quality ingredients, and careful preparation.
Future Products and Services
Frank’s All-American BarBeQue is ready to accept new challenges. Opening a second restaurant will significantly increase sales, but the second location is only the beginning of new directions for Frank’s. Although Frank has been selling his regional barbecue sauces in local outlets for years, he is now ready to sign a contract with a major regional supermarket chain to market and sell these sauces throughout New England. Preliminary studies indicate that Frank can anticipate a 20 percent annual growth rate in the sales of sauces for the next five years.
With the growth of two-income families, less and less time is available to prepare meals at home. Recognizing this simple fact, Frank’s All-American BarBeQue plans to offer a variety of prepackaged barbecue meals that can be picked up at the restaurant and reheated at home. As part of its new commitment to a web-based presence, customers will be able to order these meals by regular phone, with smartphones, or through the Internet. Customers will be able to select from a list of prepackaged dinner meals or any combination of items. Customers can designate the time to pick up the meals, and the meals will be ready for them. This service promises significant revenue growth.
Market Analysis Summary
Since the 1930s, the American public has spent at least 5 percent of its disposable income on eating out. Even with annual fluctuations, this is a strong indicator of the viability of this industry. This can be best illustrated by reviewing industry results for the last few years.
Both 2009 and 2010 were difficult years for the restaurant industry. In 2008, sales increased by 3.8 percent. However, sales fell by nearly 0.75 percent in 2009. This was the first year in the history of the industry that sales actually declined. The restaurant industry’s sales in 2009 were \$566 billion, down from over \$570 billion. Prices rose by 2.2 percent in 2009. The increase in sales for 2010 was 0.5 percent, and price increases stabilized at 0.75 percent.
It is anticipated that there will be significant price competition in every segment of the restaurant industry. Some analysts argued that the poor performances for the restaurant industry in both 2009 and 2010 could be attributed to declines in both business and personal travel. Hotel occupancy rates in 2009 were down by nearly 10 percent. A study conducted by the National Restaurant Association argued that 20 percent of the sales in casual dining restaurants might be due to travelers and visitors. Frank’s All-American BarBeQue relies to a far lesser extent on travelers as customers. A rough estimate based on credit card receipts, for the period 2006–2010, indicated that travelers represented less than 2 percent of Frank’s sales. The pressure on the restaurant industry has been felt by many chain restaurants, which significantly curtailed their expansion plans.
Even though the recession was in full bloom in 2009, many food prices rose and rose significantly. Beef prices rose between 4 percent and 12 percent, while pork prices rose between 5 percent and 13 percent. Numerous studies have indicated that the increase in commodity prices will not be a transitory phenomenon.
With 925,000 food service locations in operation in the United States, this translates into 1 restaurant for every 330 Americans.
The health-care reform bill passed in 2010 should, in the near future, provide some relief for restaurants by creating a system that will assume greater responsibility by individuals to pay for their own health-care coverage.
Restaurants must also be much more cautious in the future about the possibility of hiring illegal aliens. As a whole, the National Restaurant Association supports immigration reform. However, it is concerned that any legislation should not limit a restaurant’s ability to hire workers. It is also concerned about the cost to assure worker eligibility.
The Mintel Group, a market research firm, found that consumers who are interested in quality opt for independent restaurants over chain outlets. An increasing consumer focus on health translates into an emphasis on natural ingredients. In the barbecue industry, this translates into naturally raised meats (i.e., the avoidance of artificial growth hormones in cattle), which are a hallmark of Frank’s All-American BarBeQue.
The National Restaurant Association estimated that sales in full-service restaurants in 2010 would exceed \$184 billion—an increase of 1.2 percent from 2009 sales.
Several macroeconomic factors make opening a restaurant in Darien attractive, including the following:
• Increases in the growth domestic product (GDP). The GDP is estimated to grow 1.7 percent in 2011 and 1.5 percent in 2012. The estimates for Fairfield County are significantly higher.
• Disposable personal income. The national level of personal income should rise nearly 4 percent in 2011, and there is an expectation of 3 percent growth in 2012. These numbers appear to be much stronger in the Fairfield County area.
Although 2010 was not a banner year for the restaurant industry—it was one where more restaurants closed than opened each month—there was one bright spot: Chain barbecue restaurants grew between 2 percent and 3 percent—an auspicious sign even for independent operators.
The home meal replacement market and the existing investment in restaurant equipment provide a nice growth opportunity for restaurants. It is been estimated that takeout sales in limited service chain restaurants might be as large as 60 percent of total sales. The same study found that takeout food has been growing twice as fast as the overall restaurant industry. Natural competitors in this market are supermarkets that offer prepackaged meals. However, we feel that few—if any—supermarkets provide the quality barbecue food that can be found at Frank’s.
Market Segmentation
Frank’s All-American BarBeQue views its major market segment as suburbanites in the south shore region of Connecticut. One way of further segmenting the market is by the type of meal being provided.Table \(4\): Market Analysis provides estimated growth rates for each type of meal (plus sauce sales) and projected number of meals (and jars of sauce) for the period 2011 to 2015. Figure \(2\) illustrates the relative contributions.
Table \(4\): Market Analysis
Potential Customers Growth 2011 2012 2013 2014 2015
Lunch 8% 17,000 18,275 19,646 21,119 22,703
Dinner 5% 40,000 42,000 44,100 46,305 48,620
Takeout 20% 10,000 12,000 14,400 17,280 20,736
Sauces 15% 12,000 13,800 15,870 18,251 20,989
Total 9.37% 79,000 86,075 94,016 102,955 113,048
Market Needs
We believe that the market centers on excellent barbecue food served at reasonable prices and served in a family-friendly manner. We further believe that a growing segment of the market will want prepared meals that can be conveniently picked up and served at home. Table 16.4 "Market Analysis" provides a projected breakdown of the potential customers for the next five years. This breakdown is predicated on the type of meals served and includes the sale of sauces. We provide estimated growth rates and forecasted sale of meals (and bottles of sauces) for the period 2011 to 2015. Figure 16.2 "Market Analysis" shows the breakdown of the number of meals by type in 2015.
Web Plan Summary
Presently, Frank’s All-American BarBeQue has a very simple website. The website provides minimal information—listing some of the menu items and the restaurant’s telephone number. It was created eight years ago by a college student who was working at Frank’s.
Robert Rainsford’s professional expertise is in the area of website development. After graduating from college, Robert was hired by a firm that specialized in developing web and social media presences for other companies. He worked for that firm in New York City for seven years. Robert rose rapidly through the company’s ranks, eventually becoming one of its vice presidents. His expertise in this area will enable Frank’s All-American BarBeQue to significantly enhance its web presence. Rather than just having a website that identifies the restaurant’s location and telephone number, along with a brief summary of its menu, the new website will be far richer in content and capability. It will provide a complete menu listing, identifying all items with corresponding images. The new website will enable customers to place orders through the Internet for lunch, dinner, or takeout items. The section devoted to takeout items will enable a customer to purchase prepared meals or choose from all items on the menu to develop a prepackaged meal. Customers will be able to identify the time that they will arrive for the pickup.
The website will have links to the Facebook and Twitter accounts of Frank’s All-American BarBeQue. These connections will enhance its social media presence. Customers will be asked to post comments about their dining experience and suggestions on how Frank’s can improve its operations and service. It will enable Frank’s to expand operations and still maintain the same close customer relationship that currently exists at the Fairfield restaurant.
Website Marketing Strategy
The new web presence for Frank’s All-American BarBeQue will be geared to developing a new level of customer relationships. Customers at both restaurants will be asked to fill out forms where they will supply an e-mail address and a birthdate. (This information can also be supplied through Frank’s new website.) This information will enable Frank’s to keep customers informed of specials and offer coupons and the new rewards card program for special occasions, such as holidays or birthdays.
We view the website of Frank’s All-American BarBeQue as a major component of enhancing our relationship with our customers. It should provide convenience to customers through their ability to see what is on the menu, identify new specials, and order meals and pick them up at their convenience. The use of social media will expand awareness of Frank’s and enable it to develop closer relationships with present and future customers.
Development Requirements
Robert Rainsford tapped into his expertise in social media and has already developed a far more sophisticated website for Frank’s All-American BarBeQue. He has secured the necessary server capacity to handle additional traffic on the website. In addition, he has set up several social media accounts for Frank’s All-American BarBeQue, including Facebook and Twitter. Robert also created a program linked to a database that will monitor customer purchases through the rewards card program. This program will send out birthday notices and discounts to customers and will inform them of their current status in the rewards card program.
Robert contacted several former colleagues at his former place of employment and has identified several candidates for the role of website manager. This individual will be responsible for updating the website and the social media sites on a daily basis. He or she will also be responsible for analyzing the flow of information that comes through these sites and preparing management reports.
Strategy and Implementation Summary
The core strategy of Frank’s All-American BarBeQue is to continue what has made it a success at a new location. Simply put, our strategy is to provide our customers with the finest barbecue food in Connecticut, at reasonable prices, in a family-friendly environment. In addition, we hope to improve our ability to meet customer needs by making life more convenient for our customers. We believe that these fundamentals are universally applicable.
SWOT Analysis
A strengths, weaknesses, opportunities, and threats (SWOT) analysis was undertaken for Frank’s All-American BarBeQue.
Strengths
The key strength of Frank’s All-American BarBeQue is the quality of its food and service. It has been the recipient of numerous local and national awards for its foods and sauces. Other strengths include a highly knowledgeable management team with expertise in operating a barbecue restaurant, a close working relationship with suppliers of premier cuts of meats, and a loyal clientele in the south shore region.
Weaknesses
The weaknesses associated with this business plan center on operating an additional restaurant with a much larger capacity than the Fairfield, Connecticut, restaurant. The second location will require an experienced restaurant manager. This plan calls for a significant increase in prepared (takeout) meals. Orders will be placed either by phone or through the website. Current personnel have little experience in ratcheting up the takeout portion of the business.
Opportunities
This business plan offers significant opportunities for Frank’s All-American BarBeQue. A second, larger location will translate into a significant increase in sales. Finalizing a business relationship with the regional supermarket chain will enable Frank’s to significantly increase the production and the sales of its signature sauces. The sales of sauces are expected to increase by 20 percent per year for the next five years.
Threats
Any expansion with the opening of a new location always entails some risk. The principals of Frank’s All-American BarBeQue will be investing a significant amount of capital and will be borrowing money from a bank to open a second location. It is strongly believed that the second location will capitalize on the success of the Fairfield restaurant and will become a success.
Competitive Edge
The competitive edge of Frank’s All-American BarBeQue resides mainly in the quality of its food and its commitment to serve the food in a family-friendly environment. The quality of its food is unmatched in the entire state. No other barbecue restaurant has received the awards and the accolades that Frank’s All-American BarBeQue has received for the past forty years. Its reputation for quality gives it an edge that no other barbecue restaurant or chain can match.
Marketing Strategy
The target market for Frank’s All-American BarBeQue is essentially suburban families in the south shore region of Connecticut. These people appreciate the finest barbecue food at reasonable prices. It is expected that an important group within this target market will be families with two incomes whose busy schedules would make prepared meals a very attractive option. We further assume that this market is technically sophisticated and will appreciate the convenience of ordering these meals via the Internet.
A key component of the marketing strategy of Frank’s All-American BarBeQue is to use the Internet and technology to enhance the relationship with its customer base. Frank’s will use the website, Facebook, Twitter, and e-mails to inform customers of special food items or discounts based on holidays and customers’ birthdays. We intend to use the website as a mechanism to gain an improved insight into customer needs and wants.
Frank’s All-American BarBeQue will also initiate a rewards card program. Customers will sign up for the rewards card program either at the two locations or online. They can use this program every time they make a purchase either at the restaurants or online. After a set number of visits (seven), customers will be entitled to either discounts or free items. The rewards card program will enable Frank’s All-American BarBeQue to track customers’ buying patterns and anticipate the ways in which they can better serve their customers.
Sales Forecasts
We provide a five-year forecast of the dollar value of sales broken down by the two restaurants and the sauces in Table \(5\) illustrates a forecast for the breakdown of sales on monthly basis in 2011, and Figure \(4\) illustrates the breakdown of sales for the next five years.
Table \(5\): Sales Forecast
Sales 2011 2012 2013 2014 2015
Frank’s (Fairfield) \$1,907,183 \$1,954,863 \$2,003,734 \$2,053,827 \$2,105,173
Frank’s (Darien) \$2,222,000 \$2,555,300 \$2,810,830 \$3,091,913 \$3,401,104
Sauces \$62,500 \$75,000 \$90,000 \$108,000 \$130,000
Total sales \$4,191,683 \$4,585,163 \$4,904,564 \$5,253,740 \$5,636,277
Direct Cost of Sales 2011 2012 2013 2014 2015
Frank’s (Fairfield) \$953,594 \$977,430 \$1,001,867 \$1,026,914 \$1,052,587
Frank’s (Darien) \$1,111,000 \$1,277,650 \$1,405,415 \$1,545,957 \$1,700,552
Sauces \$31,250 \$37,500 \$45,000 \$54,000 \$64,800
Subtotal direct cost of sales \$2,095,844 \$2,292,580 \$2,452,282 \$2,626,871 \$2,817,939
Figure 16.3 Monthly Sales for Two Restaurants and Sauces
Management Summary
Currently, Frank Rainsford is the CEO and chief operating officer of Frank’s All-American BarBeQue. He is also the restaurant manager at the Fairfield restaurant. During the week, his daughter (Susan Rainsford Rogers) often replaces Frank as the restaurant manager. The Fairfield restaurant has a full-time cook who operates under Frank’s supervision, and two other full-time employees function as waiters and waitresses. These full-time employees are supplemented by six part-time employees.
Under the new management structure, Frank Rainsford will hold the position of CEO. His wife, Betty Rainsford, will be designated the president and chief operating officer. Their daughter, Susan Rainsford Rogers, will be given the title vice president for operations. She will be responsible for the day-to-day operations of the Darien, Connecticut, restaurant. Robert Rainsford will have the title of vice president of marketing. He will be responsible for all marketing activities and the operation of the website. Alice Jacobs will be the vice president of finance and the comptroller of Frank’s All-American BarBeQue.
Organizational Structure
The new management structure of Frank’s All-American BarBeQue is a basic functional layout appropriate for this type of business and is shown in Figure \(5\).
Personnel Plan
Table \(6\) is a five-year breakdown of the types and costs of personnel.
Table \(6\) Forecasts of Personnel
Personnel Plan 2011 2012 2013 2014 2015
Cooks Personnel
Cook (Fairfield) \$54,000 \$54,600 \$55,000 \$55,500 \$56,000
Cook (Darien) \$66,000 \$66,000 \$66,500 \$67,000 \$67,500
Subtotal \$120,000 \$120,600 \$121,500 \$122,500 \$123,500
Servers Personnel
Full-time servers (Fairfield) \$28,800 \$28,800 \$16,000 \$17,500 \$18,000
Full-time servers (Darien) \$57,600 \$57,600 \$24,500 \$25,000 \$2,600
Part-time servers both locations \$192,000 \$192,000 \$192,000 \$192,000 \$192,000
Subtotal \$278,400 \$278,400 \$232,500 \$234,500 \$212,600
General and Administrative Personnel
Restaurant manager (Fairfield) \$42,000 \$42,000 \$43,000 \$43,500 \$44,000
Restaurant manager (Darien) \$54,000 \$54,600 \$56,000 \$56,500 \$57,000
Subtotal \$96,000 \$96,600 \$99,000 \$100,000 \$101,000
Total people 39 39 39 39 39
Total payroll \$494,400 \$495,600 \$453,000 \$457,000 \$437,100
Financial Plan
Frank’s All-American BarBeQue will be financing the creation of a second restaurant through a combination of private investment and a bank loan. The private investment will raise \$160,000, and Frank’s will seek another \$175,000 as a two-year loan. These funds will be used to pay for equipment and leasing expenses associated with opening a second restaurant.
Important Assumptions
The assumptions associated with the grow rates of sales each year for the next five years are the keys to the financial planning process. We began with very modest assumptions of 8 percent growth in lunch sales and 5 percent growth in dinner sales. We anticipate fairly vigorous growth in takeout meals (20 percent) and sauces (15 percent). Although these are large growth rates, we do not feel that they are unrealistic.
Key Financial Indicators
Figure \(6\) provides historical (2008–2010) and forecasted (2011–2015) values for the key financial indicators.
Breakeven Analysis
InTable \(7\) and Figure \(7\), we show the results of our breakeven analysis for Frank’s All-American BarBeQue. The results indicate that with sales of approximately \$110,000 each month, Frank’s All-American BarBeQue will break even.
Table \(7\): Breakeven Analysis
Monthly revenue \$112,627
Assumptions
Average variable cost 50%
Estimated monthly fixed cost \$56,313
Projected Profit and Loss
Our analysis anticipates significant growth in profits in the next five years with the opening of a second Frank’s All-American BarBeQue in Darien. The profit margins should increase from in excess of \$850,000 in 2011 to nearly \$1,600,000 by 2015 and should be in excess of 20 percent for all five years. A complete analysis of the profit and loss statements is in Table \(8\). The annual profits are illustrated in Figure \(8\)".
Table \(8\): Profit and Loss
Pro Forma Profit and Loss 2011 2012 2013 2014 2015
Sales \$4,191,683 \$4,585,163 \$4,904,564 \$5,253,740 \$5,636,277
Direct cost of sales \$2,095,844 \$2,292,580 \$2,452,282 \$2,626,871 \$2,817,939
Cooks payroll \$120,000 \$120,600 \$121,500 \$122,500 \$123,500
Other costs of sales \$0 \$0 \$0 \$0 \$0
Total cost of sales \$2,215,844 \$2,413,180 \$2,573,782 \$2,749,371 \$2,941,439
Gross margin \$1,975,839 \$2,171,983 \$2,330,782 \$2,504,369 \$2,694,838
Gross margin % 47.14% 47.37% 47.52% 47.67% 47.81%
Operating Expenses
Servers payroll \$278,400 \$278,400 \$232,500 \$234,500 \$212,600
Advertising/promotion \$0 \$0 \$0 \$0 \$0
Other servers expenses \$0 \$0 \$0 \$0 \$0
Total servers expenses \$278,400 \$278,400 \$232,500 \$234,500 \$212,600
Servers % 6.64% 6.07% 4.74% 4.46% 3.77%
General and Administrative Expenses
General and administrative payroll \$96,000 \$96,600 \$99,000 \$100,000 \$101,000
Marketing/promotion \$12,000 \$0 \$0 \$0 \$0
Depreciation \$0 \$0 \$0 \$0 \$0
Rent \$180,000 \$0 \$0 \$0 \$0
Utilities \$13,200 \$0 \$0 \$0 \$0
Insurance \$22,000 \$0 \$0 \$0 \$0
Payroll taxes \$74,160 \$74,340 \$67,950 \$68,550 \$65,565
Other general and administrative expenses \$0 \$0 \$0 \$0 \$0
Total general and administrative expenses \$397,360 \$170,940 \$166,950 \$168,550 \$166,565
General and administrative % 9.48% 3.73% 3.40% 3.21% 2.96%
Other Expenses
Other payroll \$0 \$0 \$0 \$0 \$0
Consultants \$0 \$0 \$0 \$0 \$0
Other expenses \$0 \$0 \$0 \$0 \$0
Total other expenses \$0 \$0 \$0 \$0 \$0
Other % 0.00% 0.00% 0.00% 0.00% 0.00%
Total operating expenses \$675,760 \$449,340 \$399,450 \$403,050 \$379,165
Profit before interest and taxes \$1,300,079 \$1,722,643 \$1,931,332 \$2,101,319 \$2,315,673
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) \$1,300,079 \$1,722,643 \$1,931,332 \$2,101,319 \$2,315,673
Interest expense \$43,755 \$34,995 \$30,980 \$30,980 \$30,980
Taxes incurred \$376,897 \$506,294 \$570,106 \$621,102 \$685,408
Net profit \$879,427 \$1,181,354 \$1,330,246 \$1,449,237 \$1,599,285
Net profit/sales 20.98% 25.76% 27.12% 27.58% 28.37%
Projected Cash Flow
Table \(9\) is a five-year forecast of cash flows for Frank’s All-American BarBeQue. The forecast shows extremely strong and positive cash flows for each year.
Table \(9\): Cash Flow Forecast
Pro Forma Cash Flow
Cash Received 2011 2012 2013 2014 2015
Cash from Operations
Cash sales \$4,191,683 \$4,585,163 \$4,904,564 \$5,253,740 \$5,636,277
Subtotal cash from operations \$4,191,683 \$4,585,163 \$4,904,564 \$5,253,740 \$5,636,277
Subtotal cash received \$4,366,683 \$4,585,163 \$4,904,564 \$5,253,740 \$5,636,277
Expenditures 2011 2012 2013 2014 2015
Expenditures from Operations
Cash spending \$494,400 \$495,600 \$453,000 \$457,000 \$437,100
Bill payments \$2,500,504 \$2,911,392 \$3,085,406 \$3,338,682 \$3,587,794
Subtotal spent on operations \$2,994,904 \$3,406,992 \$3,538,406 \$3,795,682 \$4,024,894
Other liabilities principal repayment \$54,000 \$54,000 \$54,000 \$0 \$0
Long-term liabilities principal repayment \$87,600 \$87,600 \$0 \$0 \$0
Subtotal cash spent \$3,296,504 \$3,548,592 \$3,592,406 \$3,795,682 \$4,024,894
Net cash flow \$1,070,179 \$1,036,571 \$1,312,158 \$1,458,058 \$1,611,383
Cash balance \$1,172,844 \$2,209,415 \$3,521,573 \$4,979,631 \$6,591,014
Projected Balance Sheet
Table \(10\) is a balance sheet forecast for Frank’s All-American BarBeQue.
Table \(10\) Balance Sheet Forecast
Pro Forma Cash Flow
Assets 2011 2012 2013 2014 2015
Current Assets
Cash \$1,172,844 \$2,209,415 \$3,521,573 \$4,979,631 \$6,591,014
Inventory \$72,421 \$79,197 \$109,296 \$117,245 \$125,954
Other current assets \$278,372 \$278,372 \$278,372 \$278,372 \$278,372
Total current assets \$1,523,636 \$2,566,983 \$3,909,241 \$5,375,249 \$6,995,341
Long-Term Assets
Long-term assets \$583,675 \$583,675 \$583,675 \$583,675 \$583,675
Accumulated depreciation \$145,765 \$145,765 \$145,765 \$145,765 \$145,765
Total long-term assets \$437,910 \$437,910 \$437,910 \$437,910 \$437,910
Total assets \$1,961,546 \$3,004,893 \$4,347,151 \$5,813,159 \$7,433,251
Liabilities and Capital 2011 2012 2013 2014 2015
Current Liabilities
Accounts payable \$189,416 \$193,009 \$259,021 \$275,791 \$296,597
Current borrowing \$135,000 \$135,000 \$135,000 \$135,000 \$135,000
Other current liabilities \$20,329 (\$33,671) (\$87,671) (\$87,671) (\$87,671)
Subtotal current liabilities \$344,745 \$294,338 \$306,350 \$323,120 \$343,926
Long-term liabilities \$262,400 \$174,800 \$174,800 \$174,800 \$174,800
Total liabilities \$607,145 \$469,138 \$481,150 \$497,920 \$518,726
Paid-in capital \$75,000 \$75,000 \$75,000 \$75,000 \$75,000
Retained earnings \$399,975 \$1,279,402 \$2,460,755 \$3,791,002 \$5,240,239
Earnings \$879,427 \$1,181,354 \$1,330,246 \$1,449,237 \$1,599,285
Total capital \$1,354,402 \$2,535,755 \$3,866,002 \$5,315,239 \$6,914,524
Total liabilities and capital \$1,961,546 \$3,004,893 \$4,347,151 \$5,813,159 \$7,433,251
Net worth \$1,354,402 \$2,535,755 \$3,866,002 \$5,315,239 \$6,914,524
These figures clearly demonstrate that the proposed opening of a second restaurant is more than economically viable; it is an extremely lucrative project that promises to increase the net worth of the firm by 500 percent in five years. | textbooks/biz/Management/Small_Business_Management_in_the_21st_Century/16%3A_Appendix_-_A_Sample_Business_Plan/16.01%3A_Executive_Summary.txt |
Learning Objectives
• Explain the building lifecycle
• Define sustainable property management
• Identify the three spheres of sustainability
• Understand the role of real estate in sustainability
• Explain why sustainable property management matters
• Identify what’s driving sustainable property management
• Describe the main barriers of sustainable property management
1.1 Introduction
Every building has a lifecycle that begins with the initial idea conception and continues all the way through to the building’s eventual demolition, as illustrated in figure 1.1. Green building initiatives, defined as actions undertaken to minimize the environmental impact of a building, can be implemented throughout the building lifecycle. This textbook focuses on the operations and maintenance phase of the building lifecycle although there are certainly benefits in greening the building lifecycle in its entirety. Property management takes place during the operations and maintenance building lifecycle phase and includes functions such as human resources, relationship management, finance, accounting, maintenance, repairs, risk management, marketing, and leasing. So while greening property management functions cannot impact certain important aspects of the building, such as how the building is sited or built, it can impact the operations and maintenance phase, the longest phase within the building lifecycle.
The aim of green property management is to mitigate negative ecological effects associated with the building during the operations and maintenance building lifecycle phase. However, sustainable property management is a concept that incorporates the human and social elements of managing green buildings as well as the green buildings themselves. The term sustainable, which appears in the title of this book, is used specifically to convey the explicit relationships between humans, the ecological environment, and a building. In many cases, the building is seen as separate from the human, but humans create and manage buildings so they are an integral part when learning about sustainable property management.
This chapter introduces the term sustainability, what it means, and how it applies to property management. The chapter also describes the evolution of sustainable property management and introduces why sustainable property management matters. Of course, sustainable property management has many potential benefits, but there are also downsides and barriers, which must be acknowledged in order to understand why sustainable property management is not more pervasive across the property management industry.
1.2 What is Sustainable Property Management?
Sustainability, simply defined as the ability to meet current generation needs without compromising future generation needs, is on the rise across industries and the property management industry is no exception. Although sustainability, as used in the real estate context, is about preserving the environment, it is about more than that. In sustainable property management, sustainability encompasses three spheres—environmental, social, and economic (see fig. 1.2). Sustainable property management is implementing green building initiatives during the operations and maintenance phase of the building lifecycle, taking into account their environmental, social, and economic impacts with the goal of reconciling these three spheres in such a way that a balance is achieved between economic development and protection of environmental and social resources.
Example: Balancing the Three Spheres of Sustainability in Property Management
One example of balancing the three spheres of sustainability might be when a management company must decide what sort of cleaning practices to employ in a building. Cleaning products that are environmentally friendly might be more desirable for the Earth and human health, but they might also be more expensive, in which case cost must be balanced against the impact on the environment and the impact on human health. Another example is to suppose a new regulation requires all new carpet installations to be low-VOC (Volatile Organic Compounds) as these chemicals used in the carpet manufacturing process can pose a variety of health risks that negatively affect people and the Earth. For this reason, low-VOC carpeting is healthier to humans than high-VOC carpeting. Because of the regulation, Because of the regulation, tenants at all income levels have access to healthier indoor air quality. However, the carpet is expensive and, as a result, owners/managers may either (a) leave existing carpet in longer until it becomes overused and probably unhealthy, making tenants arguably worse off from a health perspective, or (b) pass the cost through to tenants, who are now financially worse off than they would have been in the absence of the new regulation. Note that there is no mechanism to force private sector owners/managers to lower the investment’s required rate of return to subsidize the new carpet. Do you support the new regulation? Something to think about in this situation is the possibility of implementing a comprehensive sustainable building plan that overall is able to create net financial savings and therefore a positive financial impact on the rate of return, while also addressing human and Earth health.
Property companies obtain various third-party independent certifications to illustrate commitment to sustainable property management, as illustrated in table 1.1.
Professional Accreditations
Logo Third-Party Green Building Accreditation Organization that Developed Accreditation
LEED Accredited Professional (AP) for Operations and Maintenance (O+M) Certification U.S. Green Building Council (USGBC)
LEED Green Associate Credential U.S. Green Building Council (USGBC)
Building Certifications
Logo Third-Party Green Building Certification Organization that Developed Certification
LEED Certification U.S. Green Building Council (USGBC)
Certified Sustainable Property (CSP) Institute of Real Estate Management (IREM)
ENERGY STAR® Building Certification Environmental Protection Agency (EPA)
Parksmart Certification Standard for Existing Structures Green Business Certification Inc. (GBCI)
Building Research Establishment Environmental Assessment Method (BREEAM) In-Use Building Research Establishment (BRE)
Green Star—Performance Green Building Council of Australia
Table 1.1: A selection of global sustainable property management accreditations and certifications.
Arguably, the most widely used green building certification throughout the world is known as LEED—Leadership in Energy and Environmental Design. LEED certification for buildings was developed by the U.S. Green Building Council (USGBC), a private non-profit organization founded in 1993, to provide certification opportunities throughout the building lifecycle. This is why there are multiple LEED certifications, including LEED for Building Design and Construction (LEED BD+C) and LEED for Operations and Maintenance (O+M) (U.S. Green Building Council, 2020). The categories associated with the LEED O+M certification include location and transportation, sustainable sites, water efficiency, energy and atmosphere, materials and resources, indoor environmental quality, innovation, and regional priority. People can also achieve a LEED credential such as LEED Green Associate to demonstrate their overall knowledge in green building principles or LEED Accredited Professional (AP) to demonstrate advanced knowledge in green building principles in a specific LEED rating system such as LEED O+M.
The Institute of Real Estate Management (IREM) offers a Certified Sustainable Property (CSP) designation, which focuses exclusively on the operations and maintenance phase of a building. This certification addresses categories such as energy, water, health, recycling, and purchasing. The ENERGY STAR certification for buildings is offered through the United States Environmental Protection Agency (EPA) and, as the name implies, focuses strictly on the energy use of a building. Parksmart, a third-party certification that focuses on sustainable parking garages, offers a Parksmart Pioneer certification for existing parking structures that focuses on management, programs, and technology and structure design. Internationally, there are green building certifications such as the Building Research Establishment Environmental Assessment Method (BREEAM) In-Use certification that originated in the United Kingdom and focuses on the operational phase of the building lifecycle. The BREEAM In-Use certification focuses on management, health and wellbeing, energy, transport, water, resources, resilience, land use and ecology, and pollution. Originating in Australia, the Green Star—Performance certification is available for the operational phase of a building and its categories include management, indoor environment quality, energy, transport, water, materials, land use and ecology, emissions, and innovation.
By no means is the green building management certifications list in table 1.1 complete, but it provides a sampling of some of the prominent certifications. The larger point here is that sustainable property management certification is happening on a comprehensive and global scale. However, it’s important to point out that just chasing a green building certification may not produce the desired sustainability results. This is because a green building certification is only as sustainable as its embodied concepts.
Section Videos
What is Corporate Sustainability?
[00:02:25] Network for Business Sustainability. https://youtu.be/ltBUjzuncQ4
What Is LEED?
[00:01:10] U.S. Green Building Council. https://youtu.be/tlVseOWToL4
Top 5 Reasons To Get ENERGY STAR Certification For Your Building
[00:03:19] ENERGY STAR. https://youtu.be/gwVkBcIjBho
Section Reference
U.S. Green Building Council. (2020). What is LEED? https://www.usgbc.org/help/what-leed
1.3 Why Sustainable Property Management Matters
Sustainable property management matters because building operation activities contribute to greenhouse gas (GHG) emissions. As of 2019, building operations represented 28 percent of global carbon dioxide emissions related to energy, representing the highest level ever recorded (United Nations Environment Programme, 2020). As seen in figure 1.3, energy and carbon dioxide emissions related to energy in residential buildings and non-residential buildings account for the largest single industry user of energy and emitter of carbon dioxide. This matters because carbon dioxide emissions, a type of greenhouse gas emissions, trap heat causing the Earth to become warmer (United States Environmental Protection Agency, 2021).
Climate change caused by greenhouse gas emissions has a number of negative effects on the Earth: shrinking water supplies, increasingly severe weather incidents, disruptions in food supply, and geographical changes to the Earth, to name just a few (Sciencing, 2021). These environmental changes not only negatively affect the environment, they also negatively affect society and the economy. As water and food are essential to human survival, a shrinking water supply and shift in food supply negatively affect human health and can increase the cost of procuring these essential supplies. Also, severe weather and rising tides that are changing the geography of the Earth affect the safety and well-being of society and incur significant costs to repair buildings and infrastructure.
Sustainable property management can reduce negative environmental externalities, which in turn can foster benefits in the social and economic spheres as well. As the three spheres of sustainability overlap, sustainable property management illustrates the concept of interdependence. For example, sustainable property management can foster a decrease in carbon dioxide emissions while also lowering energy and water costs and providing healthier indoor environments for a building’s occupants. So while sustainable property management’s focus is primarily on ecological sustainability drivers, the economic and social spheres cannot be ignored as these spheres are interrelated and dependent on each other.
Section Video
What Is Greenhouse Gas?
[00:01:16] TestTube 101. https://youtu.be/nI1iWrxO6Y8
Section References
Cairoli, Sarah. (2023, February 10). Consequences of carbon emissions for humans. sciencing.com. https://sciencing.com/consequences-of-carbon-emissions-for-humans-12730960.html
United Nations Environment Programme. (2020). 2020 Global status report for buildings and construction: Towards a zero-emission, efficient and resilient buildings and construction sector. https://globalabc.org/sites/default/files/inline-files/2020 Buildings GSR_FULL REPORT.pdf
United States Environmental Protection Agency. (2021). Sources of greenhouse gas emissions. https://www.epa.gov/ghgemissions/sources-greenhouse-gas-emissions
1.4 Evolution of Sustainable Property Management
The idea of sustainable buildings was born out of the environmental movements of the 1970s and 1980s. In response to these movements, the United Nations established the World Commission on Environment and Development in 1983. In 1987, the Report of the World Commission on Environment and Development: Our Common Future (also known as the Brundtland Report) was published by the United Nations and contained a call to action for sustainable development in the built environment.
The growth of third-party green building certifications can be used as a proxy to gauge the increased level of stakeholder demand for sustainable buildings over time. Table 1.2 shows the year various green building certifications were introduced. This table only includes green building certifications that offer an option to certify existing buildings. The first green building certification system was introduced in 1990 by the Building Research Establishment (BRE) out of the United Kingdom. ENERGY STAR and LEED certifications, out of the United States, were also introduced prior to the turn of the century. Since 2000, many more green building certifications have been created as well as updates made to existing certifications. Although there is no global reference list, over six hundred tools that assess sustainability relating to at least one sphere have been identified worldwide, including thirty-eight green building labels (McCreadie, 2004; Reed et al., 2009).
Year Label Country
1990 BREEAM United Kingdom
1993 ENERGY STAR for Buildings United States
1995 ENERGY STAR for Homes United States
1998 LEED for Building Design and Construction United States
2001 CASBEE Japan
2003 Green Star Australia
2005 LEED for Existing Buildings United States
2009 BREEAM In-Use United Kingdom
2009 DGNB System Germany
2009 BOMA 360 United States
2013 Green Star-Performance Australia
2015 IREM CSP United States
Table 1.2: Introduction of green building certifications that offer certification for existing buildings, by country and year of introduction.
When these certifications were first introduced, many of them focused on the building design and construction portion of the building lifecycle, with little or no thought given to the operations and maintenance of existing buildings. For example, while BREEAM was launched in 1990, the BREEAM In-Use certification for operations and maintenance was not created until 2009 (BREEAM, 2021). Additionally, LEED for building design and construction was introduced in 1998, but LEED for existing building operations and maintenance was not launched until the middle of the 2000s. Two notable exceptions to this focus on building design and construction during certification creation is ENERGY STAR for Buildings and ENERGY STAR for Homes, which focus strictly on the operations phase of the building lifecycle.
More recently, stakeholder demand has been a driver for increased Environmental, Social, and Governance (ESG) criteria reporting, which is a “set of standards for a company’s operations that socially conscious investors use to screen potential investments” (Chen, 2021). The Global Real Estate Sustainability Benchmark (GRESB) assessment framework, founded in 2009, is used as an ESG benchmark for real estate assets. As of 2021, 117,000 real estate assets across 1,520 property companies, Real Estate Investment Trusts (REIT), funds, and developers participated in the GRESB Real Estate Assessment, representing \$5.7 trillion of assets under management (“The GRESB ESG benchmarks,” 2021). (Chapter 2 provides further details on the GRESB Framework.) Companies can earn points for green building certifications as part of this benchmark, but ESG reporting embodies sustainability on a more holistic level, whereas green building certifications primarily address the environmental sphere of sustainability.
Example: Driver for Sustainable Building Demand
The Federal National Mortgage Association, also known as Fannie Mae, offers an economic benefit to multifamily properties with a recognized green building certification through preferential loan pricing.
Another factor driving the evolution of sustainable property management is technology. Smart buildings, made possible by advances in technology, have emerged with the goal of increasing building efficiencies as well as lowering operational costs. In smart buildings, building systems such as HVAC, lighting, and security are linked with real-time sensors that provide information to enable building automation and provide a comfortable atmosphere for building occupants. This also helps to better track operational data such as energy and water use.
Example: Evolution of Sustainable Property Management Driven By Technology
Lighting significantly influences the energy use of a building. Prior to some advances in technology, a method to encourage energy efficiency was to place a “Please turn off lights when not in use” label over the light switch to encourage occupants to turn off the lights when leaving the building space.
Although you may still see some of these on light switches, technology advanced and motion sensors were then installed within some building spaces to automatically turn the lights off when the sensor detected no more movement within that particular building space.
Technology then took another leap and smart light bulbs were invented. This enabled occupants to set timers or manually turn off the lights in a building space using a smartphone. So now, lights can be automated from virtually anywhere in the world through a smartphone.
While technology continues to advance, the conservation and cost savings concepts remain the same as proven by this example.
Sustainable property management has evolved as a strategy to address environmental concerns affecting the Earth and people, while also focusing on profit by considering net operating income (NOI) through either reducing operating expenses and/or increasing revenues. Profit is still a main focus for companies, but the environment and people are also increasingly a focus. Furthermore, the increased demand for sustainability from various stakeholders such as investors and building occupants is driving the property management industry to respond and increasingly incorporate sustainable building practices into the operations and maintenance of the real estate asset.
Section Video
The Greening Of The Real Estate Industry
[00:04:14] Urban Land Institute. https://youtu.be/EyS0hfl1miM
Section References
BREEAM. (2021). BREEAM in-use. https://www.breeam.com/discover/technical-standards/breeam-in-use/
Chen, J. (2022). What Is Environmental, Social, and Governance (ESG) Investing? Investopedia.com. https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp
GRESB. (2021, August 30). The GRESB ESG benchmarks expand in 2021 to cover \$6.4 trillion of assets under management despite global challenges from Covid-19. https://www.gresb.com/nl-en/insights/the-gresb-esg-benchmarks-expand-in-2021-to-cover-6-4-trillion-of-assets-under-management-despite-global-challenges-from-covid-19/
McCreadie, M. (2004). BRE subcontract: Assessment of sustainability tools. (BRE report No. 15961) https://download.sue-mot.org/envtooleval.pdf
Reed, R., Bilos, A., Wilkinson, S., & Schulte, K. W. (2009). International comparison of sustainable rating tools. Journal of sustainable real estate, 1(1), 1–22.
UN. Secretary-General; World Commission on Environment and Development. (1987). Report of the World Commission on Environment and Development: our common future https://digitallibrary.un.org/record/139811
1.5 Barriers to Sustainable Property Management
The real estate industry has certainly made significant progress in adopting sustainable practices, but a number of barriers still stand in the way of further progress. This can be seen in figure 1.7. First is climate change denial. Despite the fact that the U.S. EPA acknowledges that human activities cause climate change, many people remain disbelievers (U.S. EPA, 2021). Because of this disbelief, sustainable property management practices may seem somewhat irrelevant to these disbelievers, as they do not believe humans are contributing to climate change on Earth. Furthermore, even if people do believe in human-based climate change, there is a strong reliance on hyperconsumption to sustain a modern convenient lifestyle in developed and developing countries.
Building owners and property managers may also be skeptical of consumer demand for these types of features. So this may make sustainable property management a non-priority in their business development plan and thus in their corporate image. Or alternatively, they may be greenwashing their company, which is a marketing tactic that portrays a property to be greener than it actually is. This can increase a company’s corporate social image and the company can potentially acquire more business because of this image.
Some may also view the upfront cost to implement sustainable property management initiatives as too high a barrier even if there may be operating costs savings, such as reduced energy use. This is especially true if a new building is being built and the building owner does not intend to hold onto the real estate asset for a long period of time. This relates to the payback period of a capital outlay for a sustainable building initiative.
Example: Payback Period Barrier
If the building owner plans to hold the building for five years, and the payback period for a more energy efficient heating, ventilation and air conditioning (HVAC) system takes seven years to payback on the investment, the payback of the additional capital outlay for the more efficient HVAC system will not likely occur due to the payback occurring after the building is sold by that owner. This rings even truer for the merchant builders who sell their buildings immediately upon completion. An additional consideration is the lease structure, which differs among property types, that can further impede adoption of sustainable property management practices. Therefore, the upfront cost to adopt some sustainable building initiatives poses a barrier.
Even if an owner plans to hold onto a building for the long-term, a split incentive issue can arise in which either the landlord or tenant is not financially incentivized to invest in sustainable initiatives. For example, if the tenant pays their own utility bills, the property owner is not financially incentivized to provide energy efficient appliances and fixtures because the cost savings accrue to the tenant. The exception to this is if the cost savings that the tenants receive from these ecologically sustainable investments are fully capitalized into the rental rate. On the other hand, if the landlord pays for utilities, the tenant is not financially incentivized to save on utilities so they may keep their unit extra warm during the winter season and extra cool in the summer season.
Property owners and managers commonly find green building certifications too hard and too expensive to obtain. This is especially true for companies that lack the size or resources to fulfill the requirements of green building certifications. Additionally, there may be a lack of capital for implementation of certain sustainable building management initiatives. These barriers are evidenced by looking at the most prevalent green building certification system in the US, LEED. As of the end of 2015, there were only 34,000 LEED building certifications compared to the total U.S. building stock of 5,500,000, representing a certification rate of 0.7 percent (Yudelson, 2016). Yudelson (2016) also puts forward the barriers of bureaucracy, overblown benefit claims, and a narrow focus on obtaining points versus material results related to LEED certification.
Lack of knowledge and awareness as well as lack of availability of data also create barriers to sustainable property management practices. For example, the decision-makers may lack the understanding of how the initial upfront costs may generate savings down the line when implementing a sustainable property management initiative. Even if this is understood and the economic numbers make sense, the unwillingness of on-site staff to embrace these initiatives due to uncertainty, lack of training, or competing priorities can prevent these initiatives from coming to full fruition. Additionally, information asymmetry can occur because sustainable property management can mean very different things to different people. This can cause lack of investment in sustainable property management. Decision-makers may instead invest in initiatives that have a clearer quantitative benefit.
Section References
US EPA. (2021). Climate change indicators in the United States. https://www.epa.gov/climate-indicators
Yudelson, J. (2016). Reinventing green building: Why certification systems aren’t working and what we can do about it. New Society Publishers.
1.6 Conclusion
Sustainable property management utilizes sustainable building initiatives during the operations and maintenance phase of the building lifecycle, taking into account the environmental, social, and economic impacts of these building initiatives. This is becoming more commonplace in response to demand for sustainability from multiple stakeholders. Sustainable property management is important because it can positively impact all three spheres of sustainability. Furthermore, as technology is advancing it is providing more opportunities for data benchmarking and reporting, which allows for more quantifiable data on the progress of sustainable building management initiatives and their impacts on the environmental, social, and economic realms. It is important to remember that sustainable building practices are as much of a human science as well as a building science because humans, not the building itself, create and manage buildings. As the evolution of sustainable property management marches on, there remain barriers that must be addressed in order to further increase implementation of sustainable building practices.
Discussion Questions
1. How would you define sustainable property management?
2. What are the three spheres of sustainability? Provide an example of each sphere as it relates to sustainable property management.
3. Try to identify one or two sustainable property management practices at work in the buildings you occupy. What are they and do you think they have been successful?
4. Why do you think companies focus mostly on the economic sphere and not always the social and environmental spheres when considering sustainable property management initiatives?
1. What do you think would be effective incentives for companies to focus on for social and environmental spheres and not just the economic sphere of sustainability?
5. How might you try and incorporate sustainable property management into your business development plan?
6. Would you consider sustainable property management practices important to you? Why or why not?
7. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Go to https://www.nmhc.org/research-insight/the-nmhc-50/top-50-lists/2021-top-manager-list/ and choose three property management companies from this list. Review each of the three companies’ websites and report on the following:
1. Are each of the three companies addressing sustainability on their websites?
2. If so, which spheres of sustainability are they addressing and what examples do they provide related to each sphere?
3. What do you think they may be missing the mark on in regards to sustainability?
4. Were you surprised by your findings? Why or why not?
2. Research the pros and cons of green building certifications and report your findings on one page.
Figure References
Figure 1.1: Building lifecycle. Kindred Grey. (2023). CC BY 4.0.
Figure 1.2: The three spheres of sustainability. Kindred Grey. (2023). Adapted from Investigation of the Philosophy Practised in Green and Lean Manufacturing Management, by A. Aminuddin and M. Nawawi, 2013, International Journal of Customer Relationship Marketing and Management, 4(1) (DOI:10.4018/jcrmm.2013010101). Copyright 2013 by the International Journal of Customer Relationship Marketing and Management. Adapted under fair use.
Figure 1.3: Global share of buildings and construction final energy and emissions (2019). Kindred Grey. (2023). Data from United Nations Environment Programme 2020 Report. CC BY 4.0. https://globalabc.org/resources/publications/2020-global-status-report-buildings-and-construction).
Figure 1.4: Original energy efficiency attempt. Kindred Grey. (2023). CC BY 4.0.
Figure 1.5: Motion sensors. Z22. (2014). Motion sensors [photograph with adjusted color]. https://commons.wikimedia.org/wiki/File:Light_switch_with_passive_infrared_sensor.jpg. CC BY-SA 4.0.
Figure 1.6: Smart light bulbs. Jefferson William. (2019). Smart light bulbs [photograph]. Public domain. https://flic.kr/p/2hKtK3k
Figure 1.7: Sustainable property management barriers. Kindred Grey. (2023). CC BY 4.0.
Image Descriptions
Figure 1.2: 3 overlapping circles (Venn Diagram). Circle 1: Environmental – natural resource use, environmental management, pollution prevention, air/water/land waste. Circle 2: Economic – profit/cost/savings, economic growth, research and development. Circle 3: Social – standard of living, education, community, equal opportunity. Circle 1&2 overlap: Environmental-Economic – energy efficiency, subsidies/incentives for use of natural resources. Circle 2&3 overlap: Economic-Social – business ethics, fair trade, worker’s rights. Circle 3&1 overlap: Social-Environmental – environmental justice, natural resources stewardship, locally & globally. All 3 circles overlap: Sustainability. Return to figure 1.2.
Figure 1.3: 2 pie charts. Left: Energy. 8% Non-residential buildings, 22% residential buildings, 5% buildings construction industry, 28% transport, 5% other, 32% other industry. Right: Emissions. 8% Non-residential buildings (indirect), 3% Non-residential buildings (direct), 11% residential buildings (indirect), 6% residential buildings (direct), 10% buildings construction industry, 23% transport, 7% other, 32% other industry. Return to figure 1.3.
Figure 1.7: Barriers: Disbelievers, reliance on hyper consumption, skepticism of consumer demand, greenwashing, lack of availability of data, upfront cost, split incentive, expense and difficulty of green building certifications, lack of capital, lack of knowledge and awareness, lease structure, uncertainty/lack of training/competing priorities for on-site staff, information asymmetry. Return to figure 1.7. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.01%3A_Introduction_to_Sustainable_Property_Management.txt |
Learning Objectives
• Explain why the environmental sphere is important in sustainable property management
• Explain why the social sphere is important in sustainable property management
• Explain why the economic sphere is important in sustainable property management
• Recognize the interdependence of sustainable property management spheres
• Describe why a broader and measurable perspective is important to sustainable property management
• Describe the ESG framework for property management
2.1 Introduction
Sustainable buildings are more than brick and mortar that operate independently. They impact the level of negative environmental externalities that will be produced from the construction, operations and maintenance, and renovation of built space; how humans will navigate and use the space; and how companies will make profit off of the building space. Chapter 1 introduced the concept of sustainable property management and its three spheres. Chapter 2 provides more detail on these three spheres and why each one is important. The inclusion of all three spheres provide a broader perspective to understanding sustainable property management. The environmental, social, and governance (ESG) framework is also put forward in detail in this chapter to provide a framework for this broader perspective.
2.2 The Environmental Sphere
The environmental sphere of sustainability is about addressing the built environment’s impact on the ecological environment. The consequences of the built environment on ecological degradation are exemplified through increased carbon (a greenhouse gas) emissions and the resulting rising temperatures, and melting ice sheets and rising seas. One way to measure the impact of our actions on the Earth is to calculate the carbon footprint of the action. Carbon footprint, according to Oxford Learners dictionary, is “a measure of the amount of carbon dioxide that is produced by the daily activities of a person or company” (Oxford Learners Dictionary, n.d.). As the Earth does not have an active voice other than exemplifying ecological degradation, building consumers advocate for the Earth when they demand sustainable building initiatives, and decision-makers within property companies advocate when they implement sustainable building policies.
The Paris Agreement, an international agreement on climate change with the aim of limiting global warming, has accelerated prioritization of decreased greenhouse gas (GHG) emissions.
While some U.S. state governments are beginning to require GHG reporting for certain entities, it can be beneficial to get ahead of the requirement curve and calculate building GHG emissions for all real estate assets owned and/or managed. There are various methods to measure a building’s carbon footprint such as the Greenhouse Gas Protocol, an international standard that helps account for, report, and mitigate GHG emissions in a standardized framework. As the most widely used GHG emissions tracking tool, 90 percent of Fortune 500 companies use this framework for reporting to Carbon Disclosure Project (CDP), a non-profit company that runs the global disclosure system to manage environmental impacts (World Resources Institute, 2021).
There are three GHG emissions scopes based on proximity and control over emissions:
• Scope 1 measures direct emissions from a company’s activities
• Scope 2 measures indirect owned emissions based on purchased energy from a utility provider
• Scope 3 measures indirect not owned emissions that occur in the product lifecycle
Once measured, a building’s carbon footprint can be benchmarked against similar buildings to get a sense of how the building performs in relation to its peers. Once measuring and benchmarking are completed, management and mitigation of GHG emissions are possible.
Real estate asset stakeholders must also consider the part of the Earth and current landscape they are operating within, as property management is inherently a place-based discipline.
Example: Place-Based Property Management Consideration
Figure 2.1 illustrates increased temperatures in the southwestern United States, a relatively dry region. These increased temperatures can drive evaporation and make this relatively dry region even drier. This makes water conservation an important issue in this region. Also, the context of where the real estate asset is located must be taken into consideration. If the real estate asset is located in an urban context, there may be more opportunities to take advantage of public transportation opportunities to reduce carbon emissions versus a suburban real estate asset that is located in a car dependent community with little to no public transportation opportunities available.
Section Video
What is a CARBON FOOTPRINT? How to calculate and reduce it? | Climate change
[00:07:15] Sustainability Illustrated. https://youtu.be/bYb7YLsXvzg
Section References
Oxford Learners Dictionary. (n.d.). Carbon footprint. https://www.oxfordlearnersdictionaries.com/us/definition/american_english/carbon-footprint
World Resources Institute. (2021). Greenhouse gas protocol. https://www.wri.org/initiatives/greenhouse-gas-protocol
2.3 The Social Sphere
The social sphere of sustainability is about addressing the built environment’s impact on society. Buildings are built and run by human ideas and design, not by themselves. Even with building automation, if the automation fails humans have to go and fix the problem. So while the building itself is indeed tangible, the operations of the building and the impact on humans are interdependent on each other. Think about a stay you may have had at a hotel, hospital, or even an apartment. The facility itself may have been nice and looked nice, but it is likely that the people you interacted with are what truly made your stay pleasant or unpleasant. For example, were they friendly when you checked in and responsive if you brought to their attention any operations or maintenance issues of the facility? Therefore, sustainable property management is also about people as they create the building experience and make the building run in a certain way.
There is a significant disparity across people when it comes to accessing the benefits of sustainable buildings. It has been shown that socioeconomic status significantly affects the adoption of sustainable buildings (Zhou, 2016). Environmental privilege, which allows groups with power to construct and use environmental amenities for themselves and deny those amenities to less privileged groups, showcases place-based inequities. Therefore, environmental justice is an important concept to think through regarding diversity and inclusion ramifications on people, as property management is an inherently place-based discipline. As defined by the United States EPA, environmental justice is “the fair treatment and meaningful involvement of all people regardless of race, color, national origin, or income, with respect to the development, implementation, and enforcement of environmental laws, regulations, and policies” (U.S. Environmental Protection Agency, 2023). Furthermore, since low-income households experience more than double the energy burden of the median U.S. energy burden, and three times the energy burden than higher income households, the energy efficient features of sustainable buildings can be proportionately more beneficial for these households and increase diversity among users of sustainable buildings (Drehobl & Ross, 2016).
The social sphere of sustainability relates to Maslow’s hierarchy of needs as illustrated in figure 2.2, because personal lower-level needs related to standards of living need to be addressed before addressing higher-level needs. For example, the lower-level need of alleviating suffering from being too hot needs to be met first through access to air conditioning. If access to air conditioning is not readily available, people will be focused on acquiring air conditioning, not on the environmental degradation impacts from the air conditioning unit, even if the air conditioning technology being used is from a generation ago and is far worse for the ecological environment.
Universal design is another important concept to think about when it comes to accessibility of sustainable buildings. According to the National Disability Authority, universal design is “the design and composition of an environment so that it can be accessed, understood and used to the greatest extent possible by all people regardless of their age, size, ability or disability” (National Disability Authority, 2020). Building ownership and management have a responsibility to follow certain laws to ensure people of all abilities have access to sustainable buildings and the associated occupant benefits. There is also an opportunity to showcase commitment to diversity and inclusion by going above and beyond these laws to ensure increased sustainable building accessibility, such as adding information about the building accessibility features on the building webpage, having a link on the building webpage to report physical or digital barriers within and around the building, and including people with disabilities in property management operations and maintenance decisions.
Section References
Drehobl, A. & Ross, L. (2016, April). Lifting the high energy burden in America’s largest cities: How energy efficiency can improve low income and underserved communities. https://www.aceee.org/sites/default/files/publications/researchreports/u1602.pdf
National Disability Authority. (2020). What is universal design. http://universaldesign.ie/What-is-Universal-Design/
United States Environmental Protection Agency. (2023). Environmental justice. https://www.epa.gov/environmentaljustice
Zhou, T. (2016). Socioeconomic attributes’ relationship to green commercial office buildings. Journal of Environmental and Resource Economics at Colby, 3(1), 12.
2.4 The Economic Sphere
The economic sphere of sustainability is about addressing the built environment’s impact on profit. Profit is a central goal of an investment property and a necessity for building operation continuity. Although environmental and social impacts are becoming more of a focus, the main driver of most property management businesses remains the financial health of its building assets under management. Profit affects all building asset stakeholders including investors, owners, the property management company, the employees, vendors, tenants, and the community. Profitability can impact owner returns, access to financing, level of investor interest, capital that can be invested into the property to increase its appeal to prospective tenants, and business growth, to name a few. Profit fosters economic sustainability through decisions to ensure both short-term and long-term profitability as well as efficient uses of resources.
In 1970, Milton Friedman, a well-known American economist known for his strong belief in free-market capitalism, wrote an article titled “A Friedman Doctrine—The Social Responsibility of Business Is to Increase its Profits.” In this article, he argues that the priority of business executives should be to make money for the shareholders, and social responsibilities should not cut into this money-making priority (Friedman, 2007). He does note that it should personally be the employees, customers, or stockholders that choose to spend their money on certain social issues if that is what they would like to do, and that it is a government function to impose taxes as agreed by the preferences of the public to spend on various programs.
The philosophy of Milton Friedman aligns with what is known as shareholder capitalism. Figure 2.3 lays out the tenet of shareholder capitalism where the key stakeholder is the shareholder and the social responsibility of the company is seen as increasing company profits. On the other hand, Howard Bowen, also an American economist, wrote the book titled Social Responsibilities of the Businessman in 1953 which laid the foundation for corporate social responsibility (CSR). CSR is a business model that takes into account the economic, social, and environmental impacts the corporation has on multiple stakeholders versus solely the owners of the company.
The philosophy of Howard Bowen aligns with the idea of stakeholder capitalism as depicted in figure 2.3. This is where corporations are focused on serving the interests of all their stakeholders equally with the social responsibility seen as increasing the well-being of people and the Earth. CSR gained traction in the United States in the 1970s as evidenced with the policy statement issued by the Committee for Economic Development. In this policy statement, the changing social contract between businesses and society is discussed with the idea that there are broadened expectations of businesses, as they exist because of public consent and should serve the broader needs of society as well (Committee for Economic Development, 1971). By the beginning of the twenty-first century, most large companies in the U.S. had created CSR policies (Madrakhimova, 2013).
The goals of CSR policies have been to hold companies accountable for their actions. However, as stakeholders have been increasingly demanding more transparency of companies in the economic, social, and environmental dimensions, it has been difficult to compare CSR efforts across companies due to the lack of standardization in reporting. Also, companies have been criticized for marketing CSR efforts based on empty claims or for doing something once and not following up the CSR effort consistently. These issues have spurred the creation of the ESG framework, which prioritizes reporting, and standardizes and quantifies these types of efforts by companies to make sure initiatives are actually happening and continue to happen.
Section Video
Corporate Social Responsibility (CSR) Definition
Section References
Committee for Economic Development. (1971). Social responsibilities of business corporations. https://www.ced.org/pdf/Social_Responsibilities_of_Business_Corporations.pdf
Friedman, M. (2007). The social responsibility of business is to increase its profits. In Corporate ethics and corporate governance (pp. 173–178). Springer.
Madrakhimova, F. (2013, June). History of development of corporate social responsibility. Journal of Business and Economics, 4(6), 509–520. http://www.academicstar.us/UploadFile/Picture/2014-6/201461410571606.pdf
2.5 The Interdependence of Sustainable Property Management Spheres
Individual sustainability spheres do not exist alone but in a system where they are interdependent on each other. An action within one sphere will affect other sustainability spheres. Systems theory, which is a framework that was developed in response to the increasing complexity of problems in the world, can be applied to sustainability in the property management context, as systems theory is a “way of thinking that allows for the study of interconnections among systems and accounts for the nature of ‘open systems’ which interact with their environments” (Montuori, 2011, p. 414). In other words, there is interdependence in sustainable property management with the idea that various stakeholders and buildings operate in an open system and they all influence and interact with each other. Table 2.1 provides various interdependency examples of sustainable building interventions across property types to further illustrate this concept as well as to illustrate that positive, neutral, and negative impacts may vary across spheres.
Intervention Environmental Social Economic
Install LED lights in building lobby
(all product types)
Positive (+)
By using less energy, LED bulbs help reduce consumption
Neutral (~)
These lights are always on, so tenants don’t have to wait for the LED to warm up and will likely not notice the difference
Positive (+)
LED lights are more expensive to purchase but are efficient and will reduce energy bills over time
Install motion sensing lights along exterior walkway from parking lot to building
(apartment)
Positive (+)
By using less energy, motion activated lighting helps reduce consumption
Negative (–)
Lack of sufficient, continual lighting creates a safety risk as someone could wait for the lights to shut off and then ambush an unsuspecting resident; even if lights turn on at the last minute, there isn’t sufficient time for the resident to react. Similar problem if the lights fail to activate
Positive (+)
Energy bills will be reduced as the lights will not operate continually
Reduce run time for subsurface garage fans; shut off from
1 am–4 am
(office building)
Positive (+)
By running for fewer total hours, the fans will use less energy and help reduce consumption
Neutral (~)
Most office tenants will not be using the garage during this time and will be unaffected
Positive (+)
Energy bills are reduced by shutting off the fans for several hours overnight
Upgrade amenities by installing a coffee and snack station in the lobby
(office)
Negative (–)
The new amenity represents an increase in energy usage, particularly if snacks are offered through a vending machine; coffee is likely purchased in bulk with price as the determining factor and may not be sourced sustainably
Positive (+)
People benefit from placemaking initiatives and health is improved through shared interactions, a place for community
Positive (+)
A nominal usage fee will cover the cost of offering this amenity and provide additional profit
Table 2.1: Sustainable intervention interdependency examples.
2.6 A Broader and Measurable Perspective
ESG reporting, introduced in chapter 1, provides a broader and measurable perspective for stakeholders of property management companies interested in sustainability. Shareholders are increasingly demanding this transparency to make investment decisions because it matters to them as a way to ensure long-term financial performance. Consumers are also increasingly demanding this type of reporting to make purchasing decisions. Additionally, employees are increasingly using this type of reporting when deciding which companies they want to work at based on their priorities. Some countries and institutional investors require ESG reporting.
Example: Mandatory ESG Information Disclosure
As of 2017, mandatory disclosure of ESG information is required in twenty-five countries such as Australia, Italy, South Africa, and the United Kingdom (Krueger et al., 2021). The World Economic Forum’s International Business Council has collaborated with the world’s largest accounting firms, like KPMG and Ernst & Young, to launch the Measuring Stakeholder Capitalism Initiative in 2019 whose goal is to improve and standardize ESG reporting (World Economic Forum, 2021). The United States does not currently require mandatory disclosure of ESG information, but many feel this requirement is imminent. Furthermore, states and municipalities within the United States are beginning to require ESG reporting. Illinois passed the Sustainable Investing Act, which became effective in 2020, that “requires all public or government agencies involved in managing public funds to ‘develop, publish, and implement sustainable investment policies applicable to the management of all public funds under its control.’” (Zaidi, 2019). Additionally, certain states and cities such as California, Boston, Chicago, New York, and Seattle have added regulations to their pension systems to further sustainable investment (Zaidi, 2019).
ESG reporting is becoming increasingly prevalent globally (it is estimated that as of 2018, ESG is integrated into \$17.5 trillion of professionally managed assets including public equity, fixed income, and real estate sectors [Global Sustainable Investment Alliance, 2018]) and is also becoming more common in assessing real estate performance. Global Real Estate Sustainability Benchmark (GRESB), the framework introduced in chapter 1 and used to assess and standardize ESG performance in the real estate industry, jumped from approximately 750 participant members in 2016 to approximately 1,000 participant members as of 2020 who reported on their ESG efforts. Figure 2.4 illustrates a sampling of key ESG issues according to the Principles for Responsible Investing, a leading global proponent of responsible investment.
The GRESB framework is the ESG reporting benchmark used for real estate assets. There are three assessment components within the GRESB Real Estate Assessment: management, performance, and development. The management component gathers ESG information at the organizational level, while the performance component gathers ESG information about asset portfolio performance, and the development component gathers ESG information during design, construction, and major renovations. The GRESB Development Benchmark consists of the management and development components and is used for development projects, while the GRESB Real Estate Benchmark consists of the management and performance components and is used for standing investments.
For the purposes of this textbook, the focus is on the GRESB Real Estate Benchmark since this benchmark focuses on existing real estate assets. Within this GRESB Real Estate Benchmark, there are 30 points attached to the management component and 70 points attached to the performance component for a total of 100 possible points (GRESB, n.d.). Figure 2.5 illustrates that 65 percent of the management component points focus on governance criteria while the remaining 35 percent of the management component points focus on social criteria. For the performance component, 89 percent of the points are focused on environmental criteria while 11 percent are focused on social criteria. Figure 2.6 displays the aspects within each component and the points associated with each respective aspect. Specifically under the management component, leadership, policies, reporting, risk management, and stakeholder engagement are aspects, while risk assessment, targets, tenants and community, energy, GHG, water, waste, data monitoring and review, and building certifications comprise the performance component. Therefore, sustainable buildings support this ESG reporting, which is more in demand, while also being influenced and influencing other factors affecting the ESG ecosystem.
Example: Sustainable Property Management ESG Report
Relating ESG issues to sustainable property management, figure 2.7 illustrates the components of a 2020 ESG Report example from Mill Creek Residential Trust, an owner and manager of multifamily rental real estate (Mill Creek Residential, n.d.). Within section 1, Mill Creek ESG, the company’s core values are defined and five stakeholder groups are identified and composed of partners, residents, associates, neighbors, and global society. Also, seven ESG focus areas are defined including resident experience, environmental performance, certifications, associates, innovation, risk and crisis management, and neighbors. Topics included within these ESG focus areas are the well-being of residents and associates, energy and water use, LEED certifications, ethics and diversity of associates, data security, charitable giving, and local relationships.
In section 2, Mill Creek Communities, the resident experience component contains topics such as fair housing, transportation and active design, sustainable building best practices, acoustical design standards, renovations, smart and sustainable homes, promise and peace of mind guarantee, and resident feedback. The environmental performance component topics include design energy efficiency, renewable energy, operating energy and water use, carbon footprint, and net zero energy, water, and waste. The certifications component discusses the green building certifications the company utilizes in their business. In section 3, Mill Creek Residential, the associates component is comprised of culture and ethics, learning and development, health and safety, and diversity, equity and inclusion. The innovation component includes information on the innovation committee and ESG leadership. The risk and crisis management component discusses crisis preparedness, their Covid-19 response, data security and data privacy, water and fire protection, fire amenity safety, risk management performance, and climate resilience. The last component of the report is about neighbors and includes the topics of local relationships and charitable giving.
ESG reporting has been shown to provide benefits to multiple stakeholders. In locations where ESG reporting requirements are mandatory, availability and quality of ESG reporting for consumers is increased, negative ESG incidents decrease, earning forecasts by analysts become more accurate, and stock price crash risk declines (Krueger et al., 2021). Companies also participate in ESG reporting to comply with regulatory agreements, strengthen their corporate reputation, illustrate their management of risk, and answer the call for investor disclosure requests (HXE Partners, 2021). Furthermore, at companies that voluntarily incorporate environmental and social policies, stock market and accounting performance are higher than peers’ (Eccles et al., 2012). While there are obstacles to incorporating ESG reporting, such as the measurement complexity of some ESG performance as well as information on ESG metrics originating from multiple systems across the company, there is certainly a business case for ESG reporting from multiple stakeholder perspectives (Boffo & Patalano, 2020; PWC, 2021). However, because one of the key responsibilities of property managers is to operate the asset in accordance with the goals of ownership, or to counsel the ownership entity that its goals are unrealistic or inappropriate in the marketplace, it would be difficult for property management to incorporate these ESG concepts without ownership buy-in.
Section References
Boffo, R., & Patalano, R. (2020). ESG Investing: Practices, progress and challenges. OECD Paris. https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf
Eccles, R. G., Ioannou, I., & Serafeim, G. (2012). The impact of a corporate culture of sustainability on corporate behavior and performance (working paper 17950). National Bureau of Economic Research. http://www.nber.org/papers/w17950
Global Sustainable Investment Alliance. (2018). 2018 Global sustainable investment review. http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf
GRESB. (n.d.). 2021 Real estate reference guide. https://documents.gresb.com/generated_files/real_estate/2021/real_estate/reference_guide/complete.html
HXE Partners. (2021). Our services. https://www.hxepartners.com/services
Krueger, P., Sautner, Z., Tang, D. Y., & Zhong, R. (2023, January 7). The effects of mandatory ESG disclosure around the world. [European Corporate Governance Institute Finance Working Paper no. 754/2021 and Swiss Finance Institute Research Paper no. 21–44]. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3832745
Mill Creek Residential. (n.d.). 2020 Environmental social governance. https://millcreekplaces.com/2020-esg-report/
Montuori, A. (2011). Systems approach. Encyclopedia of Creativity, 2, 414–421.
PWC. (2021, October 6). Getting serious about diversity and inclusion as part of your ESG reporting. World Economic Forum. https://web.archive.org/web/20211006044604/https://www.pwc.com/us/en/services/audit-assurance/library/diversity-equity-inclusion-reporting.html
World Economic Forum (2021). Accelerating public-private collaboration towards a global solution for non-financial reporting. https://www.weforum.org/stakeholdercapitalism/about
Zaidi, A. (2019, October 4). Insight: States take lead on ESG investment regulations while feds stand still. Bloomberg Law. https://news.bloomberglaw.com/banking-law/insight-14
2.7 Conclusion
The built environment, as well as individual real property assets, affect all spheres of sustainability. The results of this impact are powerful and highly interrelated, both at the global and individual levels. As a result of this inherent interdependency, sustainable property management is a critical component of modern environmental progress, the health and well-being of society, and corporate profitability. The importance of the decisions of property managers in sustainable building operations cannot be overstated.
ESG reporting fosters inclusion of environmental, social, and economic spheres and provides a broader perspective. The increased demand from stakeholders for ESG disclosure makes the business case for sustainable property management from multiple stakeholder perspectives. It also allows companies to take ownership and accountability of their actions on society and the Earth versus keeping a grasp on a narrower view of business. As we are all interdependent on each other, the mentality does not have to be “them” versus “us,” as this interdependence is universal as a human condition.
Discussion Questions
1. How else can you apply Maslow’s hierarchy of needs to sustainable property management?
2. Do corporations have a responsibility to environmental and social causes? Why or why not? Based on your response, do your views align more with economist Milton Friedman or Howard Bowen?
3. Is sustainable property management an issue of ethics? Why or why not?
4. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Download an ESG report from a property management firm. Three examples include:
BentallGreenOak’s 2020 Corporate Responsibility Summary Report. https://www.bentallgreenoak.com/sustainable-investing.php
Gables Residential 2020 Corporate Citizenship Report. https://issuu.com/gablesresidential/docs/gables_ccr_2020_-_the_importance_of_home_-_final_d?fr=sZjBmMjIwNDg0Mw)
Mill Creek 2020 Residential ESG Report. https://millcreekplaces.com/2020-esg-report/
After downloading and reviewing the report, answer the following questions:
1. What are some ESG efforts you see as innovative and what are some ESG efforts you see as commonplace and why?
2. What ESG efforts do you feel this company is strong in, and what efforts are weak? Why
3. What can this company do to strengthen its weak points in ESG reporting?
Figure References
Figure 2.1: Temperature increases in the southwestern United States. Kindred Grey. (2023). Data from A closer look: Temperature and drought in the Southwest. EPA. (2021). (https://www.epa.gov/climate-indicators/southwest#ref2) CC BY 4.0
Figure 2.2: Maslow’s hierarchy of needs. Kindred Grey. (2023). CC BY 4.0
Figure 2.3: Shareholder versus stakeholder capitalism. Kindred Grey. (2023). Includes Money Bag by leo-graph.com, from The Noun Project. Noun Project (Noun Project license) Includes Csr by Hilmy Abiyyu Asad, from The Noun Project. Noun Project (Noun Project license). CC BY 4.0
Figure 2.4: A sampling of key ESG issues. Kindred Grey. (2023). Adapted from Environmental, social and governance issues. Principles for Responsible Investment. https://www.unpri.org/sustainability-issues/environmental-social-and-governance-issues. Includes Government, by Adrien Coquet, from The Noun Project. Noun Project (Noun Project license). Includes group, by Gregor Cresnar, from The Noun Project. Noun Project (Noun Project license). Includes Tree, by Guilherme Furtado, from The Noun Project. Noun Project (Noun Project license). CC BY 4.0
Figure 2.5: GRESB ESG components and weightings for building operators. Kindred Grey. (2023). Data from GRESB Real estate assessment reference guide, 2021. (https://documents.gresb.com/generated_files/real_estate/2021/real_estate/reference_guide/complete.html). CC BY 4.0
Figure 2.6: GRESB ESG Components and associated aspects for building operators. Kindred Grey. (2023). Data from GRESB Real estate assessment reference guide, 2021. (https://documents.gresb.com/generated_files/real_estate/2021/real_estate/reference_guide/complete.html). CC BY 4.0
Figure 2.7: Components of 2020 ESG report from Mill Creek Residential Trust. Kindred Grey. (2023). Adapted from Mill Creek ESG 2020 report. https://millcreekplaces.com/2020-esg-report/. CC BY 4.0.
Image Descriptions
Figure 2.1: Temperature map showing southwest U.S. states; values range from 1-2.2 degrees Fahrenheit. Largest temperature increases in southern CA, central Arizona, southern New Mexico, southern Nevada, eastern Utah, and western Colorado.
Figure 2.3: Milton Friedman’s shareholder capitalism: company shareholder is prioritized; social responsibility is to increase company profits. Howard Bowen’s stakeholder capitalism: all stakeholders are prioritized; social responsibility is to increase well-being of people and the planet.
Figure 2.4: Environmental: sustainable land use, plastics, water, fracking, methane, biodiversity. Social: human rights and labor standards, employee relations, conflict zones. Governance: tax avoidance, executive pay, corruption, director nominations, cyber security.
Figure 2.6: Left: Management (E is 0%, S is 35%, G is 65%). Total points: 30. Leadership: 7 points, policies: 4.5 points, reporting: 3.5 points, risk management: 5 points, stakeholder engagement: 10 points. Right: Performance (E is 89%, S is 11%, G is 0%). Total points: 70. Risk assessment: 9 points, targets: 2 points, tenants & community: 11 points. Energy: 14 points. GHG: 7 points. Water: 7 points, waste: 4 points, Data monitoring & review: 5.5 points, Building certifications: 10.5 points.
Figure 2.7: From top to bottom. Cover page. Letter of Introduction by CEO. 1) Mill Creek ESG: 1.1 Company overview, 1.2 Guiding principles, 1.3 ESG integration. 2) Mill Creek Communities: 2.1 Resident experience, 2.2 Environmental performance, 2.3 Certifications. 3) Mill Creek Residential: 3.1 Associates, 3.2 Innovation, 3.3 Risk and crisis management, 3.4 Neighbors. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.02%3A_The_Three_Spheres_of_Sustainable_Property_Management.txt |
Learning Objectives
• Identify key stakeholders in sustainable property management operations
• Identify motivations for building owners to adopt sustainable property management practices
• Identify motivations for property management companies to adopt sustainable property management practices
• Identify motivations for tenants to adopt sustainable property management practices
• Identify motivations for vendors to adopt sustainable property management practices
• Identify motivations for communities to adopt sustainable property management practices
3.1 Introduction
Various stakeholders significantly influence sustainable property management implementation. By understanding their motivations for sustainable building operations, an appropriate strategy can be devised that addresses their particular needs. Motivations can vary among stakeholders, so it is important to develop the sustainable property management plan based on the goals that are important to that particular stakeholder. This chapter identifies key stakeholders in sustainable property operations as illustrated in figure 3.1 and some common motivations for each stakeholder. Collaboration among stakeholders is key during this process of getting everyone on board with a sustainable property management plan.
3.2 Building Owners
The building owner typically holds the most influence over sustainable building initiative decisions. Although property management companies occasionally come to building owners pitching sustainable property management initiatives, more building owners influence property management companies to adopt sustainable building practices at this point and time. Figure 3.2 depicts common motivating factors for pursuing sustainable building initiatives from a building owner perspective.
Local laws and regulations motivate building owners to engage with sustainable property management. The Clean Energy Omnibus Amendment Act of 2018 enacted in Washington DC is an example where commercial and multifamily buildings under a certain energy threshold must improve their performance by 20 percent over a five-year compliance period or undertake other prescriptive measures (Department of Energy & Environment, n.d.). This mandates that building owners engage with sustainable building management practices. Some building owners also experience pressure from investors and the marketplace to implement ESG policies, as well as face reporting requirements based on these implemented ESG policies. Some investors and consumers simply will not invest with a building owner that does not have ESG policies and procedures in place. This is evidenced by the results of the PricewaterhouseCoopers (PwC) 2021 Global Investor ESG Survey where 49 percent of respondents “express willingness to divest from companies that aren’t taking sufficient action on ESG issues” (PriceWaterhouseCoopers, 2021).
One popular method that building owners use to incorporate ESG policies are green building certifications and the GRESB framework. These frameworks can assist building owners to more easily engage in sustainable property management practices by providing a pathway toward sustainable property management at the real estate asset level and organizational level. These certifications also provide an opportunity for asset distinction and enhanced market image. They may even be a recruiting tool, especially for younger generations who may be more aligned with sustainable building concepts.
Some business owners who may not necessarily care about sustainable building concepts engage with these concepts due to the potential positive financial statement impacts. For example, there is a law in Virginia that allows local jurisdictions to offer a reduced local property tax rate for buildings that reach a specific energy efficiency threshold (Database of State Incentives for Renewables & Efficiency, 2020). Historically, research has found that eco labels have economic benefits such as higher rents, higher occupancy, and increased sales prices. Specifically, green certified buildings garner 2.5–8.9 percent higher rents, increased occupancy rates of 3–11 percent, and 5.76–26 percent higher sales price in the commercial sector (Eichholtz, Kok, & Quigley, 2010; Fuerst & McAllister, 2009, 2011; Miller, Spivey, & Florance, 2008; Reichardt, Fuerst, Rottke, & Zietz, 2012; Stanley & Wang, 2017; Wachter, n.d.; Wiley, Benefield, & Johnson, 2010). Research has also generally shown operating cost savings such as greater energy and water efficiency in green buildings compared to conventional buildings (Hopkins, 2016). That is not to say that all green certified buildings act in this manner. For example, research has also found some green certified buildings consume more energy than non-certified buildings (Menassa, Mangasarian, El Asmar, & Kirar, 2011; Newsham, Mancini, & Birt, 2009; Oates & Sullivan, 2011). This showcases building variability and the need to assess each building for the appropriate green building initiatives based on its features. Some building owners also adhere to an environmentally conscientious corporate agenda to tap into their desire to “do good” for the environment. This type of agenda engages building owners with sustainable property management to keep them on the path of being more environmentally friendly.
It should be noted that there are barriers to sustainable property management initiatives from the perspective of the building owner. The uncertainty in time and cost to implement sustainable initiatives as well as the lack of market demand in some markets create a disincentive for property owners to invest in sustainable measures (Kriese & Scholz, 2011; Kyrö et al., 2012; Miller & Buys, 2008). Another deterrent faced by building owners is the investment in energy efficient appliances and fixtures if the tenant pays for their own utilities and the tenants’ cost savings are not fully capitalized into the rental rate (Blumstein et al., 1980; Davis, 2011; Klein, Drucker, & Vizzier, 2009; Economidou, 2014).
Section References
Blumstein, C., Krieg, B., Schipper, L., & York, C. (1980). Overcoming social and institutional barriers to energy conservation. Energy, 5(4), 355–371.
Database of State Incentives for Renewables & Efficiency (2020, June 29). Local option—Property tax assessment for energy efficient buildings. https://programs.dsireusa.org/system/program/detail/2983
Davis, L. W. (2011). Evaluating the slow adoption of energy efficient investments: Are renters less likely to have energy efficient appliances? In D. Fullerton and C. Wolfram (Eds.), The design and implementation of U.S. climate policy (pp. 301–316). University of Chicago Press.
Department of Energy & Environment (2023, February). Clean energy DC omnibus amendment act. https://doee.dc.gov/service/clean-energy-dc-act
Economidou, M. (2014). Overcoming the split incentive barrier in the building sector (workshop summary). Publications Office of the European Union. https://publications.jrc.ec.europa.eu/repository/handle/JRC90407
Eichholtz, P., Kok, N., & Quigley, J. M. (2010). Doing well by doing good? Green office buildings. The American Economic Review, 100(5), 2492–2509.
Fuerst, F., & McAllister, P. (2009). An investigation of the effect of eco-labeling on office occupancy rates. Journal of Sustainable Real Estate, 1(1), 49–64.
Fuerst, F., & McAllister, P. (2011). Green noise or green value? Measuring the effects of environmental certification on office values. Real Estate Economics, 39(1), 45–69.
Hopkins, E. A. (2016). An exploration of green building costs and benefits: Searching for the higher ed context. Journal of Real Estate Literature, 24(1), 67–84.
Klein, J., Drucker, A., & Vizzier, K. (2009). A practical guide to green real estate management. Institute of Real Estate Management.
Kriese, U., & Scholz, R. W. (2011). The positioning of sustainability within residential property marketing. Urban Studies, 48(7), 1503–1527.
Kyrö, R., Heinonen, J., & Junnila, S. (2012). Housing managers key to reducing the greenhouse gas emissions of multi-family housing companies? A mixed method approach. Building and Environment, 56, 203–210.
Menassa, C., Mangasarian, S., El Asmar, M., & Kirar, C. (2011). Energy consumption evaluation of U.S. Navy LEED-certified buildings. Journal of Performance of Constructed Facilities, 26(1), 46–53.
Miller, E., & Buys, L. (2008). Retrofitting commercial office buildings for sustainability: Tenants’ perspectives. Journal of Property Investment & Finance, 26(6), 552–561.
Miller, N., Spivey, J., & Florance, A. (2008). Does green pay off? Journal of Real Estate Portfolio Management, 14(4), 385–400.
Newsham, G. R., Mancini, S., & Birt, B. J. (2009). Do LEED-certified buildings save energy? Yes, but…. Energy and Buildings, 41(8), 897–905.
Oates, D., & Sullivan, K. T. (2011). Postoccupancy energy consumption survey of Arizona’s LEED new construction population. Journal of Construction Engineering and Management, 138(6), 742–750.
PricewaterhouseCoopers. (2021, October 28). Companies failing to act on ESG issues risk losing investors, finds new PwC survey. https://www.pwc.com/gx/en/news-room/press-releases/2021/pwc-esg-investor-survey-2021.html
Reichardt, A., Fuerst, F., Rottke, N., & Zietz, J. (2012). Sustainable building certification and the rent premium: A panel data approach. Journal of Real Estate Research, 34(1), 99–126.
Stanley, J., & Wang, Y. (2017). An analysis of LEED certification and rent effects in existing U.S. office buildings. In N. E. Coulsen, Y. Wang & C. A. Lipscomb (Eds.), Energy Efficiency and the Future of Real Estate (pp. 99–136). Palgrave Macmillan.
Wachter, S. (2013). Valuing energy efficient buildings. http://www.cbei.psu.edu/wp-content/uploads/2016/07/Valuing-Energy-Efficient-Buildings.pdf&sa=D&source=docs&ust=1678218728093622&usg=AOvVaw18xZwhvX7Lq2RkxnhORSqD
Wiley, J. A., Benefield, J. D., & Johnson, K. H. (2010). Green design and the market for commercial office space. The Journal of Real Estate Finance and Economics, 41(2), 228–243.
3.3 Property Management Companies
Figure 3.3 illustrates some common motivating factors for pursuing sustainable building initiatives from a property management company perspective.
In some cases, there are sustainable property management responsibilities outlined in the management agreement. Examples may include the requirement of ENERGY STAR Portfolio Manager reporting, and managing maintenance in a way that optimizes energy efficiency, such as wiping down coils at specific intervals to optimize efficiency, avoiding heating pools above 79 degrees to minimize evaporation, or only using LED light bulbs when light bulbs need to be replaced. It can be helpful for property managers to create and regularly update a sustainable property management plan that incorporates these responsibilities as well as other items deemed important by various stakeholders to run the property more sustainably while also aligning with property ownership goals.
The incorporation of conservation practices into performance expectations and/or annual performance evaluations is another motivating factor for property management companies to engage with sustainable property management principles. If sustainable property management concepts are part of performance expectations and subsequent performance evaluations, employees will very likely take these concepts seriously and work toward implementation throughout the property. While sustainable property management responsibilities are not widely incorporated into the management agreement and the employee evaluation process just yet, it is something to consider in order to increase sustainable property management practices at the real estate asset.
There are also potential positive leasing impacts for buildings that are managed in a sustainable manner. Showcasing sustainable initiatives can potentially make units easier to lease and make the building more in demand in a market that views sustainable building practices as important. Sustainable property management can also translate into higher property management fees due to this increase in lease activity. This is because property management fees are commonly based on rental income figures. Property owners can also incentivize property managers to reduce operating costs through sustainable measures by basing the management fee on operating expenses as well.
While it is true that property managers have a plethora of responsibilities and this may seem like “just one more thing to do“ in some cases, effectively embedding sustainable property management responsibilities into property management operations can benefit the property manager from a marketing, financial, risk management, and maintenance perspective. In reality, these practices can help them in their jobs and may help them to achieve certain thresholds for financial incentives and bonuses. However, barriers to engagement with sustainable practices persist in the property management industry, such as trepidation about new sustainable technologies and the lack of systems to properly evaluate the costs and benefits of sustainable building measures (Epstein & Roy, 2003; Pinkse & Dommisse, 2009).
Section References
Epstein, M. J., & Roy, M. J. (2003). Making the business case for sustainability. Journal of Corporate Citizenship, 2003(9), 79-96.
Pinkse, J., & Dommisse, M. (2009). Overcoming barriers to sustainability: An explanation of residential builders’ reluctance to adopt clean technologies. Business Strategy and the Environment, 18(8), 515-527.
3.4 Tenants
Figure 3.4 depicts various common motivating factors for pursuing sustainable building initiatives from a tenant perspective.
Enhanced well-being is a motivating factor for tenants to engage with sustainable property management practices. Examples of tenants engaging with sustainable property management practices for well-being purposes include taking advantage of physical, mental, and social health opportunities at the building, waiting to run the dishwasher or do laundry until there is a full load to save on utility costs, and not smoking. Tenant education programs can help tenants learn about ways to incorporate sustainable property management practices on a regular basis. Program examples include a handbook for tenants, programming on site for tenants, as well as signage throughout the property. Content can be created by the property management firm or drawn from other sources such as Better Buildings, an initiative of the U.S. Department of Energy (DOE). Information about how each initiative helps meet goals for all three spheres of sustainability fosters action on the part of the tenant. Also, statistics can help motivate tenants to act. For example, instead of just asking tenants to unplug their appliances and devices while not in use, the statistic that plug loads can account for 30 percent of building energy, and equating this percentage to money saved and GHG emission reductions, can be used (EPA, n.d.). A tenant education program can also include real-time energy and water monitoring, as illustrated in figure 3.5, to help engage tenants in reducing their consumption.
Rewards are another tool to engage residents in sustainable property management practices. For example, contests relating to reducing consumption can be part of the real-time monitoring building display and rewards given for reaching certain goals. Recycling campaigns can also be implemented with rewards such as a gift card, free food, or a reusable water bottle when certain recycling thresholds are met. Recognition can also be used as a reward if there are limited funds available. Lower utility costs also motivate tenants to engage with sustainable property management principles. Partnering with tenants to educate them on how to reduce their utility bills through sustainable practices can help the tenant save money, reduce GHG emissions, and foster relationships between the tenant and property manager.
Of course lower utility bills is only a motivating factor if the tenant pays for their own utilities. In some cases, the building owner pays for the utilities so this motivating factor would be irrelevant. There are also other barriers to tenant engagement. For example, a busy single parent working two jobs may not reasonably have the time to unplug unused appliances or follow other green tenant practices; similarly, it may not be safe or even physically possible for elderly residents in a retirement community apartment tower to reach down to unplug things.
Section Reference
EPA (n.d.). 8 Great strategies to engage tenants on energy efficiency. https://betterbuildingssolutioncenter.energy.gov/sites/default/files/attachments/8-Great-Strategies-to-Engage-Tenants.pdf
3.5 Vendors
Property vendors include contractors and suppliers. Figure 3.6 illustrates some common motivating factors for pursuing sustainable building initiatives from a vendor perspective.
The property owner may require vendors adhere to certain sustainability standards for operations at the property. These requirements can be detailed out in the service agreement between the property manager, who acts as an agent for the building owner, and the vendor. For example, there can be a clause in the landscape service agreement that the blade on mowers be raised to a certain level to allow longer grass, which makes it more drought-resistant. The grass height can occasionally be measured to ensure that the vendor is in compliance with the agreed-upon mower level per the service agreement. For supplies, the vendor service agreement can have a clause that only allows the property manager to select office products from a sustainable item list. This may include recycled paper and compostable cups. It’s important that there is someone on the property management team dedicated to regularly reviewing and enforcing the terms of these service agreements to ensure compliance with sustainability standards.
Considering the increased demand from investors and the market for sustainable building initiatives, there may be new business opportunities for vendors by offering supplies and services that are more sustainable. The creation of programs to address customer demands for sustainable services and products can help vendors gain a competitive edge, while vendors not willing to offer more sustainable services and products stand to lose business. However, it may cost vendors more to offer these sustainable materials and methods. Additionally, since some vendors may not be willing to offer these services, the owner/manager may be left with higher costs and/or fewer vendors to select from, which may impact cost or timeliness of deliveries. One way to address these barriers is for the property manager to negotiate a long-term contract based on collaboration to help counteract any higher costs and timeliness issues. By working with property personnel, vendors can collaborate on how to embed more sustainable practices into business operations through economies of scale and an agreed-upon timeline. This can also help align values and beliefs and lay a foundation for a long-term working partnership.
3.6 Communities
Wider community members are motivated to engage with sustainable property management principles for various reasons. Figure 3.7 lays out some common reasons for community engagement.
A sustainable lifestyle is increasingly becoming important to people, especially younger generations. Not only does this include ecologically sustainable practices such as recycling, minimizing single use plastics, and shopping local; it also focuses on economic opportunity through ethical sourcing, holding corporations accountable for their actions by boycotting or quitting from companies that appear irresponsible, and saving money by driving less, shopping from thrift stores, and minimizing hyper-consumerism. Engaging community members who find a sustainable lifestyle important can further sustainability efforts at the property and wider community as they can provide innovative ideas and extra support to get others on board with sustainability efforts. The wider community is also motivated to engage with sustainable property practices because they see that it can help with community development. For example, they may get involved to help the property set up farmers’ markets, a community garden, community yoga, service projects, a running club, a community compost bin, and green spaces, which help enhance the quality of the community. They can also educate and enlist the support of the community for initiatives that the community may at first consider negative externalities, such as installation of solar panels that will create a glare for surrounding properties. These collaborations among various community members can help the community and property thrive economically, socially, and environmentally by potentially increasing property values, building social relationships, and mitigating negative ecological externalities of the built environment.
There may be barriers to engagement by the community. For example, a composting area may produce an offensive smell, which the community may consider a negative externality. Another example is neighbors who oppose a farmers’ market because it causes nonresidents to park in their parking spaces when visiting the farmers’ market. When barriers like these arise, it is important to look for compromises and joint solutions that meet the needs of different stakeholders, but without disrespecting their right to opinions about the built environment. In the case of the farmers’ market example, the property manager could agree to somehow police parking violations as part of their programing efforts, although it should be noted that there is operational time and cost associated with this solution.
3.7 Conclusion
This chapter outlined various motivations for implementing sustainable property management practices. As can be seen, collaboration among various stakeholders is essential for a successful sustainable property management program at the property. Collaboration occurs through mutual respect and understanding of motivations while working toward compromises and joint solutions. This type of collaboration cultivates relationships among stakeholders and the desire to be good corporate and community citizens.
Discussion Questions
1. What other factors may motivate key stakeholders in adopting a sustainable property management plan? And why is it a motivating factor for that particular stakeholder?
2. As a building occupant, what sustainability features, if any, are important to you?
3. Do you think sustainable property management operations will become a requirement in the future? Why or why not?
4. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Watch the following video: https://www.youtube.com/watch?v=TWOVY1Q_otA. After watching the video, in one paragraph discuss how Bob Willard’s presentation can be applied to the property management field.
2. Use the link below to access the Database of State Incentives for Renewables & Efficiency:
https://www.dsireusa.org/
1. Enter your zip code on the homepage to find incentives for renewables and efficiency in your area
2. From the list provided, choose an incentive and answer the following:
1. Name of the incentive
2. State/Territory of the incentive
3. Category of the incentive
4. Policy/Incentive Type
5. When it was created
6. When it was last updated
7. The goal of the incentive
Figure References
Figure 3.1: Key stakeholders in sustainable property management operations. Kindred Grey. (2023). CC BY 4.0.
Figure 3.2: Common motivating factors for building owners. Kindred Grey. (2023). CC BY 4.0.
Figure 3.3: Common motivating factors for property management companies. Kindred Grey. (2023). CC BY 4.0.
Figure 3.4: Common motivating factors for tenants. Kindred Grey. (2023). CC BY 4.0.
Figure 3.5: Real-time building energy monitoring example. Grand Canyon National Park. (2013). Lobby video display [photograph]. https://flic.kr/p/dMHdJq. CC BY 2.0.
Figure 3.6: Common motivating factors for vendors. Kindred Grey. (2023). CC BY 4.0.
Figure 3.7: Common motivating factors for communities. Kindred Grey. (2023). CC BY 4.0.
Image Descriptions
Figure 3.2: Motivating factors for building owners: local laws and regulations, investor and market pressure, green building certifications and GRESB points, positive financial statement impacts, environmentally conscientious corporate agenda.
Figure 3.3: Motivating factors for property management companies: property management agreement requirement, performance evaluation expectations, positive leasing impacts, higher management fees. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.03%3A_Stakeholder_Motivations_for_Sustainable_Property_Management_Practices.txt |
Learning Objectives
• Describe pathways to increase energy efficiency
• Describe pathways to increase water efficiency
• Describe pathways to increase indoor environmental quality
• Describe pathways to waste management
• Describe pathways to increase site sustainability
4.1 Introduction
Maintenance and repairs are continual functions throughout the operations phase of the building lifecycle. Proper maintenance and prompt repairs extend the life of building equipment and keep the property running efficiently. Making these functions more sustainable can further the efficiency and effectiveness of the building systems while also lowering operational costs, decreasing ecological disturbances, and increasing building occupant comfort. This holistically increases sustainability at the property. Sustainable concepts including energy efficiency, water efficiency, indoor environmental quality, waste management, and site sustainability considerations are covered in this chapter as well as some best practices.
4.2 Energy Efficiency
Energy efficiency is a fundamental concept for increasing the sustainability of a property. Higher amounts of greenhouse gases are emitted from buildings that use nonrenewable energy inefficiently. This not only harms the ecological environment to a greater degree, but also creates higher bills for the landlord and building user.
In 2020, residential and commercial buildings in the United States consumed 40 percent of total U.S. energy consumption (U.S. Energy Information Administration, 2022). Figure 4.1 and figure 4.2 illustrate the major end uses in commercial and residential buildings. Lighting, refrigeration, ventilation, and cooling consumed the most electricity in commercial buildings while air conditioning, space heating, water heating, and lighting consumed the most electricity in residential buildings. Strategies to make buildings more energy efficient involve reduction of greenhouse gas emissions by lowering energy use from traditional sources such as fossil fuels or by transferring over to renewable energy. These efforts can bring the building closer to net zero energy, where a building generates as much energy as the building consumes, or net positive energy, where the property generates more energy than the building consumes. However, it is more difficult to achieve net zero energy and net positive energy solely from building operations without first considering this goal during the building design and construction process.
A holistic energy audit is the first step to understanding the property’s energy consumption. The energy audit, an assessment of energy use and efficiency within the property, is holistic in the sense that all energy end uses are assessed and the impacts of these energy uses on environmental, social, and economic spheres are taken into consideration. A best practice is to create a checklist that will assist in identifying and prioritizing energy consumption reduction opportunities. Also, it is helpful to conduct energy audits every few years to continually evaluate the property’s energy consumption and identify potential strategies to reduce energy consumption as well as consider the energy needs of the stakeholders.
Energy audits vary in scope and can be performed through either a self-assessment or energy professional, or some combination of the two. During a self-assessment energy audit, the following can be inspected:
• Any air leak locations
• Ventilation
• Insulation levels
• Heating and cooling equipment
• Lighting
• Appliances and Electronics
Professional energy audits tend to be more comprehensive. Specialists trained in this line of work tend to identify more issues than a self-assessment will. Specialists provide the services listed above in the self-assessment and can also include services such as:
• Prior utility bill examination
• Blower door test (illustrated in figure 4.3, and a video on how this test works is at the end of this section)
• Thermographic scan (illustrated in figure 4.4, and a video on how this test works is at the end of this section)
• Air infiltration measurements
When considering an energy audit at the property, some property managers may begin with a professional energy audit, whereas other property managers may first do a self-assessment and then set up a professional energy audit. A combination of both can be most effective because the property manager can share the self-assessment with the professional energy auditor, which can provide additional solutions above and beyond their standard energy audit. This combination also helps property managers become more familiar with the building components that can be helpful in catching issues early.
For further information, the United States Department of Energy offers a “Do-It-Yourself Home Energy Assessments” webpage that goes into more detail: https://www.energy.gov/energysaver/do-it-yourself-home-energy-assessments
Energy benchmarking is a significant component of an energy audit because it measures energy consumption and compares it to similar buildings as well as to other buildings in the company’s portfolio. Benchmarking also provides a baseline for energy measurement and can be used to set future energy consumption goals. ENERGY STAR Portfolio Manager® is a widely used benchmarking tool for commercial buildings with approximately 25 percent of U.S. commercial building space utilizing this measurement and tracking tool (ENERGY STAR, n.d.). Utility bill data and basic building information are inputted and a score is generated comparing the subject building to similar buildings in the United States while accounting for weather and operating condition variations. The building score can be between 1–100 with 50 being the median score. The higher the score, the more energy efficient the subject building is compared to its peer buildings.
Energy efficiency recommendations are then put forward based on the building energy audit and benchmarking findings, and these include energy efficiency goals with associated target dates. An energy management policy is helpful in laying out the pathways to reach these goals within the respective timeframes and can include implementation of energy management best practice policies and energy efficient products. For example, an energy efficiency best practice policy can be to regularly schedule a walkthrough of all equipment to identify any items that are not functioning properly and flag them for repair and put a target date for the repair. Also, energy efficient product recommendations vary in the levels of upfront cost and subsequent savings during operations. For example, changing out traditional incandescent light bulbs to light emitting diode (LED) lightbulbs is a much lower cost recommendation than installing a photovoltaic (PV) array on the site, but also does not produce the same subsequent savings during operations. The next few paragraphs discuss some ideas to increase the energy efficiency of major end uses at the building level.
Lighting
Motion sensors are one method to increase the energy efficiency of lighting at a property. Motion sensors are installed to automatically turn the lights off when the sensor detects no more movement within the respective building space. Switching to more energy efficient light bulbs is another way to increase energy efficiency. There are three main types of light bulbs, as illustrated in figures 4.5–4.7. The incandescent light bulb is the traditional light bulb with the shortest lifespan and lowest energy efficiency. The compact fluorescent lamps (CFL) have a longer lifespan and higher energy efficiency than the incandescent lightbulb, but the LED is the most efficient light bulb with the longest lifespan. When we consider sustainability’s environmental, social, and economic spheres, we find the LED is the most energy efficient, the maintenance staff onsite does not have to change the bulbs as often, and—although LED light bulbs cost more upfront—they are the most cost-effective long term due to their longer lifespan and energy efficiency. Also, material costs are reduced because LED light bulbs need to be replaced less often. Smart light bulbs are an LED light bulb option that allows the building user to set timers or manually turn off the lights in the building space using their smartphone, tablet, or smart home automation system.
HVAC
Annual service of HVAC equipment by a professional is important for peak performance. Also, quarterly HVAC air filter replacement is recommended to maintain optimum energy efficiency, as dirty air filters decrease the efficiency of HVAC equipment. If the unit is reaching the end of its expected lifetime or when replacement is needed due to a malfunction, a more energy efficient unit can be considered. ENERGY STAR certification is available for HVAC units and a list of ENERGY STAR options can be reviewed at energystar.gov.
Air leaks and low insulation levels within the building space can make HVAC equipment work harder. Therefore, in addition to evaluating the HVAC equipment itself, it is important to identify any air leaks and evaluate the costs and benefits of sealing the air leaks. Air leaks can commonly occur in ductwork, windows, doors, plumbing fixtures, lighting fixtures, flooring edges, and electrical outlets. Caulking and weather stripping are cost effective methods to reduce air leaks. A more expensive method would be to replace windows with more energy efficient ones to reduce air leakage. However, this option may be more economically sensible as windows approach or are past their expected lifetime. Properly insulating areas of the building space with minimum recommended insulation levels can also increase the energy efficiency of the building. Considering the social sphere of sustainability, reduced air leakage and higher insulation levels typically increase occupant comfort.
Appliances and Electronics
Consider the time spent using various appliances and electronics throughout your day. These can include a refrigerator, oven, stove, microwave, dishwasher, washer, dryer, coffee maker, phone, computer, and television, to name some examples. Also consider energy consumed by IT equipment within data centers. This energy consumption can be decreased by adjusting the settings of the devices or purchasing more energy-efficient devices. Furthermore, these devices consume energy even when they are turned off or on standby mode. This is known as vampire load or phantom power. Therefore, a best practice is to unplug a device when not using it. Another option, with upfront costs, is to install European-style outlets with shut off switches, as illustrated in figure 4.8. This prevents the building user from having to unplug appliances and electronics when not in use, but instead they just flip the switch on the outlet.
Water Heating
In the residential context, water heating is important for showering, cleaning dishes, and cleaning clothes. A cost-free way to decrease energy consumption of a water heater is to turn down the thermostat. This lowers cost and energy emissions without significantly affecting the comfort of taking a shower. Another cost-free method to reduce water heating is to use cold water for clothes washing. A low-cost method to decrease the energy emission from a water heater is to insulate the storage tank and the pipes. This reduces heat loss and the unit does not turn on as frequently. When considering new water heater choices, ENERGY STAR certified options are available and can be found at energystar.gov.
Energy Reduction Alternatives
Sometimes, energy reduction may not be possible. Therefore, bringing renewable energy to the operation of the building may be an opportunity to decrease fossil fuel use and associated greenhouse gas emissions. There are a variety of opportunities to include renewable energy into the building operations. First, electricity generated from renewable energy sources can be purchased directly from the utility company in many cases. Considering the economic sphere, there is typically a slight increase in cost for this option compared to nonrenewable power sources. In regions where utility companies do not offer this option, renewable energy certificates (RECs) can be purchased to illustrate the building’s commitment to operate on renewable energy.
Alternatively, renewable energy systems can be installed on the building site. While not an inexpensive upfront investment, the subsequent savings during operations can make up for this initial cost outlay. For example, a PV array can be installed to generate solar power for the building’s energy needs. Any solar power not used by the building is fed back to the power grid for use by other customers and the building would receive an REC that can be sold to others or be used as a credit against the building’s energy usage (referred to as net metering). It should be noted that net metering benefits are subject to jurisdiction and system capacity limits for jurisdictions that currently offer the net metering benefit. Also, disadvantages of solar power include the expense of the panels that are often impossible to recycle, which puts the embedded toxic chemicals (that facilitate the energy capture) directly into landfills where they leach.
Section Videos
ENERGY STAR: A Simple Choice (Appliances)
[00:01:56] ENERGY STAR. https://youtu.be/NtER86Cf_d4
Blower Door Test: How It Works
[00:03:20] GreenfabTV. https://youtu.be/0Vk-qk-vLb4
How an Infrared Camera works during a Home Inspection
[00:02:14] The Home Inspector. https://youtu.be/h0J3A_Uep_k
Section References
ENERGY STAR. (n.d.). Benchmark your building using ENERGY STAR portfolio manager. https://www.energystar.gov/buildings/benchmark.
U.S. Energy Information Administration. (2022, December 23). Frequently asked questions. https://www.eia.gov/tools/faqs/faq.php?id=86&t=1
4.3 Water Efficiency
While this section discusses water efficiency, it is important to note the connection between water efficiency and energy efficiency as a substantial amount of energy is needed to provide drinking water (also referred to as potable water) and for treating wastewater (also referred to as non-potable water). Water efficiency is also important on its own as there is a limited supply of freshwater and the cost of household water utility bills is rising—up 43 percent from 2012 to 2021 (Bluefield Research, 2021). Reducing water use will help maintain the supply of freshwater while also decreasing water utility bills.
In 2015, approximately 12 percent of total water in the United States was withdrawn for public supply to domestic, industrial, commercial, and other users, and about 1 percent for self-supplied residences, for instance in well use (USGS, 2018). Figures 4.9 and 4.10 illustrate the end uses of water in office and residential buildings. Domestic/restroom use consumes the greatest percentage of water in office buildings, followed by cooling and heating, landscaping, and kitchen/dishwashing respectively. Toilets consume the greatest percentage of water in the residential setting, followed by showers, faucets, clothes washers, leaks, and other.
Just like energy efficiency, a water assessment is the first step to understanding a building’s water consumption. The items to evaluate during a water assessment include locating any water leaks, checking plumbing fixtures, and evaluating the working order of appliances, cooling and heating systems, and any irrigation systems. A best practice is to create a checklist that will assist in identifying and prioritizing water consumption reduction opportunities during the water assessment. The United States Environmental Protection Agency (EPA) offers a water assessment checklist template that can be found at: https://www.epa.gov/sites/default/files/2017-01/documents/ws-commercial-water-assessment-checklist.pdf. Also it is helpful to perform a water assessment on a regular basis to continually evaluate the property’s water consumption and identify potential strategies to reduce water consumption.
Water benchmarking is an important factor in a water assessment because it measures water consumption across the building and compares water use over time and across any properties in the company’s building portfolio. Benchmarking provides a baseline for water measurement and can be used to set future water consumption goals. ENERGY STAR Portfolio Manager can also be used to benchmark water use.
Recommendations are then put forward based on the water assessment. The establishment of a water management policy that includes water efficiency best management practices and water efficiency goals with associated target dates aids in the implementation of the recommendations. For example, a water efficiency best management practice can be to regularly schedule a walkthrough of all plumbing fixtures to identify any items that are not functioning properly and flag them for repair and put a target date for the repair.
These recommendations vary in the levels of upfront cost and subsequent savings during operations. For example, raising the blade on a lawn mower to allow the grass to grow longer and more drought-resistant is a no-cost recommendation with hard to quantify subsequent savings during operations. On the other hand, replacing all older toilets with low-flow flushing models will indeed have upfront costs but also have quantifiable utility cost savings once in operation. The next few paragraphs discuss some ideas to increase the water efficiency of major end uses at the building level.
Leaks
Leaks account for 12 percent of water use in the residential building sector. Therefore, regularly checking for leaks and repairing them promptly is important to the building’s overall water efficiency strategy. While some leaks are obvious, some are not so obvious. A visual inspection can detect drips from a faucet or water stains on a ceiling from a pipe leak. However, a leaking toilet may not be visible to the eye. An easy and almost no-cost method to check for leaks in a toilet is to put a couple of drops of food coloring in the toilet tank overnight, do not flush the toilet during this time, and see if the food coloring has seeped into the toilet bowl in the morning. If the food coloring has seeped into the toilet bowl, this confirms a leaky toilet that needs to be fixed.
Plumbing Fixtures and Valves
It is beneficial to regularly check plumbing fixtures and valves to ensure that they are still working properly and are clean. This includes faucets in the kitchen and bathrooms, and fixtures in the shower, bathtub, and toilet. A low-cost way to decrease water consumption is to install aerators on sinks if there is no aerator currently on the fixture. An aerator, illustrated in figure 4.11, screws into the faucet and adds air to the water which reduces the amount of water consumed while also controlling the stream of water. If it is an older plumbing fixture, replacement of the old aerator with a model that lowers the water flow rate will reduce water consumption. Another way to consume less water is to have the water pressure checked to make sure it is at the proper level for the fixture, that it is not too high. This also helps lengthen the life of the fixture. A more expensive way to decrease water consumption is to replace toilets and/or fixtures with WaterSense labeled models. WaterSense is a labeling program for water-efficient products sponsored by the EPA and includes products such as toilets, showerheads, bathroom faucets, and urinals.
Appliances
It is beneficial to regularly assess appliances such as clothes washers and dishwashers to ensure proper working order. Regular cleaning is important so that buildup does not occur that could make the appliance less efficient. Also, running them only when full reduces water consumption. As they reach the end of their lifecycle, new models that are more water efficient can be considered. ENERGY STAR certified clothes washers use approximately 1/3 less water than conventional clothes washers and certified dishwashers save on average 3,870 gallons of water over the lifetime of the appliance (ENERGY STAR, n.d.a; ENERGY STAR, n.d.b). A list of certified clothes washers and certified dishwashers can be found on the ENERGY STAR website.
Cooling and Heating
The amount of water used for the cooling and heating equipment in a commercial building is tied to the amount of energy used for the operation. Therefore, the implementation of energy efficient measures will also reduce the amount of water needed to operate these systems. Also, captured rainwater and air handler condensation can be used as an alternative to increase efficiency. Regular evaluation of the working order of these systems is important to ensure optimal efficiency.
Landscaping
There are various methods that can be employed to increase water efficiency for landscaping at a building site. The first method to consider is xeriscaping, which is using native drought-resistant plants at the property.
Example: Landscaping That Increases Water Efficiency
Figure 4.12 illustrates an example of a xeriscape garden which requires less watering than a traditional lawn. Alternatively, figure 4.13 depicts a brown lawn in California, a state that has grappled with droughts and associated water restrictions throughout the recent years. Although green grass paint for lawns is available for sale to make this brown lawn green, a long-term solution would be to transition to xeriscaping the grounds versus maintaining a lawn in places like California and the arid U.S. Southwest.
Irrigation systems are another area to examine when considering water efficiency. Drip irrigation systems are more water efficient than traditional sprinkler irrigation systems because they deliver water directly to the root zone of plants over a longer period of time. This method also helps prevent overwatering and reduces evaporation. Drip irrigation systems may work well in some landscape settings while also saving resources. Smart irrigation technology is another option that can be added to various types of irrigation systems; instead of a user-determined fixed schedule, a complete controller or a sensor added to an existing irrigation timer can use soil moisture data or weather data to determine when the landscape needs watering. Sensors that detect rain and moisture can also be an option added to different types of irrigation systems, versus running on a timer, which makes the irrigation system more efficient. Rainwater harvesting is another option to reduce water for irrigation. Rainwater harvesting involves the collection of rainwater runoff to a storage system, such as a tank that can be used later as illustrated in figure 4.14. Other non-potable uses for rainwater include activities such as watering gardens and flushing toilets. Regular inspection is important for any of these options to ensure proper and efficient functioning. Some states have legal restrictions on rainwater catchment, so property managers need to check with their local jurisdictions before implementing a rainwater harvesting program.
Section References
Bluefield Research. (2021, August 23). Up 43% over last decade, water rates rising faster than other household utility bills. https://www.bluefieldresearch.com/ns/up-43-over-last-decade-water-rates-rising-faster-than-other-household-utility-bills/
ENERGY STAR. (n.d.a). Clothes washers. https://www.energystar.gov/products/clothes_washers
ENERGY STAR. (n.d.b) Dishwashers. https://www.energystar.gov/products/dishwashers
USGS. (2018, June). Summary of estimated water use in the United States in 2015. https://pubs.usgs.gov/fs/2018/3035/fs20183035.pdf
De Olivia, A. (2021, June 30). Making water in a desert, from sunlight and air. CNN. https://amp.cnn.com/cnn/2021/06/30/middleeast/source-global-dubai-spc-intl/index.html
4.4 Indoor Environmental Quality (IEQ)
Indoor environmental quality encompasses indoor air quality (IAQ), acoustics, thermal comfort, lighting, and views from a building, as illustrated in figure 4.15. This section will cover these main components of IEQ and put forward ideas to increase IEQ throughout the building space.
IAQ
IAQ refers to the quality of the air within a building space. IAQ is an important consideration because some pollutant concentrations are higher indoors than outdoors. Furthermore, Americans on average spend approximately 90 percent of their time indoors (EPA, 2021). Pollutant source examples include tobacco smoke, volatile organic compounds (VOCs), cleaning supplies, building materials, mold, radon, and carbon monoxide. Sick building syndrome (SBS) occurs when contaminants and pollutants reach a certain level within the building and cause building occupants severe discomfort, including headaches, dizziness, fatigue, and/or irritation to the eyes, nose, or throat.
There are a variety of ways to reduce contaminants and pollutants throughout the building space. First and foremost, it is important to ensure there is proper ventilation within the building with adequate air exchange between indoor and outdoor air. Changing air filters as part of preventative maintenance can also help with IAQ. Regularly cleaned building entryways and floors help rid the building space from contaminants. A smoking policy that prohibits smoking inside the building and within a certain distance outside of the building can also be part of a building’s IAQ plan. Some office campuses and multifamily rental communities have prohibited smoking anywhere on site whether it be indoors or outdoors.
Volatile organic compounds (VOCs) are airborne chemicals that are emitted from many products such as paint, carpeting, furniture, office equipment, and cleaning supplies. VOCs can decrease the IAQ in a building and cause adverse health effects to building occupants. There are third-party certifications that help consumers limit their exposure to VOCs. GREENGUARD Certification, offered through global safety science company UL Solutions, is available for building materials, furniture, furnishings, electronic equipment, cleaning, and maintenance products. Prior to receiving GREENGUARD Certification, the product is tested for a plethora of chemicals and must meet the low emission level standard to receive the certification. Green Seal labels can be found on cleaning products that are safer and more ecologically friendly. One way to formalize using products with lower VOCs is to implement an environmentally preferable purchasing (EPP) program to secure products with reduced negative environmental impacts. Staples, a retail company specializing in the sale of office products, offers Staples® Sustainable Earth™ products that can be used for creating a sustainable purchasing guide for on-site staff that only lets them choose items from this line of products. For example, the only option would be to choose recycled copy paper versus virgin copy paper.
A pest control program is important at the building because it manages and mitigates adverse impacts on humans and buildings, reducing site damage from pests such as cockroaches, ants, bed bugs, spiders, and termites. Conventional pest management focuses on regular applications of pesticides to control pests in and around the building. Integrated pest management (IPM) is a more sustainable option that encompasses a more holistic strategy to lower the risks to people and the environment, and focuses on the building and the surrounding landscape areas as well. Rather than relying mainly on pesticide application to control pests, there are other steps that are first taken before pesticides are applied in a thoughtful manner. The first step is to create a threshold for pest populations that will be used to determine if pest control needs to be taken. Pests are then identified and monitored to see if they meet this threshold and if pest control is needed. Prevention is also a critical step in IPM to reduce the need for pesticides. For example, cleaning out food and drink containers before putting them in a recycle bin and sealing building cracks can help prevent pests. Once these steps are in place and pest control is deemed necessary, targeted chemicals are used first before general pesticides are sprayed widely. It is important to regularly evaluate the IPM program that is put into place and modify where necessary to improve the effectiveness of the program.
Acoustics
Building acoustics impact the performance of the building and the associated health and well-being of the building occupants. Effective building acoustics minimize the noise transmission from one building space to another while also controlling the sound within a specific building space. While building acoustic considerations are important to consider during the building design and construction phase of the lifecycle, there are some actions to consider during the operations phase of the building should building acoustics be an issue. The installation of acoustical ceiling tiles as pictured in figure 4.16, furniture, or spray-on acoustical treatments can improve building acoustics. Sound masking systems are another option that can help tune out background noise in office settings.
Thermal Comfort
Thermal comfort, the sense of whether a person feels too hot or too cold, is another consideration in the overall IEQ of a building. As with acoustics, thermal comfort considerations are important during building design and construction. Once the building is in operation, regular occupant surveys can provide information regarding the level of thermal comfort satisfaction. If there is a high level of thermal comfort dissatisfaction, examination and adjustment of the HVAC system’s air speed, moisture level, and air temperature can help address this dissatisfaction. Additionally, in an office setting, fans can be placed near individual workstations so that building occupants have more control over their immediate environment. It should be noted that there is often difficulty in balancing the social and ecological sustainability spheres within the thermal comfort context, because people can be legitimately uncomfortable as a result of many greening initiatives that attempt to regulate temperature without a heavy reliance on air-conditioning.
Lighting
Building space is illuminated by natural and artificial light sources. These sources affect the building occupants’ circadian rhythms with bright light fostering a feeling of alertness while soft light cultivates a feeling of relaxation. Lighting can also affect energy efficiency. It is important that the goal of each building space be considered when deciding on lighting choices. When possible, access to natural light is best for the health and well-being of the building occupants. Daylighting is a technique that allows natural light into the building space and reduces the energy load requirements for lighting, resulting in reduced lighting costs and ecological impacts. Building light shelves, which are placed above eye-level, maximize daylighting by directing light onto the building ceiling and deep into the building while also reducing heat and glare. The tradeoff is that the addition of internal glass leads to a more expensive tenant build-out and has a significant impact on upfront costs. These considerations highlight the difficulty that sometimes arises in balancing the three spheres of sustainability. In an office context, daylighting techniques combined with artificial task lighting at workspaces can be an efficient mix of both natural and artificial light sources.
Views
Access to views of the outdoors from building spaces cultivates health and well-being for building occupants. Biophilia, the human condition of seeking connection with nature and other living beings, can be maximized in building views to increase cognitive performance and reduce stress levels. Premiums are regularly charged for a city view, mountain view, or water view. While the building orientation is decided upon during design and construction, during the operations and maintenance building lifecycle phase, indoor configurations of furnishings and fixtures can be considered to maximize views of the outdoors.
Section Video
Particles in your indoor air and strategies to improve indoor air quality
[00:01:15] U.S. EPA. https://youtu.be/JZx_mRTpSts
Section Reference
EPA. (2021). Report on the environment: Indoor air quality. https://www.epa.gov/report-environment/indoor-air-quality#:~:text=Americans%2C%20on%20average%2C%20spend%20approximately,higher%20than%20typical%20outdoor%20concentrations.
4.5 Waste Management
Waste management is an important consideration in the building operation and maintenance plan. The first step in establishing a waste management program is a waste stream audit. While not the most glamorous job, it assists in identifying the type and amount of waste in the building’s waste stream. The ENERGY STAR® Portfolio Manager® tool can be used for tracking and measuring this waste. The results of this audit provide a baseline that can be used to set future waste diversion goals.
The waste diversion rate is the amount of waste that is diverted from landfills through recycling and source reduction activities. The less waste produced within a building, the less amount of times the waste management provider needs to provide trash haul away service. This saves on the number of trash container pulls and associated costs for these services. Furthermore, this puts less strain on the ecological environment. Total Resource Use and Efficiency (TRUE) project certification, a rating system that complements LEED project certification, can also assist with waste management goals. To receive TRUE certification, a building must have a zero-waste policy in place and divert a minimum of 90 percent of waste from landfills, incinerators or the environment for twelve months. An individual can obtain a TRUE Advisor certification and advocate for the TRUE building certification by adopting a holistic waste strategy that focuses on the product lifecycle in its entirety and on the reduction, reuse, and recycling of products.
Figure 4.17 illustrates a symbol that is commonly used in recycling campaigns. The words associated with these arrows are reduce, reuse, and recycle. The first word in this signage is reduce, but the main focus is commonly on recycling. The word reduce is first in the motto and is the most resource efficient. Reusing is the second most resource efficient option, followed by recycling. Therefore, it is not just about the waste diversion rate, but also the waste generation rate. However, this concept can be difficult to implement in hyperconsumerism societies such as the United States.
Section Videos
How Much Plastic is in the Ocean?
[00:04:59] Be Smart. https://youtu.be/YFZS3Vh4lfI
Adidas x Parley—A Mission for our Oceans
[00:01:06] https://youtu.be/ogNWB0XlOo8
Case Study: “Swap Room”—Recycling Unwanted Goods in an Apartment Complex
[00:01:45] Green Strata. https://youtu.be/gCqX3wTNJ9M
How Garbage is Recycled at the US’ Largest Recycling Facility
[00:03:30] Insider. https://youtu.be/L2Rc8oTOtd8
4.6 Site Sustainability
Many site sustainability options should be considered during the building design and construction process. For example, an undeveloped site, or greenfield, may be the target for a new building with sustainable features. Let’s also assume it is far from amenities and public transportation, so a car is necessary for all trips. While the building may contain many sustainable features, the building site as a whole causes a relatively high amount of site ecology destruction and greenhouse gas emissions through car dependence. Conversely, a previously developed site, or brownfield, may be the target for a conventional building. Let’s also assume it is in an urban area close to amenities that are walkable, such as shopping, work, and entertainment. While the building may not contain many sustainable features, the location of the site makes it a sustainable site. There are cost implications to both infill/redevelopment sites and greenfield sites that also affect site selection decisions and must be balanced with a green/environmental agenda in the context of the project budget and lending realities.
Of course, when acquiring an existing building, this choice has already been made. But there are still site sustainability options during the operations and maintenance building lifecycle phase. Site sustainability considerations such as landscaping and rainwater management considerations were discussed above, but there are more options to consider.
Transportation options are an important site sustainability consideration. Thinking through modes of available transportation can increase site sustainability. Options include walking, biking, public transportation, carpooling, or driving alone to the site. While there are limitations based on the building’s location relative to the existing landscape, there are still possibilities to increase sustainability through transportation to the site. For example, if an office site is in a rural location that is car dependent, tenant incentives can be put into place to incentivize carpooling. Virginia Tech offers this type of incentive by offering a parking pass for carpoolers that is less expensive than a parking pass for a single driver. This can reduce emissions and fuel consumption as well as costs for building occupants.
Paving options and roof considerations are also important to site sustainability. Pavement and rooftops contribute to the heat island effect and stormwater runoff. The heat island effect occurs in urban areas where structures like buildings and parking lots absorb and re-emit more heat from the sun than natural surfaces and create higher temperatures than in more rural areas. Stormwater runoff increases when impermeable surfaces increase, like parking lots, driveways, sidewalks, and roofs. Highly reflective, light colored, porous materials can be used for sidewalks to reduce the heat island effect and stormwater runoff. A lighter roof can help reduce the heat island effect and adding some type of vegetated roof can decrease stormwater runoff. These are options to consider when paving needs to be done and the roof needs to be replaced during the operations phase of the building lifecycle.
Light pollution is also a site sustainability consideration. Light pollution occurs when artificial light is used excessively or inappropriately at night. Figure 4.18 illustrates an example of light pollution with glare, skyglow, light trespass, and clutter (See https://www.darksky.org/light-pollution/ for more information on light pollution and these components). Furthermore, light pollution increases GHG in the atmosphere and disrupts human and wildlife patterns. While artificial light is necessary at night for illumination and safety, appropriate use of it is an important consideration. Figure 4.19 illustrates a photograph taken with and without a light pollution filter that reduces the transmission of light to illustrate the appropriate use of artificial light at night. Therefore, light pollution reduction is an important consideration when replacing lighting at a property during the operations phase of the building lifecycle.
Section Video
The Kandi Machine—China’s Sweet Pollution Solution
[00:08:34] Aaron Rockett. https://youtu.be/fiEJPbxL2hI
4.7 Conclusion
There are a variety of opportunities to implement sustainable practices into the maintenance and repair functions during the operations phase of the building lifecycle. While this chapter focuses on making the property more efficient, the human stakeholders are the decision makers of these sustainable initiatives and as such the building maintenance and repair functions remain a human-centered process. Regular property performance evaluation and sustainable implementation solutions holistically improve sustainability by saving both building owners and building tenants money, mitigating negative ecological externalities, and providing a nice place for building occupants. While some sustainable initiatives discussed in this chapter are relatively low-cost, some are expensive and cost is a significant barrier. Financial concepts related to sustainable property management will be further discussed in chapter 7.
Discussion Questions
1. Make a list of buildings you regularly spend your time in (i.e., residence, workspace, classroom, gym, etc.).
1. Are any of these building spaces without access to natural light? How does it make you feel?
2. Think about how artificial light compares to natural light throughout day and night. How does it make you feel?
3. Do any of these building spaces have views? If so, what is the view of and what feelings do these building views cultivate?
2. Think about buildings you have been in or buildings you have seen in pictures. What is one of your favorite building views and why? How does the view make you feel?
3. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Read the article titled, “Proposal Seeks to Dim NYC Skyline at Night to Save Energy” at the link below:
https://www.pressherald.com/2015/05/16/proposal-seeks-to-dim-nyc-skyline-at-night-to-save-energy/
Read the webpage: https://www.darksky.org/light-pollution/. Based on these readings, what are the pros and cons of the proposal to dim the New York City skyline at night?
2. Find two examples of biophilic design within a building space.
1. Share pictures of each biophilic design and source of the picture.
2. List the specific features that incorporate biophilic design principles.
3. Share what feelings are invoked within you when looking at these biophilic design examples.
Figure References
Figure 4.1: Electricity use in U.S. commercial buildings by major end use (2018). Kindred Grey. (2023). Data from Forms EIA-871A and E of the 2018 Commercial Buildings Energy Consumption Survey. (2022, December). U.S. Energy Information Administration. (http://www.eia.gov/consumption/commercial/data/2018). CC BY 4.0
Figure 4.2: Residential site electricity consumption by end use (2015). Kindred Grey. (2023). Data from Use of energy explained: Energy use in homes. (2019, May 9). U.S. Energy Information Administration. (https://www.eia.gov/energyexplained/use-of-energy/electricity-use-in-homes.php). CC BY 4.0
Figure 4.3: Blower door test illustration. Jim Duncan. (2012). Getting ready for the blower door test. https://flic.kr/p/bu6yBq. CC BY-NC-SA 2.0
Figure 4.4: Thermographic inspection illustration. Thomas Quesnel. (2019). Infrared thermographic home inspections. Public domain. https://flic.kr/p/2gfwQGN
Figure 4.5: Incandescent light bulb illustration. Anton Fomkin. (2008). The incandescent light bulb. https://flic.kr/p/5D9eEk. CC BY 2.0
Figure 4.6: CFL light bulb illustration. MattysFlicks. (2013). Accidental lighting. https://flic.kr/p/fTvigP. CC BY 2.0
Figure 4.7: LED light bulb illustration. Theron Trowbridge. (2010). Toshiba LED light bulbs. https://flic.kr/p/7uePo4. CC BY-NC 2.0
Figure 4.8: Outlet with shut-off switch illustration. ben_osteen. (2010). USB wall socket. https://flic.kr/p/7sGzLT. CC BY 2.0
Figure 4.9: Water use in U.S. office buildings by major end use. Kindred Grey. (2023). Data from Saving water in office buildings. (2012, November). U.S. Environmental Protection Agency. (https://www.epa.gov/sites/default/files/2017-01/documents/ws-commercial-factsheet-offices.pdf). CC BY 4.0
Figure 4.10: Water use in U.S. residential buildings by major end use. Kindred Grey. (2023). Data from Data and information used by WaterSense. (2022, August 29). U.S. Environmental Protection Agency. (https://www.epa.gov/watersense/data-and-information-used-watersense). CC BY 4.0
Figure 4.11: Faucet aerator illustration. HomeSpot HQ. (2011). Faucet aerator. https://flic.kr/p/e3oDtt. CC BY 2.0
Figure 4.12: Xeriscape garden example. Mahmood Al-Yousif. (2008). Xeriscape garden. https://flic.kr/p/4G38Hp. CC BY-NC-ND 2.0
Figure 4.13: California brown lawn example. Kevin Cortopassi. (2014). CaIPERS and the drought. https://flic.kr/p/o4QuhC. CC BY-ND 2.0
Figure 4.14: Rainwater harvesting storage tank example. SuSanA Secretariat. (2011). Rainwater harvesting tank. https://flic.kr/p/a7AMjt. CC BY 2.0
Figure 4.15: Main IEQ components. Kindred Grey. (2023). CC BY 4.0
Figure 4.16: Acoustic ceiling tiles example. Melinda Young Stewart. (2019). Hanging lamps. https://flic.kr/p/2dXPSn3. CC BY-NC-ND 2.0
Figure 4.17: Example of a reduce, reuse, recycle symbol. Steve Snodgrass. (2011). Reduce, reuse, recycle. https://flic.kr/p/9sgWLi. CC BY 2.0
Figure 4.18: Light pollution example. makelessnoise. (2006). Make light pollution illegal. https://flic.kr/p/aSYGq. CC BY 2.0
Figure 4.19: Light pollution reduction example. Fernando Vega. (2019). IMG_3856 Light pollution filter. https://flic.kr/p/2gfFgth. CC BY-NC-SA 2.0
Image Descriptions
Figure 4.1: Vertical bar chart showing electricity use in commercial buildings by major end uses (2018). Y-axis shows Kilowatt Hours in billions, x-axis shows major end uses. Ventilation: 18%, lighting: 17%, cooling: 14%, refrigeration: 9%, computing: 7%, space heating: 6%, cooking: 2%, water heating: 2%, office equipment: 1%, all other (includes motor, pumps, air compressors, process equipment, backup electricity generation, and miscellaneous appliances, and plug-loads): 24%.
Figure 4.2: Horizontal bar chart showing residential site electricity consumption by end use (2015). X-axis shows percent of total end use, y-axis shows end uses. Air conditioning: 17%, space heating: 15%, water heating: 13.8%, lighting: 10%, refrigerators: 7%, TVs and related: 7%, clothes dryers: 4%, ceiling fans: 2%, air handlers for heating: 2%, separate freezers: 2%, cooking: 2%, dehumidifiers: 1%, microwaves: 1%, pool pumps: 1%, air handlers for cooling: 1%, humidifiers: 0.5%, dishwashers: 0.5%, clothes washers: 0.5%, hot tub heaters: 0.5%, evaporative coolers: 0.5%, hot tub pumps: 0.5%, all other miscellaneous: 13%.
Figure 4.3: Red fabric door with a fan in the middle replaces a standard front door. The door is attached to a computer system that measures air tightness of buildings.
Figure 4.9: Pie chart showing end uses of water in office buildings. Kitchen/dishwashing: 13%, landscaping: 22%, cooling and heating: 28%, domestic/restroom: 37%.
Figure 4.13: A field of dead grass outside of an office building. A sign in the grass reads “Pardon the appearance of our lawns. Due to the drought and current water restrictions, CalPERS has stopped watering the grass.”
Figure 4.19: Big picture: city skyline with a few buildings lit up at night. Sky is pitch black and clear. Small picture: Same skyline with many buildings lit up at night. Sky is light and cloudy. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.04%3A_Sustainable_Building_Maintenance_and_Repair_Practices.txt |
Learning Objectives
• Describe the risk management process model
• Identify environmental risk management components
• Identify social risk management components
• Identify governance risk management components
• Describe how ESG risk management concepts relate to sustainable property management
5.1 Introduction
The human condition tends to consider immediate risks more frequently than distant risks. However, both types of risks are important when considering the sustainability and resiliency of a real estate asset. The process of risk management first identifies property liabilities and then assesses associated control measures; risk management actions are then carried out to bring these risks within acceptable levels. Risk management helps protect the property and associated stakeholders such as building occupants, the building owner, and the property management company.
The incorporation of sustainability measures through the utilization of the ESG reporting framework can identify and address risks to create a more resilient property and organization. ESG, introduced in chapter 1, stands for environmental, social, and governance. This chapter will cover various environmental, social, and governance risks and associated risk management initiatives as investors are increasingly using the ESG framework for decision-making in their investments.
5.2 The Risk Management Process Model
The risk management process model, as illustrated in figure 5.1, can be applied to all ESG components. The model is depicted as a circle with arrows representing a cycle and iterative process that takes place continually versus just one time. The first step is to identify potential risks and the likelihood of occurrence of these risks. The next steps are to assess the impact of these potential risks on the property and then identify measures to respond to these risks to avert, minimize, and address damages and losses. This process is sometimes referred to as a gap analysis, as it assesses current business practices and the changes that need to be made in order to close the gap on these shortcomings. Once risk management measures are identified, they need to be prioritized and then funded based on priority. The last steps are to implement the measures and evaluate the risk management measures in place. This evaluation identifies any necessary changes that should be made. It is important that these risk management processes be performed at the asset level of a building portfolio on an ongoing basis, as identified risks and associated risk management measures may change throughout time. Also, identified risks and associated risk management measures will vary by property depending on location, product type, size, age, occupant mix, and turnover frequency.
5.3 Environmental Risk Management
Environmental risk management examples include climate risk management, environmental regulation management, and resource management.
Climate Risk Management
Climate science shows average temperatures are rising, which is causing greater frequency and severity of climate risks such as flooding, wildfires, hurricanes, earthquakes, rise in sea level, droughts, and a sustained trend toward increased average temperatures. In a report released in 2018, inland flood risk, sea level rise and coastal floods, and hurricanes or typhoons were used as climate risk factors to assess the amount of real estate exposure to climate hazards in the United States. Of the 73,500 properties owned by 321 real estate investment trusts (REITs), 35 percent were identified to be exposed to these climate risk hazards (Starkman, 2018). Examples of location-based climate risks include hurricane damage to beachfront condo towers in Miami, first-floor and basement unit flooding in New York City, and drought in Nevada and California, which puts pressure on the development of new units as well as threatens existing assets.
The first step in climate risk management is to identify these potential physical risks and the likelihood of occurrence at the property. Once any physical risks are identified, the material impacts that may be caused to the property directly and indirectly should be spelled out. Examples include higher insurance premiums, higher energy bills for cooling the building space, and disruption in operations and resulting lower revenue. The next step is to identify measures to incorporate resilience to these physical risks at the property. Resilience can include durable property features such as xeriscaping to address drought risks.
Example: Climate Risk Management
An example of climate risk management can be seen in Miami Beach, Florida. Figure 5.2 shows pictures of flooding in South Beach, Miami, that have increased in frequency and severity in recent years due to the rising sea level. The continued rise in sea level has required the City of Miami Beach to raise their streets by multiple feet. This risk management measure is obviously extremely expensive and time consuming, but something necessary if people continue to want to live, work, and play here.
Environmental Regulation Management
Environmental regulations are put forward with the goal of improving environmental quality and protecting human health. These types of regulations can be introduced at the federal, state, and/or local levels. A federal example is Section 608 of the Clean Air Act (CAA) that regulates the disposal of refrigeration air conditioning equipment (United States Environmental Protection Agency, 2011). This regulation is required by law and ensures that emissions of ozone-depleting substances are minimized during the disposal of this equipment. An example at the state level is Virginia’s High-Performance Buildings Act that requires electric vehicle–charging infrastructure installation for new state and local government building construction or renovation (Virginia Clean Cities, 2021). Locally, the City of San Francisco passed the Renewable Energy Law that requires private commercial buildings larger than 50,000 square feet to be powered by 100 percent renewable electricity (City and County of San Francisco, 2019).
A climate transition plan can reduce environmental regulation risk by preparing the property company for legislation that has recently been enacted or may be forthcoming relating to carbon taxes or lower carbon footprint requirements. A climate transition plan is a plan that lays out how the property and organization will adjust building operations to incorporate climate science recommendations. Holistically, property owners and management companies can incorporate a climate transition plan taking into account the building operations and organization-wide policies. Not only can a climate transition plan reduce environmental risk, as the decarbonization of buildings impacts climate change to the greatest degree, a climate transition plan can help organizations address climate change and support the transition toward a low-carbon economy.
Example: Climate Transition Plan
In April 2019, the city council in New York City approved Mayor Bill de Blasio’s (pictured in fig. 5.3) Climate Mobilization Act. This act is one of the most ambitious plans for reducing greenhouse gas emissions in the world and pledges New York City to carbon neutrality by 2050. Local Law 97 is part of this act and requires buildings to meet aggressive carbon reduction targets. Specifically, under this law most buildings over 25,000 square feet are mandated to meet new energy efficiency and greenhouse gas emission limits by 2024, and then stricter limits by 2030. The aim of the law is to reduce greenhouse gas emissions 40 percent by 2030 and 80 percent by 2050. Climate transition plans for these properties are essential to ensure compliance with these new local requirements and to reduce environmental regulation risk.
Resource Management
Resource management takes into account how resources such as energy, water, and waste are handled at the property. Value is created and risk is lowered when energy and water consumption are lowered and there is less waste disposal at the property. Reductions in these resources lower operating costs immediately and potentially can lower operating costs further should environmental regulations be imposed, such as a carbon tax.
An Environmental Management System (EMS) is a helpful framework to address resource management risks by increasing operational efficiency and mitigating environmental impacts. Each EMS is customized to a particular property and is a process to continually review and evaluate opportunities to improve the environmental performance of the property. As illustrated in figure 5.4, the EMS process includes planning environmental goals of the property based on environmental impacts and requirements of the property, establishing goals and programs to reduce these environmental impacts, reviewing and evaluating the progress of the EMS in achieving these property goals, and acting based on this review and evaluation. It is important to note that a risk management measure that is feasible at one property or company may not be reasonable or feasible for another property or company. Company and property resources must be considered.
Section Video
What is ISO 14001 Environment Management Systems EMS training
[00:02:13] Best Practice. https://youtu.be/XDaNmdBPwqM
Section References
City and County of San Francisco. (2019, September 17). Board of supervisors votes unanimously to power San Francisco’s downtown with 100 percent renewable electricity. https://sfmayor.org/article/board-supervisors-votes-unanimously-power-san-franciscos-downtown-100-percent-renewable
Starkman, K. (2018). Climate risk, real estate, and the bottom line. https://www.preventionweb.net/news/report-climate-risk-real-estate-and-bottom-line
United States Environmental Protection Agency. (2011, February). Construction and demolition: How to properly dispose of refrigeration and air-conditioning equipment. https://www.epa.gov/sites/default/files/documents/ConstrAndDemo_EquipDisposal.pdf
Virginia Clean Cities. (2021, June 3). High performance buildings act take effect on July 1. https://vacleancities.org/high-performance-buildings-act-take-effect-on-july-1/
5.4 Social Risk Management
Social risk management examples include health and safety measures, effective supply chain management, and diversity and inclusion measures.
Health and Safety Measures
Health and safety risks of the building occupants, employees, contractors, and community are important considerations. Exposure to these risks can open up the property and organization to a negative reputation and potential criminal consequences. It can also decrease stakeholder satisfaction, which can subsequently reduce revenue. To build a more resilient business, the real estate organization must invest in the health and safety of these stakeholders. Examples include implementing procedures to prevent workplace injuries, providing good ventilation with access to fresh air and clean water, and providing a tobacco-free work environment.
Effective Supply Chain Management
A supply chain refers to services and supplies used to operate the property and organization. As illustrated in figure 5.5, common components of a property management supply chain include accounting services, banking services, cleaning services, general contractor services, landscaping services, legal services, marketing services, office supplies, pest control services, and trash removal services. General contractor services include HVAC, plumbing, and electrical maintenance and repair. Engaging with the supply chain on ESG issues and detailing out the standards between the property and vendor can decrease risk exposure. This is because effective supply chain management helps reduce operating costs and avoid supply shortages. A disruption in the property’s supply chain can put a strain on purchasing and contracting strategies already in place and also impact the property’s reputation. This can impact financial performance because of an increase in price from suppliers and a lack of availability, causing a decrease in occupant satisfaction and resulting lost revenue should they choose to go to another property.
Diversity and Inclusion Measures
Diversity and inclusion are often referred to together, but are not synonymous. Diversity refers to the characteristics that make individuals unique, including race, gender, age, ethnicity, sexual orientation, abilities, and others. Inclusion refers to creating a culture where everyone feels a sense of belonging and is valued for their unique perspectives and contributions. A social risk assessment can be performed to evaluate the degree to which diversity and inclusion are part of the environment. At the organizational level, this can include examining the gender ratio, gender pay gaps, age group distribution, racial diversity, and board of directors composition. This is important, as the inclusion of a diverse workforce decreases exposure to risk by increasing the perspectives for problem solving and increasing the competitive profile for the property management company.
At the property level, an apartment community example is offering inclusive programming to include households with and without children. A mixed-use example is ensuring access for people with disabilities or who are elderly, as well as using the common area for a range of different programming initiatives. These types of initiatives can help building users feel more welcomed and valued.
5.5 Governance Risk Management
Governance risk management examples include disclosure, implementation strategies, and cybersecurity.
Disclosure
ESG disclosure is important for transparency and showcases ESG activities being performed at the property and organizational levels. Disclosure opportunities include investor reporting, an exclusive ESG report, GRESB participation, and a section dedicated to ESG on the property and organization website. Disclosing ESG activities illustrates consideration and management of ESG risks and can increase resiliency. Disclosure can also help attract investors who are increasingly concerned with a company’s ESG initiatives.
Implementation Strategies
The strategies for implementing ESG policies are important because they provide pathways for policy implementation. Thoughtfully creating these pathways can manage risk so that the ESG risk management measures are effectively implemented at the property level and within the organization. Some strategies to consider include creation of an ESG committee tasked with monitoring and evaluating ESG initiatives. It is important that senior management decision makers are included on this task force so that ESG policies are more easily applied throughout the organization. Another strategy is to create a standardized checklist that can be used at each property to evaluate sustainability broken into E, S, and G component sections. This can foster easier implementation of ESG initiatives at the property level. Also, making a commitment to public ESG leadership principles is a strategy that can showcase commitment and also help inform ESG policies within the property and organization. An example of such public ESG principles are the United Nations’ Sustainable Development Goals (SDGs) as listed in figure 5.6. These seventeen interconnected goals, introduced in 2015 with the intention to be achieved by 2030, provide pathways for a more sustainable future for all. The Royal Institution of Chartered Surveyors (RICS), a global organization that creates and enforces standards related to real estate, has partnered with the United Nations Global Compact to make it easier for real estate companies to implement the SDGs throughout real estate businesses. They have done this through creation of a document titled “Advancing Responsible Business in Land, Construction, Real Estate Use and Investment—Making the Sustainable Development Goals a Reality” that provides resources such as a toolbox, case studies, and self-assessment checklist. Further information on this resource can be found at: https://www.rics.org/north-america/about-rics/responsible-business/un-sustainable-development/.
Cybersecurity
Cybersecurity refers to the protection of the networking system, hardware, software, and data of a property and organization from cyberattacks. A cyberattack can target computer networks, infrastructure or computer devices, with \$200,000 being the average cost of a cyberattack on a business (Steinberg, 2020). This is a significant threat for the sustainability of the real estate organization, and policies should be implemented to incorporate cybersecurity into property management operations. Examples of cybersecurity initiatives include installation of anti-virus software, stronger password requirements, multi-factor authentication, encrypted networks, and data backup policies. These initiatives can reduce risks of a cyberattack.
Section Video
Do you know all 17 SDGs?
[00:01:24] United Nations. https://youtu.be/0XTBYMfZyrM
Section Reference
Steinberg, S. (2020, March 9). Cyberattacks now cost companies \$200,000 on average, putting many out of business. CNBC. https://www.cnbc.com/2019/10/13/cyberattacks-cost-small-companies-200k-putting-many-out-of-business.html
5.6 Conclusion
This chapter introduced the risk management process model that can be applied to environmental, social, and governance risk management components both at the property and organization levels. ESG initiatives are interconnected and provide a holistic look at risk management. ESG initiatives can be implemented at the property, property portfolio, and organizational levels and should contain goals that are measurable and reasonable. Risk management initiatives will vary depending on the property age, location, size, condition, occupant mix, and turnover frequency. While this chapter introduces a sampling of ESG risk management components, by no means is it an exhaustive list. Furthermore, the ESG framework has limitations. The measurement of ESG performance is complex and requires data that companies may not have previously collected, which can cause inaccurate results. Also, applying a single global benchmark to real estate assets, which inherently are not homogeneous, can cause ESG ratings to be imprecise. But a basic understanding of ESG risk management components is necessary in this environment where investors are increasingly using ESG components to make investment decisions.
Discussion Questions
1. What is an example of the E of ESG as applied to property management, and how does this example address risk management?
2. What is an example of the S of ESG as applied to property management, and how does this example address risk management?
3. What is an example of the G of ESG as applied to property management, and how does this example address risk management?
4. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Research the rising sea level issues in Miami Beach, FL, and answer the questions below:
1. Is real estate still being built near the water in Miami Beach? Why or why not?
2. Using ESG as a framework, what are the risks of continuing to build real estate near the water in Miami Beach, FL?
3. Is it ethical to build real estate near the water in Miami Beach, FL? Why or why not?
2. Research a local environmental regulation that affects buildings and provide the following details:
1. Where was it passed?
2. When was it passed?
3. What is the goal of the law?
4. Is there a plan in place to help buildings comply with the law?
5. What is your reaction to the law?
3. Find a real estate company’s ESG plan and summarize the plan. Is there anything that particularly stands out to you? Why?
4. Refer to the UN’s website on the SDGs (https://www.un.org/sustainabledevelopment/sustainable-development-goals/) and choose five SDGs and how you can apply them to property management operations.
Figure References
Figure 5.1: Risk management process model. Kindred Grey. (2023). CC BY 4.0.
Figure 5.2: Flooding in South Beach, Miami, Florida. Left image: maxstrz. (2009). CC BY 2.0. https://flic.kr/p/6u5gkd Right image: maxstrz. (2009). South Beach flood. https://flic.kr/p/6u17PM. CC BY 2.0
Figure 5.3: Image of Mayor Bill de Blasio (New York City mayor from 2014-2021). KevinCase. (2013). NYC Mayor Bill de Blasio. https://flic.kr/p/hcxKLM. CC BY 2.0
Figure 5.4: EMS process model. Kindred Grey. (2023). CC BY 4.0
Figure 5.5: Common property management supply chain components. Kindred Grey. (2023). CC BY 4.0
Figure 5.6: United Nations’ SDGs. Kindred Grey. (2023). Adapted from The 17 Goals. (n.d.). United Nations Department of Economic and Social Affairs. (https://sdgs.un.org/goals). CC BY 4.0
Image Descriptions
Figure 5.1: The circular model begins with 1) Risk identification, 2) Risk impact assessment, 3) Risk management measures identification, 4) Risk management measures prioritization, 5) Risk management measures funding, 6) Risk management measures implementation, 7) Risk management measures evaluation. Return to figure 5.1.
Figure 5.2: Left: A sign directs pedestrians away from a flooded sidewalk with an overturned post office collection container. Right: A person stands in knee-high deep flood waters next to a vehicle in the street. Return to figure 5.2.
Figure 5.5: The components include these services: marketing, landscaping, office supplies, legal, accounting, cleaning, banking, general contractor, pest control, and trash removal. Return to figure 5.5.
Figure 5.6: Goal 1) no poverty, Goal 2) zero hunger, Goal 3) good health and well-being, Goal 4) quality education, Goal 5) gender equality, Goal 6) clean water and sanitation, Goal 7) affordable and clean energy, Goal 8) decent work and economic growth, Goal 9) industry, innovation, and infrastructure, Goal 10) reduced inequalities, Goal 11) sustainable cities and communities, Goal 12) responsible consumption and production, Goal 13) climate action, Goal 14) life below water, Goal 15) life on land, Goal 16) peace, justice, and strong institutions, Goal 17) partnerships. Return to figure 5.6. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.05%3A_The_Intersection_of_Sustainable_Property_Management_and_Risk_Management.txt |
Learning Objectives
• Explain how a market analysis informs the supply and demand of sustainable building initiatives
• Identify sustainable building initiatives in a marketing plan
• Describe greenwashing
• Identify green lease components
• Explain the role of a tenant satisfaction survey in assessing sustainable building initiatives
6.1 Introduction
There are many opportunities for property management companies to integrate sustainable practices into the marketing and leasing function. The first step is to perform a market analysis to evaluate the supply and demand of sustainable building initiatives both regionally and locally. This market analysis determines what sustainable property management components can be added to the property marketing plan to attract tenants to the property. Once the tenant is attracted to the property, green lease concepts can be added to the leasing plan to set the basis for sustainable building operations. During the lease, it is a best practice for the property company to engage with tenants through a tenant satisfaction survey on sustainable building initiatives. This feedback is evaluated and any necessary adjustments made to increase tenant satisfaction and foster tenant retention. Holistically, the social sphere of sustainability is addressed through happier tenants, the economic sphere is addressed through increased revenue from tenant retention, and the environmental sphere is addressed through mitigation of ecological impacts through sustainable marketing and leasing practices.
6.2 Market Analysis
Marketing and leasing activities are informed by a market analysis. A market analysis consists of acquiring knowledge about the demographic and economic profiles of the region and neighborhood as it relates to the subject property. Demographics are population data such as education, income, religion, gender, ethnicity, race, age, and marital status information. The economic profile includes data such as the area’s largest employers, the mix of industries, employment statistics, and visitor statistics. Regional and neighborhood analyses of demographic and economic profiles help determine the supply and demand of various buildings and their associated features. Sustainable building features are the focus when considering a sustainable property management plan.
While the majority of Americans believe climate change impacts are a priority, sustainable building initiatives vary depending upon location (Tyson et al., 2021). In 2021, a study was released ranking the 100 largest cities in the United States on the promotion of an environmentally friendly lifestyle, based on the dimensions of environment, transportation, energy sources, and lifestyle and policy (McCann, 2021). Figure 6.1 lists the most sustainable and least sustainable cities in the United States based on this study. From review of this figure, it is likely that sustainable property management initiatives in Gilbert, Arizona, are in less demand than in San Diego, California. However, if there is no supply of sustainable building initiatives in Gilbert, there may be unrecognized or unrealized demand in a specific area in Gilbert that values sustainable building initiatives. This is why a neighborhood analysis is also important.
The market analysis is informed by market signals regarding sustainable building practices. Some relevant questions about market signals include:
• Is the market that the property operates within signaling higher rental rates for sustainable building management practices? Or are they required to merely remain competitive?
• Are there image and brand impacts of providing sustainable property management services?
• Will there be reduced demand for this property in the future if sustainable property management practices are not practiced due to a shift in consumer preferences?
Section References
McCann, A. (2021, October 5). Greenest cities in America. WalletHub. https://wallethub.com/edu/most-least-green-cities/16246
Tyson, A., Kennedy, B., & Funk, C. (2021, May 26). Climate energy and environmental policy. In Gen Z, Millennials stand out for climate change activism, social media engagement with issue. Pew Research Center. https://www.pewresearch.org/science/2021/05/26/climate-energy-and-environmental-policy/
6.3 Marketing Plan
A marketing plan contains the marketing goals for the property in order to attract tenants. The addition of sustainable property management activities to the property marketing plan can help attract tenants that value sustainable building initiatives from various perspectives. If operating in a market that does not place value on sustainable building initiatives from an ecological standpoint, the marketing plan can highlight these initiatives from an economic or health and well-being perspective to appeal to the market.
Example: Marketing Plan
For example, in a market that values the ecological sphere of sustainability, energy-efficient appliances can be advertised to provide a lower-carbon lifestyle and lower utility bills. In a market that does not value the ecological sphere of sustainability, energy-efficient appliances can simply be advertised as providing lower utility bills for the tenant. Alternatively, in a market that values the ecological sphere of sustainability, the property can market its use of low VOC flooring and paints as better for the planet and as a benefit to the occupant’s level of indoor air quality. In a market that does not value the ecological sphere of sustainability, the property can market its use of low VOC flooring and paints solely as a benefit to the occupant’s level of indoor air quality.
Greenwashing, a marketing tactic that portrays a property to be greener than it actually is, is a consideration when creating the marketing plan. While a property company certainly wants to advertise sustainable building initiatives, caution should be taken to ensure consumers are not being deceived that a building is more sustainable than a conventional building when it is not or making claims that have not been verified. Some common examples of greenwashing in property management include marketing the property as energy efficient when it truly is not or advertising the property as having a low carbon footprint when this has not been verified. Properties may be advertised as being eco-friendly with no details and varying colors of green may be used in their marketing materials.
One way to address greenwashing is for tenants and investors to look for reporting efforts on sustainable building initiatives. This can most likely be found through a property company’s ESG reporting, if they participate in this type of reporting. Another method is to look for third-party building and product certifications such as LEED building certification and ENERGY STAR products. These efforts to use third-party certifications can be showcased on the property’s marketing materials, including the certification logos on websites and print materials. Showcasing these logos can also provide positive brand reputation and attract potential tenants. A property’s Walk Score is another third party scoring metric to consider showcasing in the marketing plan’s sustainable activities. Although the property manager doesn’t dictate where the building is sited, a high Walk Score can be attractive to tenants. A Walk Score can be between 0 and 100 and the higher the number, the higher the walkability of the property. Figure 6.2 illustrates the various levels of a Walk Score. The Walk Score website also offers a Transit Score and Bike Score, with the same scoring range, that may be worthwhile to showcase within the property’s marketing materials.
6.4 Leasing Plan
Leasing structures vary widely depending on the property type. Residential leases typically do not vary much from one tenant to another within the same property, with the exception of rent amount and lease start and end dates. Commercial leases, on the other hand, are typically multiple years with lease escalations included as well as a greater propensity for negotiation depending upon the market and tenant. A leasing plan contains the guidelines concerning leasing parameters such as rent, rent term, concessions, tenant allowances, and common area maintenance pass-throughs. The leasing plan contents will vary based on property sector and company guidelines.
In some cases, a lease request for proposal (RFP) is submitted by a tenant to building owners to compare various building space opportunities. The RFP can include various requirements of the tenant such as the size of the building space, common area spaces that the tenant is responsible for paying their pro-rata share of, the proposed use of the space, the lease term and rate, renewal options, tenant improvements, and parking requirements. The lease RFP also may contain sections related to HVAC responsibilities, janitorial services, building amenities, and any sustainable building initiatives. For example, a lease RFP may require a certain level of LEED certification as a corporate responsibility strategy to showcase they are environmentally friendly and also to respond to employees who are requesting sustainable spaces.
The leasing plan can also incorporate green lease concepts. A green lease is a collaboration between property owner, property manager, and property tenant to align sustainable building interests by sharing in the costs and benefits of incorporating sustainable initiatives within the building space. Green leases help to address the split incentive barrier that sometimes prevents either the tenant or landlord from implementing sustainable building initiatives. Green lease language examples can be found at https://www.imt.org/wp-content/uploads/2020/02/IMT-Green-Lease-Language-Examples-January-2020.pdf
Example: Green Leasing
For example, if the tenant is responsible for utility bills, there is no significant financial incentive for the landlord to provide capital improvements that yield energy savings as they will not fully realize the cost savings of these improvements. While there may be some capacity to raise rents because of energy-efficient capital improvements, it is unlikely the landlord will recover their full investment. In order for both landlord and tenant to financially benefit from capital improvements that yield energy savings, a lease provision can be added to resolve this barrier so that both parties are working together toward energy-efficient capital improvements.
Green Lease Leaders, developed by the Institute for Market Transformation and the U.S. Department of Energy’s Better Buildings Alliance, provides a framework for implementing green lease standards. While this framework is limited in scope, it does provide standardization for landlords and tenants. Figure 6.3 illustrates the prerequisites and credits for this framework to demonstrate leadership in green leasing for landlords in both commercial and multifamily settings. To achieve Silver recognition the landlord must meet two of the three prerequisites and address at least five of the best practices credits, while Gold recognition requires proof of execution of these prerequisites and best practices credits through documentation such as an executed lease. For further reading, the Green Lease Leaders Reference Guide for Tenants can be found here: https://www.greenleaseleaders.com/wp-content/uploads/2021/02/Green-Lease-Leaders-Tenants-Reference-Guide-FINAL.pdf.
Figure 6.4 illustrates the prerequisites and credits for this framework to demonstrate leadership in green leasing for tenants in commercial settings. To achieve silver recognition, the tenant must meet both prerequisites and address at least five of the best practices credits while gold recognition requires proof of execution of these prerequisites and best practices credits through documentation such as an executed lease. For further reading, The Green Lease Leaders Reference Guide for Landlords can be found here: https://www.greenleaseleaders.com/wp-content/uploads/2022/02/Green-Lease-Leaders-Landlords-Reference-Guide-FINAL.pdf.
6.5 Tenant Satisfaction Survey
Tenant feedback on sustainable property management practices helps the property company understand issues that are important to tenants and subsequently helps retain tenants through resolution of any issues. It is holistic in the sense that it takes into account the health and well-being of the building occupants while also fostering a positive economic situation for the property company through increased tenant satisfaction and tenant retention. A best practice to elicit this feedback is through a regularly occurring tenant satisfaction survey. A tenant satisfaction survey is useful to not only assess what sustainable products and services may be important to tenants that are not currently in place, but also to assess tenants’ level of knowledge about sustainable initiatives at the property or company level. It also provides feedback on what sustainable initiatives are working well at the property and company level. This feedback can inform recommendations for sustainable building initiatives moving forward.
There are multiple formats for a tenant satisfaction survey. A questionnaire, interview, focus group, or a combination of these methods can be used to create the format for building occupant feedback. For example, a focus group consisting of a smaller group of tenants may be the first step in crafting a full property or property portfolio questionnaire. The responses from this focus group can help in crafting a standardized survey for the property as a whole. A standardized survey can also be helpful when comparing results and looking for themes across the property portfolio. If using a questionnaire, a 1-5 scale can be used to assess tenant satisfaction on sustainable building initiatives, with 1 being very unsatisfied to 5 being very satisfied. Below are areas where questions can be crafted related to satisfaction with sustainable property management:
• Energy Efficiency
• Water Efficiency
• Indoor Environmental Quality
• Waste Management
• Site Sustainability
The results of the sustainable property management tenant satisfaction survey are helpful in informing future decisions toward a sustainable property management plan. They assist the property company in understanding the satisfaction of current sustainable building offerings as well as the level of tenant interest. These results are likely to vary by tenant, building, and market. If there is lower interest in sustainable building initiatives, tenants may still find satisfaction in a sustainable building initiative should it reduce operating costs and/or increase the health and well-being of building occupants. If any of the feedback needs further clarification, a focus group can help with this clarification.
Based on the feedback from the surveys, a plan can be developed to incorporate the feedback that includes specific action to be taken, deadlines for implementation, and how these action items will be funded. Once this plan is implemented, evaluation through another tenant satisfaction survey is important to assess the success of these implemented actions. Continual tenant engagement and collaboration can cultivate a higher level of tenant satisfaction, which may promote improved tenant retention rates. By retaining tenants, a property is able to continue collecting rental revenue and also does not have to spend funds marketing and finding new tenants.
6.6 Conclusion
A market analysis is critical to evaluating the position of the subject property to the broader market of properties within the region and neighborhood as it relates to sustainable building initiatives. The interest in sustainable building activities will likely vary by tenant, property, and market so the property company needs to understand the market within which they operate. If tenants have a relatively low interest in sustainable building initiatives, the property can appeal to the financial and health benefits of the initiative both in the marketing plan and tenant satisfaction survey. In markets that value sustainable building activities, including these activities in the marketing plan can enhance a property’s competitive profile in the marketplace for prospective tenants, and provide positive reputation impacts. Once a tenant is attracted to the property, creating leases with sustainable measures within the terms sets the basis for sustainable building operations. During the lease, a tenant satisfaction survey engages tenants with the sustainable activities taking place at the property and can assess their level of satisfaction and interest in these activities. This helps inform the future of a sustainable property management plan.
Discussion Questions
1. What is the difference between a market analysis and a marketing plan?
2. Why does demand for sustainable building initiatives vary by U.S. city?
3. How can a tenant satisfaction survey be helpful in assessing sustainable building initiatives?
4. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Research a multifamily community in the municipality where you reside and answer the following questions:
1. Does their website advertise any sustainable building initiatives?
2. If so, do you believe any greenwashing is occurring? Why or why not?
2. Look up the Walk Score, Transit Score, and Bike Score (https://www.walkscore.com/) of the building you researched in the first question and answer the following questions:
1. What is the Walk Score?
2. What is the Transit Score?
3. What is the Bike Score?
4. Do you find value in these scores? Why or why not?
3. Create five questions a property manager may want to ask through a questionnaire, interview, or focus group to obtain tenant satisfaction information about sustainable building initiatives. Explain why these questions are important to ask.
Figure References
Figure 6.1: Greenest and least green cities in the United States (2021). Kindred Grey. (2023). Data from Greenest cities in America. (2022, October 5). WalletHub. https://wallethub.com/edu/most-least-green-cities/16246.. CC BY 4.0
Figure 6.2: Walk score levels. Kindred Grey. (2023). Data from How Walk Score works. (2023). Walk Score. https://www.walkscore.com/how-it-works/.. CC BY 4.0
Figure 6.3: Green lease leaders landlord framework prerequisites and credits. Kindred Grey. (2023). Data from Green lease leaders reference guide for landlords. (n.d.). https://www.greenleaseleaders.com/wp-content/uploads/2022/02/Green-Lease-Leaders-Landlords-Reference-Guide-FINAL.pdf. CC BY 4.0
Figure 6.4: Green lease leaders tenant framework prerequisites and credits. Kindred Grey. (2023). Data from Green lease leaders reference guide for landlords. (n.d.). https://www.greenleaseleaders.com/wp-content/uploads/2022/02/Green-Lease-Leaders-Landlords-Reference-Guide-FINAL.pdf. CC BY 4.0
Image Descriptions
Figure 6.1: The top ten greenest cities in the U.S. are 1) San Diego, CA, 2) San Francisco, CA, 3) Portland, OR, 4) Irvine, CA, 5) Honolulu, HI, 6) Fremont, CA, 7) Washington, D.C., 8) Oakland, CA, 9) Seattle, WA, and 10) San Jose, CA. The least green cities in the U.S. are 100) Gilbert, AZ, 99) Mesa, AZ, 98) Glendale, AZ, 97) Baton Rouge, LA, 96) Chandler, AZ, 95) Newark, NJ, 94) Hialeah, FL, 93) Houston, TX, 92) Detroit, MI, and 91) Louisville, KY. Return to figure 6.1.
Figure 6.2: The score of 90-100 is a walker’s paradise: daily errands do not require a car; 70-89 is very walkable: most errands can be accomplished on foot; 50-69 is somewhat walkable: some errands can be accomplished on foot; 25-49 is car-dependent: most errands require a car; and 0-24 is car-dependent: all errands require a car. Return to figure 6.2.
Figure 6.3: Prerequisites: provide sustainability contact information; implement cost recovery clause for energy efficiency upgrades benefiting tenant; implement energy efficiency improvements during unit turns (multifamily only). Best practices credits: track common area energy use; track common area water use; disclose whole-building ENERGY STAR score to tenant annually; disclose whole building ENERGY STAR water score to tenant annually (multifamily only); ensure brokers or leasing agent(s) have energy training; implement landlord energy management best practices; require tenants to purchase on-site renewables if offered by landlord and competitively priced; meter tenant spaces for electricity use; request annual tenant energy disclosure; require minimum energy efficiency fit-out for tenants; establish a tenant energy efficient engagement and training plan; and demonstrate innovation in leasing. Return to figure 6.3.
Figure 6.4: Prerequisites: provide sustainability contact to landlords; and require minimum energy efficiency standards for fit-outs. Best practices credits include: track tenant space energy use; track tenant space water use; request whole-building ENERGY STAR score from landlord annually; ensure transaction management team receives energy training; implement tenant energy management best practices; purchase on-site renewables if offered by landlord and competitively prices; accept cost recovery for efficiency upgrades benefiting tenant; include requests for energy information in site selection questionnaire; commit to actively contributing to a whole building performance reduction goal in carbon or energy use intensity (EUI); and establish social impact goals for health, resiliency, diversity, and climate. Return to figure 6.4. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.06%3A_Integrating_Sustainable_Practices_into_Marketing_and_Leasing.txt |
Learning Objectives
• Explain how sustainable property management initiatives affect the property statement of cash flow
• Calculate the cash-on-cash return for sustainable initiatives
• Calculate the simple payback period for sustainable initiatives
• Calculate the discounted payback period for sustainable initiatives
• Calculate a cost-benefit analysis for sustainable initiatives
7.1 Introduction
Previous chapters discussed the social, environmental, and economic spheres of sustainable property management. This chapter takes a closer look at the economic sphere of sustainability. It introduces calculations to determine if a sustainable building initiative makes financial sense. There are multiple metrics within the accounting and finance function to account for sustainable initiatives. These include the calculation of net operating income (NOI), before-tax cash flow, cash-on-cash return, payback period, and cost-benefit analysis. Some impacts of sustainable building initiatives are difficult to monetize, such as the cost of carbon, an employee wellness initiative, or the enjoyment of building users from using power generated from renewable energy sources. However, sustainable property management initiatives will impact the economic condition at the property. As the overarching goal of a property manager is to increase property NOI, it is important to consider the associated economic impacts of sustainable initiatives at the property.
7.2 Statement of Cash Flow and Sustainable Property Management
It is crucial for the property manager to understand how to evaluate each line item of a cash flow statement. This financial literacy aids in understanding the financial impacts of various sustainable property management initiatives. The property cash flow statement is broken into “above the line” categories and “below the line” categories. “Above the line” categories refer to categories above the NOI line item and “below the line” refers to categories below the NOI line item. Figure 7.1 illustrates an example of a property statement of cash flows. The revenue category includes all line items down to effective gross income (EGI). The operating expenses (OPEX) category is below the revenue category, and the list below figure 7.1 illustrates common operating expense line items.
Common operating expense line items:
• Legal
• Maintenance and Repairs
• Management Fee
• Marketing
• Payroll
• Property Insurance
• Real Estate Taxes
• Supplies
• Telephone & Internet
• Services
• Landscaping
• Pest Control
• Trash Removal
• Utilities
• Electricity
• Heating Fuel
• Water & Sewer
As per figure 7.1, NOI is calculated by subtracting operating expenses (OPEX) from effective gross income (EGI). NOI is a significant calculation because it is a common measure the real estate industry uses to determine the financial health of a property. NOI is also important because it is a major element in the calculation of market value of an asset. Annual debt service (ADS), capital expenditures (CAPEX), and replacement reserves line items are typically accounted for below NOI. ADS is the total amount of principal and interest payments made over a twelve month period, CAPEX are expenses that are not regularly occurring operating expenses such as parking lot paving, and replacement reserves is like a savings account where funds are put annually to “save” for planned building component replacements as well as serve as an emergency fund. For example, the replacement reserves line item may be used to annually contribute funds for a planned roof replacement in five years. ADS, CAPEX, and replacement reserves are subtracted from NOI to arrive at before-tax cash flow (BTCF). (Note that before-tax cash flow refers to before income-tax considerations, not real estate taxes which are part of operating expenses.)
Example: Sustainable Property Management Initiatives and Associated Before-Tax Cash Flow Statement Impacts
Sustainable property management initiatives can impact each of the before-tax cash flow statement categories. Within the revenue category, marketing the sustainable initiatives at the property can attract more tenants and therefore increase occupancy; this could increase rent revenue. This quantification is relatively difficult because there is no exact calculation, but tenant satisfaction surveys (as discussed in chapter 6) can help inform property management on the importance of sustainable initiatives in attracting and retaining tenants at the property. Within the operating expense category, changing from conventional light bulbs to LED light bulbs can reduce electricity expenses. Also, maintenance and repairs could decrease because LED light bulbs last longer so they do not need to be changed out as often. Upfront, the cost of the LED light bulbs would be accounted for either in CAPEX or maintenance and repairs, depending on the size and cost of the project. Debt service is typically not a line item that property managers influence, but there are financing options for sustainable buildings such as Fannie Mae’s Multifamily program that offers preferential pricing for sustainable buildings.
The CAPEX item for sustainable initiative implementation may increase in the current year statement of cash flow, but there tend to be positive financial impacts in future years from these expenditures. These future year impacts can be accounted for in a forecasted statement of cash flow, commonly called a proforma statement of cash flow. A proforma statement of cash flow is helpful in planning for the potential impacts of sustainable initiatives. For example, it can account for an initial capital outlay to change from conventional landscaping to a xeriscape landscape design, but also account for lower water bills, maintenance, and fertilizer costs in future years as this type of landscape requires less watering, less maintenance, and less fertilizer. Therefore, property cash flow will experience more upfront cost impacts and property NOI will experience more operational cost saving impacts.
7.3 Cash-on-Cash Return Analysis
A helpful and easy calculation to quickly analyze a return of a sustainable building initiative is a cash-on-cash return. The cash-on-cash return calculates the rate of return on the cash invested in a property based on the annual cash income earned. The equation is as follows:
Cash-on-Cash Return = Annual Cash Income / Total Cash Invested
Let’s use an example to apply this equation.
Example: Cash-on-Cash Calculation
It cost the property \$9,100 to replace traditional light bulbs with more energy-efficient LED light bulbs. The annual electricity savings from installing LED light bulbs is projected to be \$2,350.
Calculate the cash-on-cash return.
Step 1: Apply the cash-on-cash return formula.
Cash-on-Cash Return = Annual Cash Income / Total Cash Invested
Cash-on-Cash Return = \$2,350 / \$9,100
Cash-on-Cash Return = 25.82 percent
The results of the cash-on-cash return can be used to compare the property owner’s required rate of return against the cash-on-cash return. The investor will move forward if the cash-on-cash return is greater to or equal to the required rate of return. For example, suppose the property owner’s required rate of return in the example above is 8 percent. Since the cash-on-cash return of 25.82 percent is greater than the required rate of return of 8 percent, the investor will move forward on the sustainable initiative.
The cash-on-cash return is different from return on investment (ROI) because the cash-on-cash return is a snapshot of an annual cash income based on cash invested, whereas ROI takes into account the gain or loss over the life of ownership and divides that gain or loss by the the cost of the investment. However, both the cash-on-cash return and ROI can be misleading as they do not account for the time value of money or the holding period of an investment. A cost-benefit analysis is introduced in a later section in this chapter that takes these variables into account.
7.4 Payback Period Analysis
There are no-cost, low-cost, and high-cost sustainable property management initiatives. No-cost examples include turning off lights and equipment when not in use. Low-cost examples include providing recycling bins to tenants and changing from conventional light bulbs to LED light bulbs. High-cost examples include adding solar panels to the property and installing a green roof on the building. The simple payback period, a calculation that determines the amount of time it takes to recover the upfront costs of an investment, can be calculated for sustainable initiatives that have upfront costs. The formula can be seen below and an example of this formula applied is found in the box below.
Simple Payback Period = Initial Investment Costs / Annual Savings
Example: Simple Payback Period Calculation
It cost the property \$9,100 to replace traditional light bulbs with more energy-efficient LED light bulbs. The annual electricity savings from installing LED light bulbs is projected to be \$2,350.
Calculate the simple payback period.
Step 1: Apply the simple payback period formula.
Simple Payback Period = Initial Investment Costs / Annual Savings
Simple Payback Period = \$9,100 / \$2,350
Simple Payback Period = 3.87 years
A discounted payback period analysis takes into account time value of money by applying a discount rate to discount the future cash flows. The discount rate is either the cost of capital or a required “hurdle” rate-of-return metric, which an investment must minimally achieve; otherwise the money will be invested elsewhere. For example, a property company may be paying 5 percent on its debt, so 5 percent is used as the discount rate to represent this cost of capital. Alternatively, shareholders may require a 9 percent return, so 9 percent is used as the discount rate to represent this required rate of return to invest in a project. The formula can be seen below and an example of this formula applied is found in the box below. These calculations can also be done on a financial calculator or financial analysis spreadsheet.
Discounted Payback Period = Preceding Year that Discounted Payback Return Occurs + (Absolute Value of Cumulative Discounted Cash Flow in this Preceding Year / Discounted Cash Flow for the Year After Discounted Payback Return Occurs)
Example: Discounted Payback Period Calculation
It cost the property \$9,100 to replace traditional light bulbs with more energy-efficient LED light bulbs. The annual electricity savings from installing LED light bulbs is projected to be \$2,350. The discount rate = 8 percent.
Calculate the discounted payback period.
Step 1: Create the chart described below that determines the first year that cumulative discounted cash flows become positive.
1. Calculate the simple payback period.
2. Based on the number of years for the simple payback period, list out the years in the chart.
3. Add the net cash flow by year.
4. Use the discounting cash flow formula to arrive at the discounted net cash flow: Discounting Cash Flow = Net Cash Flow / (1 + Discount Rate)Time Period.
5. Find the cumulative discounted cash flow by subtracting the previous year cumulative discounted cash flow from the current year discounted net cash flow.
6. If the cumulative discounted cash flow remains negative after completing these steps, keep adding an additional year column with the above components until the cumulative discounted cash flow is positive.
Time Zero Year 1 Year 2 Year 3 Year 4 Year 5
Net Cash Flow (9,100.00) 2,350 .00 2,350.00 2,350.00 2,350.00 2,350.00
Discounting Cash Flow Formula (9,100.00) / (1 + 8 percent)^0 2,350 / (1 + 8 percent)^1 2,350 / (1 + 8 percent) ^2 2,350 / (1 + 8 percent)^3 2,350 / (1 + 8 percent)^4 2,350 / (1 + 8 percent)^5
Discounted Net Cash Flow (9,100.00) 2,175 .93 2,014.75 1,865.51 1,727.32 1,599.37
Cumulative Discounted Cash Flows (9,100.00) (6,924.07) (4,909.33) (3,043.82) (1,316.50) 282.87
Table 7.1: The first year that cumulative discounted cash flows become positive. Negative numbers are bolded.
Step 2: Apply the discounted payback period formula.
Discounted Payback Period = Preceding Year that Discounted Payback Return Occurs + (Absolute Value of Cumulative Discounted Cash Flow in this Preceding Year / Discounted Cash Flow for the Year After Discounted Payback Return Occurs)
Discounted Payback Period = 4 + 1,316.50 / 1,599.37
Discounted Payback Period = 1,316.50 / 1,599.37 = .82
Discounted Payback Period = 4 + .82
Discounted Payback Period = 4.82
Discounted Payback Period = 4.82 years
As you can see from the above example, the discounted payback period is greater than the simple payback period because the time value of money is factored in. The time value of money concept is that a dollar is worth more today than a dollar tomorrow because of the opportunity cost of investing the dollar somewhere else. This is why future cash flows are discounted.
7.5 Cost-Benefit Analysis
Both the simple payback period and discounted payback period discussed in the previous section do not take into account the savings once the initial capital outlay is paid back. Therefore, a cost-benefit analysis is useful when taking into account the initial capital outlay and the savings once this initial capital outlay is paid back. A cost-benefit analysis is a decision-making tool to determine if the benefits outweigh the costs of a potential investment throughout the product lifecycle. The net present value (NPV) is a helpful calculation when carrying out a cost-benefit analysis. The investor will move forward if NPV is equal to or greater than zero. If the NPV is equal to zero, the investor achieves their required rate of return. If the NPV is greater than zero, the investor achieves a return higher than their required rate of return. In order to determine NPV, the discount rate, product lifecycle, initial costs, and operating savings are needed. A simple formula for NPV is below:
NPV = Today’s Value of Expected Cash Flows — Today’s Value of Cash Invested
Let’s again use the example used throughout the chapter, but this time performing an NPV calculation as illustrated in the box below.
Example: Net Present Value Calculation
It cost the property \$9,100 to replace traditional light bulbs with more energy-efficient LED light bulbs. The annual electricity savings from installing LED light bulbs is projected to be \$2,350. The discount rate = 8 percent. The LED lighting useful life is between 30,000 and 50,000 hours (LED Basics, n.d.). Assume 2,080 hours annually for LED lighting use and 40,000 hours of useful life for LED lighting. Therefore, the LED lighting useful life is 40,000 / 2,080 = 19.23 years. Conservatively, 19 years will be used as the LED lighting product lifecycle.
Calculate the NPV.
Step 1: Create chart below.
1. List out the number of years of the product useful life in the first column.
2. List out the annual cash flow during the product’s useful life.
3. Calculate the discount factor for each year: 1/(1 + Discount Rate)Year.
4. Calculate the present value by multiplying the cash flow by the discount rate.
5. Sum all present value rows to come up with the net present value.
Year Cash flow Discount factor Present value
0 (9,100) 1.0000 (9,100.00)
1 2,350 0.9259 2,175.93
2 2,350 0.8573 2,014.75
3 2,350 0.7938 1,865.51
4 2,350 0.7350 1,727.32
5 2,350 0.6806 1,599.37
6 2,350 0.6302 1,480.90
7 2,350 0.5835 1,371.20
8 2,350 0.5403 1,269.63
9 2,350 0.5002 1,175.59
10 2,350 0.4632 1,088.50
11 2,350 0.4289 1,007.87
12 2,350 0.3971 933.22
13 2,350 0.3677 864.09
14 2,350 0.3405 800.08
15 2,350 0.3152 740.82
16 2,350 0.2919 685.94
17 2,350 0.2703 635.13
18 2,350 0.2502 588.09
19 2,350 0.2317 544.52
Total 35,550 10.6036 13,468.46
Table 7.2: Year, cash flow, discount factor, and present value. Negative numbers are bolded.
Step 2: Calculate NPV.
NPV = Today’s Value of Expected Cash Flows — Today’s Value of Cash Invested
Net Present Value = 13,468.46
If NPV is equal to zero, the investor achieves their required rate of return. If NPV is greater than zero, the investor achieves a return higher than their required rate of return. In the above example, since NPV is greater than 0, the project is projected to achieve a return higher than their required rate of return. NPV is also helpful to use when comparing alternative projects because it provides a tangible number for comparison purposes. There is an NPV function in Excel, but Excel does not take into account Year 0 in the calculation, so the result in Excel will differ from the manual calculation if there is cash flowing in Year 0. This can be corrected in Excel by excluding the cash outflow in year 0 when calculating NPV and then subtracting out the initial cash outflow from the NPV calculation in Excel.
Benefit-cost ratio (BCR) is another popular calculation when carrying out a cost-benefit analysis. The BCR equation is as follows:
BCR = Discounted Value of Incremental Benefits / Absolute Value of Discounted Value of Incremental Costs
Let’s again use the example used throughout the chapter, but this time performing a BCR calculation as illustrated in the box below.
Example: Benefit-Cost Ratio Calculation
It cost the property \$9,100 to replace traditional light bulbs with more energy-efficient LED light bulbs. The annual electricity savings from installing LED light bulbs is projected to be \$2,350. The discount rate = 8 percent. The LED lighting useful life is between 30,000 and 50,000 hours (LED Basics, n.d.). Assume 2,080 hours annually for LED lighting use and 40,000 hours of useful life for LED lighting. Therefore, the LED lighting annual useful life is 40,000 / 2,080 = 19.23 years. Conservatively, 19 years will be used as the LED lighting product lifecycle.
Calculate the NPV.
Step 1: Create chart below.
1. List out the number of years of the product useful life in the first column.
2. List out the annual cash flow during the product’s useful life.
3. Calculate the discount factor for each year: 1/(1 + Discount Rate)Year.
4. Calculate the present value by multiplying the cash flow by the discount rate.
Year Cash flow Discount factor Present value
0 (9,100) 1.0000 (9,100.00)
1 2,350 0.9259 2,175.93
2 2,350 0.8573 2,014.75
3 2,350 0.7938 1,865.51
4 2,350 0.7350 1,727.32
5 2,350 0.6806 1,599.37
6 2,350 0.6302 1,480.90
7 2,350 0.5835 1,371.20
8 2,350 0.5403 1,269.63
9 2,350 0.5002 1,175.59
10 2,350 0.4632 1,088.50
11 2,350 0.4289 1,007.87
12 2,350 0.3971 933.22
13 2,350 0.3677 864.09
14 2,350 0.3405 800.08
15 2,350 0.3152 740.82
16 2,350 0.2919 685.94
17 2,350 0.2703 635.13
18 2,350 0.2502 588.09
19 2,350 0.2317 544.52
Total 35,550 10.6036 13,468.46
Table 7.3: Year, cash flow, discount factor, and present value. Negative numbers are bolded.
Step 2: Sum up the present value of savings (22,568.46).
Step 3: Sum up the present value of costs (9,100.00).
Step 4: Apply the BCR formula from up above.
BCR = Discounted Value of Incremental Benefits / Absolute Value of Discounted Value of Incremental Costs
BCR = 22,568.46 / 9,100.00
BCR = 2.48
If BCR is equal to one, the investor achieves their required rate of return. If the BCR is greater than one, the investor achieves a return higher than their required rate of return. In the above example, because the BCR is greater than one, this indicator also shows this sustainable initiative makes sense from a financial standpoint. The BCR ratio can also be used to compare various sustainable building projects.
As the discount rate rises, the NPV and BCR decrease. As the product lifecycle increases, the NPV increases along with the BCR.
Section Reference
Office of Energy Efficiency and Renewable Energy. (n.d.). LED basics: Solid-state lighting. https://www.energy.gov/eere/ssl/led-basics
7.6 Conclusion
In review, depending on the calculation used, the sustainable initiative should be pursued if the cash-on-cash return is greater than or equal to the required rate of return, the simple or discounted payback period is less than the allowable payback period, NPV is greater than or equal to 0, or if the BCR is greater than 1. Also, as the discount rate rises, the NPV and BCR decrease, and as the product lifecycle increases, the NPV increases along with the BCR.
A property manager who can perform financial evaluations is essential in the sustainable building initiative decision-making process. By understanding the statement of cash flow and various financial calculations introduced in this chapter, the property manager can determine the financial viability of sustainable building initiatives. These financial results can be shared with property ownership to illustrate which sustainability building initiatives make sense financially. However, it is important that the property manager be cognizant of the property owner’s goals and objectives as these can affect which analysis is relevant. For example, if a property owner does not plan to hold the real estate asset for a long time period, the NPV calculation may not be relevant, but the payback period may be appropriate to determine if the real estate asset will recover the initial investment prior to the sale of the real estate asset. For long-term property holders, the NPV may be more relevant as it takes into account the product lifecycle. No calculation can capture all costs and benefits due to intangible components, but it is important to also consider these intangible elements during the sustainable building decision-making process.
Discussion Questions
1. What is the difference between the payback period and discounted payback period? Why does this difference matter?
2. How can the actions of the property management firm affect the outcome of these calculations?
3. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Consider the following scenario and then answer the questions below:A property owner is evaluating a landscape transition from a traditional lawn to xeriscaping. Year 0 cost to change from lawn to a xeriscape landscape is \$9.25/sf. There is 1,100 sf of lawn to be changed out. As this landscape design change is not considered a typical operating expense, the costs would not be part of NOI. The water savings from this landscape design change are \$75/month and maintenance savings are \$55/month. The life expectancy of this xeriscape landscape design is 10 years. The discount rate is 8.5 percent.
1. What statement of cash flow line items are affected from this scenario in both the current year and future years?
2. What is the cash-on-cash return?
3. What is the simple payback period?
4. What is the discounted payback period?
5. What is the NPV?
6. What is the BCR?
7. What should be considered when advising the property owner on the financial viability of this project?
Figure References
Figure 7.1: Statement of cash flow example. Kindred Grey. (2023). CC BY 4.0
Figure 7.2: Discount rate and product lifecycle in relation to NPV and BCR. Kindred Grey. (2023). CC BY 4.0
Image Descriptions
Figure 7.1: Stacked linear algebraic equation. Everything above NOI is “above the line,” everything below NOI is “below the line.” Above the line is broken into revenues (first 6 lines) and expenses (OPEX). From top to bottom: Gross potential income (GPI). (-) Loss to lease. (-) Vacancy and collection loss. (=) net rent revenue. (+) ancillary income. (+) expense reimbursements. (=) effective gross income (EGI). (-) operating expenses (OPEX). (=) net operating income (NOI). (-) annual debt services (ADS). (-) capital expenditures. (-) replacement reserves. (=) before-tax cash flow (BTCF). Return to figure 7.1.
Figure 7.2: As discount rate increases, NPV and BCR decrease (negatively correlated). As product lifecycle increases, NPV and BCR increase (positively correlated). Return to figure 7.2. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.07%3A_Financial_Evaluation_of_Sustainable_Building_Initiatives.txt |
Learning Objectives
• Identify building certifications that focus on health of humans within the built environment
• Describe strategies to enhance the physical dimension of health in the built environment
• Describe strategies to enhance the mental dimension of health in the built environment
• Describe strategies to enhance the social dimension of health in the built environment
• Identify various smart devices that can enhance health in the built environment
8.1 Introduction
Chapter 7 took a closer look at the economic sphere of sustainability within sustainable property management. This chapter examines the social sphere of sustainability within sustainable property management, specifically the health of humans within the built environment. There has been an increased focus on health within the built environment. This is evidenced by the formation of the World Green Building Council in 2002, which now encompasses approximately seventy green building councils around the world, with one of their three strategic areas being health and well-being (World Green Building Council, 2022). Additionally, the WELL Building Standard® and Fitwel Certification were launched in 2014 and 2017, respectively, to provide third-party building certifications focused on human health within the built environment that work together with environmental building certifications. As of 2021, there were 33,986 enrolled or certified WELL projects in 100 countries, and as of 2022, there were approximately 4,375 certified, pending certification, and registered Fitwel projects in approximately fifty countries (International WELL Building Institute, 2022; Active Design Advisors, Inc., 2022).
The World Health Organization (WHO) defines health as a “state of complete physical, mental and social well-being and not merely the absence of disease or infirmity” (WHO, 2022). This definition highlights the holistic and interconnected nature of a person’s well-being, consisting of three distinct yet interconnected dimensions. These three interconnected dimensions of human health are illustrated in figure 8.1 and are significantly impacted by the built environment as we live, work, and play within it. This impact is felt not only by building occupants and users, but also the community at large. This chapter will examine how these physical, mental, and social dimensions can be addressed in sustainable property management. While dimensions do overlap, strategies most closely aligned with that particular dimension will be presented in the respective health dimension section. This chapter will also look at how smart building technology can be an ally in sustainable property management to cultivate human health.
Section Videos
What is WELL and why it matters
[00:06:51] International WELL Building Institute. https://youtu.be/w0ivwp6Va_c
What is Fitwel Certification?
[00:01:07] UL Solutions. https://youtu.be/etoZMivl9WE
Section References
Active Design Advisors, Inc. (2022). Fitwel is the world’s leading certification system committed to building health for all®. https://www.fitwel.org/
International WELL Building Institute. (2022). Healthier companies outperform their peers. https://www.wellcertified.com/why-well/
World Green Building Council. (2022). About us: Our mission. https://worldgbc.org/our-mission
8.2 Physical Dimension
Many building features can be optimized during the building design and construction phase to address the physical dimension of human health. Some examples include:
• Siting the building so that walkable amenities are available to the building user to promote more physical activity
• Designing the building so that natural daylight exposure is optimized
• Installing building systems that optimize indoor air quality
There are also many opportunities to incorporate the physical dimension of human health during the building’s operations and maintenance phase. Sustainable property management can address physical health through physical space alterations and programming. Physical space alterations can range from relatively small modifications to large retrofits using capital expenditures, whereas programming can range from building occupants to the community as a whole. A small physical space alteration example would be adding a living plant wall, while a large retrofit example would be upgrading the HVAC equipment. Programming examples include offering yoga classes or a running club for building occupants or for the community as a whole.
There are a variety of strategies to cultivating physical health within sustainable property management. Main components include:
• More physical activity opportunities
• Increased access to healthy food and drink
• Building user safety promotion
(Please note that Indoor Environmental Quality [IEQ] is also a main component of physical health within the built environment and is discussed in detail in chapter 4.)
More physical activity opportunities
Physical activity is a central element of the physical dimension. Introducing more physical activity opportunities can help building users become more physically active. For example, a stair renovation can be completed to make the stairs more inviting so that building users find them an attractive alternative to elevators. Another strategy is to encourage active transportation such as walking and biking. One example to foster active transportation would be to reconfigure indoor space for bike parking. Figure 8.2 illustrates an example of bike parking so that building users can arrive at the building by bike and have a safe place to park their bike. Indoor and outdoor areas can also be reconfigured to provide fitness areas. For example, an outdoor walking trail can be added if there is adequate space on site, so that building users can be active during breaks or even perhaps have a walking meeting. Additionally, indoor space can be reconfigured to provide a fitness area with cardio and weight training equipment. Programming can also be added to encourage more physical activity. Examples include forming a walking club so building occupants can meet and exercise together, and creating physical activity incentive programs such as fitness competitions with prizes to motivate building occupants.
Increased access to healthy food and drink
There are numerous strategies to increase the availability of healthy food and drink options. One strategy to encourage healthier drinks is adding access to high quality drinking water. Having a free water option in the cafeteria, restaurant, fitness center, or lobby of a building can encourage building occupants to drink more water versus paying for a soda at the cafeteria or vending machine. This may also be seen as a building amenity for tenants. Free reusable water bottles can also be given to tenants to encourage them to drink more water versus less healthy alternatives such as soda.
A strategy to increase access to healthier foods is to provide healthier options in vending machines within the building. Figure 8.3 illustrates various vending machine options. The picture on the left shows the least healthiest options with mostly candy, the middle picture some healthier options such as pita chips and fruit gummies, and the picture on the right showing the healthiest options with whole fruit. The change to a vending machine with healthier options can persuade consumers to make healthier choices. Another way to persuade consumers toward healthier food choices is to display the nutritional information of each menu item. This helps the consumer make a more informed decision before making a selection. Also, any food service in the building can provide smaller portion sizes by using smaller cups, plates, and bowls. This can help reduce calorie consumption. Furthermore, food display cases and advertising can highlight the healthier options available. For example, healthier salads can be showcased and placed where the consumer will see them before they see a pizza option. Additionally, offering a local farmer’s market on site or a community supported agriculture (CSA) program can increase healthy food options to tenants and also support the local community. Nutrition programming on site can also help educate building occupants on healthy eating habits.
Building user safety promotion
There are various strategies to promote building user safety. Stair safety can be increased by ensuring adequate lighting at staircases, properly placed handrails, and a non-slip surface on stairs. Proper maintenance of sidewalks and streets on the property can decrease the risk of injuries to pedestrians and bicyclists. To discourage crime, lighting that is functioning properly throughout the property is important so that criminals have fewer places to hide. Properly maintained landscaping is also important so that potential criminals cannot hide in overgrown vegetation. A best practice is for on-site personnel to tour the property on a regular basis to check for any safety issues that need to be addressed such as a cracked sidewalk, burned out light bulb, overgrown landscaping, or any debris causing a hazard on stairs.
8.3 Mental Dimension
Sustainable property management also addresses the mental dimension of human health within the built environment. While we intrinsically know that the mind and body are connected, this section will focus on strategies more closely associated with the mental dimension. Essential components of the mental dimension include:
• Mental health resources
• Restorative spaces and programming
• Wayfinding
(Please note that Indoor Environmental Quality (IEQ) is also a main component of mental health within the built environment and is discussed in detail in chapter 4.)
Mental health resources
Mental illness is prevalent in the United States, with one in five Americans being diagnosed with a mental illness during any given year and more than half of Americans expected to experience a mental illness or mental disorder diagnosis sometime during their lifetime (Substance Abuse and Mental Health Services Administration, 2016; Kessler et al., 2007). While sustainable property management is not the panacea for these illnesses, it can be an ally to help provide mental health resources through education, programming, policies, and accommodations both at a property level and organizational level. Mental health education and programming can help to normalize mental health issues as well as cultivate acceptance of disease within the mind. Figure 8.4 illustrates a mental health resource: an advertisement to cultivate awareness, acceptance, and a pathway for help for building users. Property managers could also place mental health resource flyers in the lobby. Policies and accommodations can be helpful to property employees suffering from a mental health issue. For example, employee assistance programs can be offered for depression and anxiety treatment as well as referrals to other qualified professionals if needed. Additionally, work-life balance policies can be created so that there is time for property employees to handle family challenges and potentially lessen mental health impacts. Accommodations can include a suitable work environment and time for a property employee to go to mental health appointments.
Restorative spaces and programming
Restorative spaces are important in sustainable property management to decrease stress and promote relaxation. Natural elements, natural lighting, and indoor plants can help cultivate a restorative space within a building. An example of this is the creation of a living wall within a building space as illustrated in figure 8.5. An outdoor sitting area surrounded by nature can also be created as a restorative space for building users. Space can also be configured within the building for a meditation room. Meditation is a mindfulness practice that can be restorative in nature. Meditation rooms, as illustrated in figure 8.6, are becoming increasingly common among various property sectors. This is evidenced by the creation of The 50 Best Campus Meditation Spaces which can be found at: https://web.archive.org/web/20220808140555/http://www.bestcounselingschools.org/best-campus-meditation-spaces/. Programming can also be offered to building occupants to introduce mindfulness practices for relaxation and stress reduction. In addition to meditation, programming on labyrinth work can be introduced to promote relaxation. Stress management workshops facilitated by a professional can also promote restoration.
The minimization of clutter can also make a space feel more inviting and relaxing. Figure 8.7 shows a cluttered and neat desk. A neat desk can invoke a calmer state within the employee. One strategy to help property management employees minimize clutter is to put programming in place that provides time and tips to declutter workspaces. The implementation of a time during the evening that property management employees must cut off work, work emails, and the like can promote restoration so that employees do not feel that they need to respond to work situations during all hours of the day and night. However, the reality is that property managers must respond to emergencies which can happen throughout the night such as a fire, loss of power, or a leak. But the on-call person can rotate so that everyone can turn off their work responsibilities on some nights. Altruism, which has also been shown to help with stress management, can be incorporated into programming by offering charitable activities for building users such as donating blood or participating in a charity run (Post, 2014).
Wayfinding
Wayfinding helps building users access and navigate the building space by providing identification, directional, orientation, and regulation signage. Figure 8.8 illustrates wayfinding signage using both words and images. Bad wayfinding facilitates people getting lost or finding navigation of the building space difficult. This can invoke feelings of frustration or anxiety. On the other hand, effective wayfinding design helps building users not familiar with the space to easily navigate their surroundings. Imagine how helpful this can be in a retail or hospital setting. For example, in a retail setting, effective wayfinding helps the consumer arrive at the appropriate section of merchandise as well as a fitting room when relevant. In the hospital setting, it helps direct the building user to the appropriate department. Therefore, it is important to review current wayfinding design and update accordingly. An effective wayfinding plan provides clear, consistent, and concise messaging. As a comprehensive example, the wayfinding master plan for Virginia Tech can be found here: https://www.facilities.vt.edu/content/dam/facilities_vt_edu/design-and-construction-standards/appendices/Appendix%20F%20-%20Campus%20Wayfinding%20Guidelines.pdf.
Section References
Kessler, R. C., Angermeyer, M., Anthony, J. C., De Graaf, R., Demyttenaere, K., Gasquet, I., De Girolamo, G., Gluzman, S., Gureje, O., Haro, J. M., Kawakami, N., Karam, A., Levinson, D., Mora, M. E. M., Oakley Browne, M. A., Posada-Villa, J., Stein, D. J., Tsang, C. H. A., Auilar-Gaxiola, S., … Üstün, T. B. (2007, October). Lifetime prevalence and age-of-onset distributions of mental disorders in the World Health Organization’s World Mental Health Survey Initiative. World Psychiatry, 6(3), 168.
Post, S. G. (2014). It’s good to be good: 2014 Biennial scientific report on health, happiness, longevity, and helping others. International Journal of Person Centered Medicine, 2014(2), 1–53.
Substance Abuse and Mental Health Services Administration. (2016). Key substance use and mental health indicators in the United States: Results from the 2015 National Survey on Drug Use and Health. Center for Behavioral Health Statistics and Quality.
8.4 Social Dimension
Humans are social beings and social behavior is important to human health (Young, 2008). The encouragement of socialization among building users and the community can enhance health. Critical components of the social dimension of human health include:
• Amenities that encourage socialization
• Equitable and inclusive spaces and programs
• Community engagement programs
Amenities that encourage socialization
There are a plethora of amenities that can foster socialization and a sense of belonging. As illustrated in figure 8.9, socialization amenities might include a recreation room with a pool table can be created as well as a pool league to foster connections among building users. In the multifamily property sector, outdoor grilling stations, pet parks, pools, and community lounges are all examples of opportunities for social engagement. Additionally, programming within these amenities, such as a pool party or a “yappy” hour, can bring building occupants together. In the office sector, conference rooms, multipurpose collaboration areas, dining options such as food trucks, and mentorship programs can bring people together.
Equitable and inclusive spaces and programs
Social equity and inclusion are critical considerations when promoting socialization within the physical building space and building programming initiatives. Social equity through universal design is one method to address equity and inclusion within the physical building space. According to the National Disability Authority, universal design is “the design and composition of an environment so that it can be accessed, understood and used to the greatest extent possible by all people regardless of their age, size, ability or disability” (National Disability Authority, 2020). Examples include automated doors, tables and counters at a variety of heights, flat entrances, braille on signage, and task lighting. Figure 8.10 highlights additional examples of universal design: in kitchen environments with accessible cutting boards; and within bathroom environments with a flat shower entrance, bench, grab bars, various shower head heights, accessible soaps, and space underneath the sink for a wheelchair. While some accessibility strategies must be completed to comply with Americans with Disabilities Act (ADA) regulations, a focus that is also friendly toward various groups of people with disabling conditions, such as wheelchair-friendliness, fosters the universal design concept.
Social equity through programming, such as lower prices for healthier food if possible, increases access for more diverse socio-economic groups. Programming to increase awareness and knowledge of equitable and inclusive environments also promotes the social dimension of human health within the built environment. While there are plenty more examples, this is an overview of the diversity of initiatives available to increase equity among building users.
Community engagement programs
Engaging with the local community is another way to enhance the social dimension within health beyond building occupants. This can be accomplished through community engagement programs that address community concerns, enhance public spaces, employ the local community within the building, and support community groups through various charity events. Some examples include volunteering within local community non-profits, sponsoring programming within public spaces such as a music festival or arts exhibition, and meeting with community officials on concerns they may have over any building operations.
Section References
National Disability Authority. (2020). What is universal design. http://universaldesign.ie/What-is-Universal-Design/.
Young, S. N. (2008, September). The neurobiology of human social behaviour: An important but neglected topic. Journal of Psychiatry & Neuroscience: JPN, 33(5), 391.
8.5 Smart Device Technology as an Ally to Health in Sustainable Property Management
A smart device is “an electronic gadget that is able to connect, share and interact with its user and other smart devices” (Technopedia, 2022). These smart devices can be an ally to health within sustainable property management for both property management employees and tenants. For example, a discount can be offered to property employees for wearable smart devices that track physical activity and quality of sleep to support them on their path to enhanced health. A smartphone or tablet can be used to download apps for mindfulness practices, nutrition logs, socialization apps, relaxation music, or upbeat music for aerobic activity. These health apps can also be shared with tenants to promote health among building occupants. Smart thermostats can be provided to building occupants for increased thermal comfort in the building, while smart locks and doorbells can be installed for increased occupant safety in the multifamily sector. Smart speakers can be utilized for meal prep help as well as a mind and body workout repertoire. Smart refrigerators can be promoted that can track meals eaten and calories consumed as well as provide recipes based on the foods in the refrigerator. A partnership can be formed with a local appliance store to offer a discount on these types of refrigerators. While these smart devices can promote a healthier lifestyle, programming is important for educating and training potential smart device users for optimal effectiveness.
Section Reference
Technopedia. (2022). Smart device. https://www.techopedia.com/definition/31463/smart-device
8.6 Conclusion
This chapter illustrated how sustainable property management also focuses on the human health experience through physical, mental, and social dimensions. It also looked at how smart building technology can be an ally in sustainable property management to cultivate human health. Some of the strategies discussed in this chapter are expensive and may be considered during retrofits or by using capital expenditures. Other strategies are relatively low cost and do not require any space alterations. The property management personnel need to understand the market that the building is operating within as this will often dictate what physical, mental, and social strategies will be utilized on-site. Also, property layout will impact strategies. For example, active transportation by bike may not be possible depending on where the building is located. The careful selection of health strategies can not only attract and retain tenants, but also form building users into engaged community citizens.
Discussion Questions
1. What opportunities are there to cultivate the physical, mental, and social dimension of health within the community you live? Which, if any, do you take advantage of?
2. Do you own any smart devices? If so, in what ways do they help with your health? Do you see any of these smart devices hindering your health?
3. This chapter presented strategies within particular dimensions of health, while acknowledging that dimensions do overlap. Provide an example of a physical-mental, mental-social, social-physical, or physical-mental-social strategy, and explain why your example has that particular overlap.
4. What is your key takeaway from this chapter? In which section did you find it?
Activities
1. Labyrinth Exercise
1. Complete this finger labyrinth by clicking on the below link and following the directions:
https://shepherdscorner.org/2020/03/25/finger-labyrinths-for-meditation/.
2. After completing the labyrinth, explain how you felt during and after the exercise.
2. Research a WELL certified or Fitwel certified project and report back:
1. Project name and location
2. Five key features of the building that qualified for certification
Figure References
Figure 8.1: The three dimensions of health in sustainable property management. Kindred Grey. (2023). CC BY 4.0
Figure 8.2: Bike parking example. San Francisco Bicycle Coalition. (2012). Atlassian bike parking [photograph]. https://flic.kr/p/bUMg3Q. CC BY-NC-ND 2.0
Figure 8.3: Vending machine options. Left: tkraska. (2011). [photograph]. https://flic.kr/p/9mPM5X. CC BY 2.0. Middle: Bing. (2015). [photograph]. https://flic.kr/p/ru2Kkp. CC BY-NC-SA 2.0. Right: Martin Deutsch. (2010). Fruit vending machine [photograph]. https://flic.kr/p/8C3wvo. CC BY-NC-ND 2.0
Figure 8.4: Mental health resource example. Rupert Ganzer. (2008). Depression [photograph]. https://flic.kr/p/5B2R6v. CC BY-NC-SA 2.0
Figure 8.5: Living wall example. LiveWall Living Wall Systems. (2015). Sanseveria-living-wall-design [photograph]. https://flic.kr/p/xkmf6W. CC BY-NC-SA 2.0
Figure 8.6: Meditation room example. Corinne Staley. (2012). Meditation room [photograph]. https://flic.kr/p/bUYRNg. CC BY-NC 2.0
Figure 8.7: Cluttered versus neat workspace. Kindred Grey. (2023). Includes James Emery. (2007). Workspace_2615 [photograph]. https://flic.kr/p/2e1m4j. CC BY 2.0. Includes Jason de Villa. (2009). Freedom from cable clutter! [photograph]. https://flic.kr/p/7pLL1v. CC BY-NC 2.0.
Figure 8.8: Wayfinding example. Joe Shlabotnik. (2005). Meditation room [photograph]. https://flic.kr/p/2PUKij. CC BY 2.0
Figure 8.9: Socialization amenities. Pennsylvania DMVA. (2013). Soldiers’ & sailors’ home [photograph]. https://flic.kr/p/q8xkQ7. CC BY-NC-ND 2.0
Figure 8.10: Universal design examples. Left: Fairfax County. (2011). [photograph]. https://flic.kr/p/9uoh5r. CC BY-ND 2.0. Right: Summit Design Remodeling. (2011). [photograph]. https://flic.kr/p/a15S7P. CC BY-NC-SA 2.0
Image descriptions
Figure 8.4: A large sign on the side of a building reads, “Depression is a flaw in chemistry, not character. For free information call 1-800-829-8289.” Return to image 8.4.
Figure 8.6: A room has mats or cushions laid out on the floor in front of 3 open windows. Except for a clock on the wall, there is no other decoration. Return to image 8.6.
Figure 8.10: Left: kitchen with accessible cutting boards. Right: bathroom with a flat shower entrance, bench, grab bars, various shower head heights, accessible soaps, and space underneath the sink for a wheelchair. Return to image 8.10. | textbooks/biz/Management/Sustainable_Property_Management_(Hopkins)/1.08%3A_Human_Health_Considerations.txt |
learning objective
After studying this section, students should be able to do the following:
1. Recognize the bold new approach for delivering information to today’s college students (aka digital natives) that Unnamed Publisher creates.
Knowledge is a Flat World
The textbook publishing industry is undergoing staggering change as many traditional business models and practices quickly lose relevance. Peer-to-peer textbook trading networks, online used-book sellers, and a gray market that allows low-priced international editions to displace expensive U.S. texts push publishers to reconsider outmoded ways of delivering content. Likewise, the digital natives who make up our university student bodies (that’s you!) inspire educators to think about the transfer of knowledge in exciting new ways.
How do we best communicate the most current thinking in our disciplines to students who expect up-to-the-minute information at a keystroke and who view educational materials as community—indeed, world—resources that can and should be shared and interactively constructed?
Enter Unnamed Publisher, an innovative, open source publishing company. We’ve created a new kind of text—one premised on the idea that college course material can wield wider influence and be of greatest public benefit as it becomes easily and inexpensively available to anyone with a desire to learn.
A new alternative to introductory texts that can cost into three figures and provide information that is extraneous or outdated, Launch! offers a basic text at no cost to students. Instead, we generate revenue through individually priced materials such as discretionary hard copies of the text (for those of you who still like to mark up your book the old-fashioned way), study guides, podcasts and streaming interviews (à la iTunes), user-generated content, advertising sales, and corporate sponsorships.
Learn about Advertising by Learning about Advertisers (Real Ones)
There’s something else that’s really unique and cool about Launch! Welcome to the first advertising textbook written in partnership with a real-life advertising agency. It’s fine to talk about ad campaigns from the past, but we’d rather hear about one from the horse’s mouth—while it’s still happening. We’re going to teach you about the ad biz the way you’ll learn it if you choose to make it your career (and we hope you do). None of that shiny, happy, “talking heads” stuff; we’re going to take the gloves off and show you how a campaign works (and sometimes doesn’t) from the vantage point of the people who have to do it every day. Prepare to Launch!
1.02: Meet Our Agency Partner- SSK
LEARNING OBJECTIVE
After studying this section, students should be able to do the following:
1. Characterize the Shepardson, Stern and Kaminsky (SS+K) organization, a creatively-driven strategic communications firm, and how it works to secure clients.
Get to know Shepardson, Stern and Kaminsky (SS+K) as it works on a campaign for msnbc.com, a media brand in search of an identity. SS+K opened its doors in 1993 and now has offices in New York, Boston, and Los Angeles. With over \$70 million in billings, SS+K is an independent agency owned by its partners, with a minority ownership by Creative Artists Agency (CAA)—perhaps the most powerful talent and literary agency in the world. CAA also owns the Intelligence Group, a market research and trend forecasting company.
For this text, we interview the agency partners, the creative director, the account people, the creative team (copywriter and art director), the public relations experts, the account planners and research specialists, and the digital professionals who took the msnbc.com campaign from pitch to completion. And, a member of our author team knows this agency up close and personal: Amit Nizan was the account manager at SS+K who lived and breathed the msnbc.com campaign. A 2003 graduate of the renowned undergraduate advertising program at the University of Florida, Amit will help us take you through the planning and execution of this campaign as a young, dynamic advertising professional actually experienced it. Not too long ago she was a student just like you, so she feels your pain!
Through their words and documents you will follow, step by step, the thirteen-month process of bringing SS+K’s campaign vision of “A Fuller Spectrum of News” to light. To allow us to bring you the inside story on how the agency created the msnbc.com campaign, msnbc.com and SS+K granted FWK full access to its creative work, internal processes, and employees. The result is a resource that offers new ways to teach and talk about the real world of advertising with course content that is affordable, accessible, timely, and relevant. Welcome to advertising education on steroids.
OK, So Who Is SS+K?
SS+K was founded in 1993 by three former political consultants—Rob Shepardson, Lenny Stern, and Mark Kaminsky—and a famous copywriter, David McCall. To this day, the agency is a mash-up of those roots in politics and creativity, bolstered by a dose of entertainment marketing via its partnership with CAA and the staff’s passion to learn and apply the latest technology. SS+K has become a haven for talented refugees from every corner of the communications world.
SS+K offers a full array of services to its clients, including advertising, marketing, design, public relations, public affairs, and research. Although many ad agencies, PR firms, and marketing consultancies endorsed integrated strategies over the last decade, SS+K believes that most agencies have built-in biases toward one type of solution. They tend to treat “integration” as an item on a check-off list. Ad agencies think in terms of ads. PR shops generate PR ideas. And so on…but not SS+K. For them, it is about delivering the right message at the right time to the right audience with the right medium. They call their approach to these types of media-neutral ideas Asymmetric Communications. Their perspective encourages the agency to “think outside the box” by employing a mix of traditional and new media (like urban games) to engage the audience in surprising ways and uncover opportunities to connect with them.
This perspective is a consumer-centric approach the agency uses to find unique and surprising ways for clients to connect with and engage their target audiences. For example, instead of using traditional methods and messaging to increase awareness of Qwest Wireless among high school students, Qwest worked with SS+K to design an urban game called ConQwest that involved teams of students, newly created semacodes for use on cell phones, and giant inflatable game pieces. Semacode is a trade name for machine-readable two-dimensional black and white symbols that act as “barcode URLs.”
True to their political roots, the agency consulted with the Obama presidential campaign on driving more interest and participation among young voters. Since its inception, SS+K has maintained a high-profile nonprofit business, including work with UNICEF, Share Our Strength, the Bill & Melinda Gates Foundation, and the Lance Armstrong Foundation’s “LIVESTRONG” campaign.
The agency understands how to work with short lead times and mine for deep consumer insights that animate its work. It’s a combination that has made SS+K increasingly popular with a growing roster of clients, including Delta Airlines, Credo Mobile, Polo Ralph Lauren, AutoMart—and our client for this book, msnbc.com.
After fifteen years in business, all three founding partners—Rob Shephardson, Lenny Stern, and Mark Kaminsky—are still active in the firm, and they’ve added other key partners such as Executive Creative Director Marty Cooke to continue to provide fresh ideas and leadership.
Our SS+K Odyssey
Here’s how we got started: once SS+K agreed to participate in this unique partnership, it was time for us to become familiar with the campaign. First, our intrepid author Lisa Duke Cornell reaches out to Russell Stevens, a partner at SS+K.
Dr. Duke Cornell flew up from Gainesville (where she teaches advertising at the University of Florida) and came in to meet the whole SS+K crew, teach them a little about Unnamed Publisher, and learn a lot about SS+K. Throughout the text, you will find links to the interviews Dr. Duke Cornell conducted with the team based in New York. In addition, she interviewed key team members from the Los Angeles and Boston offices.
Amit Nizan joined the author team in the spring of 2008. Drawing on personal knowledge of the agency and the msnbc.com account, Ms. Nizan immersed herself in the interviews and information the team provided to Dr. Duke Cornell.
Launch! unfolds chapter by chapter across a timeline for msnbc.com’s first branding campaign. Before we get into that, let’s meet the full cast of characters who worked on the msnbc.com account with Ms. Nizan.
Additional SS+K employees worked on aspects of the msnbc.com account, including Jeannie O’Toole (Head of Print Production), John Kirkwood (Web and Video Production), Tim Player (Studio Manager), Kelly Kraft (Project Manager), Amy Gaiser (PR), Janetti Chon (PR), Aaron Taylor-Waldman (Studio Designer), Alice Ann Wilson (Head of Design), Natalie Cho (Designer), Sonya Fridman (Designer), Joe Sayaman (Copywriter), and Rochelle Ardesher (Project Manager).
As you can see, it takes a village to work on an account. Each of the people beyond the core team contributed their respective expertise to the production and execution of the first-ever msnbc.com branding campaign.
How SS+K Works
How is an ad agency not an ad agency? SS+K does not consider itself an advertising agency, but instead a creatively-driven strategic communications firm that solves problems through a variety of innovative techniques—including but not limited to traditional advertising approaches. You’re going to see throughout this book that SS+K is not alone in this regard—the advertising industry seems to change its stripes almost daily as new technologies and trends evolve!
As a remnant from SS+K’s founders’ days as political consultants the agency uses an integrated model. SS+K is media-agnostic; this means it doesn’t care what medium or discipline it uses to solve a client’s problem as long as the solution delivers the right message at the right time to the right audience with the right medium.
Video Spotlight
Working Together (click to see video)
Marty Cooke explains how different disciplines mesh at SS+K.
key takeaway
Welcome to a new model of textbook learning. This book is different from others in two really important ways:
• It’s the first open source, professionally authored advertising/marketing textbook ever.
• It’s the first advertising textbook written in partnership with a real-life advertising agency.
The SS+K agency is going to help us learn how to do advertising by actually doing advertising. Follow along with us as we chronicle its efforts to win the important msnbc.com account and then deliver on its strategy to make this media brand the source of news for the customers the site hopes to reach.
exercises
• List four facts that characterize the Shepardson, Stern and Kaminsky (SS+K) communications organization. Be specific.
• SS+K uses a distinctive trademarked approach for engaging clients and audiences in the advertising and communication process. Briefly describe SS+K’s asymmetric approach to formulating communications and ideas.
• Discuss the integrated model of communication presented in this chapter section. Why does SS+K describe itself as being “media-agnostic” in its approach to communication? | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/01%3A_Meet_SSK_-_A_Real_Agency_Pitches_a_Real_Client/1.01%3A_Why_Launch.txt |
learning objective
After studying this section, students should be able to do the following:
1. Understand the process by which an agency makes a pitch for a client’s business by responding to a Request for Proposal.
How does the client decide which agencies to work with? It all starts with the pitch, where the client invites an agency to present itself with the hope of winning the account. Once a client decides on a list of agencies to pitch their business, it may send these agencies a request for proposal (RFP). In an RFP, the client lays out basic information about its business and requirements for the job, along with a list of questions that will help the client determine how the agencies work and if they are suited to the task at hand.
In some cases, agencies may approach clients they feel would be a good match for their talents or would add depth or luster to their roster. Alternatively, when agencies are well known for a particular campaign or approach, clients will seek them out. However, just as when an individual is searching for work, word of mouth and personal relationships play an important role in the process. It’s not just what you know, it’s who you know.
Why the Pitch Is Such a Big Deal
The client’s stake in agency pitches is high: management’s jobs, the brand’s future, and millions of dollars may ride on the campaigns the winning agency creates. For example, in 2007, despite having spent over \$900 million on marketing that year, Microsoft was not performing well against competitors such as Google and Apple. Identifying a key need to boost market share, the software giant embarked on a search for a new agency to enhance its brand image. By February of 2008, Microsoft had narrowed its search to two agencies; it then chose Crispin Porter + Bogusky for a new \$200–300 million “consumer blitz.”Rupal Parekh and Alice Z. Cuneo, “Microsoft Narrows to Crispin, Fallon,” Advertising Age, December 21, 2007, adage.com/agencynews/article?article_id=122776 (accessed July 16, 2008).
Just as the client invests large sums in the advertising campaign, the costs for agencies also are enormous, whether or not they win the business. In order to pitch effectively, the agency must allocate material resources and a tremendous number of team hours to meetings, research, and creation of the pitch. Sometimes, when the assignment, chemistry, or timing isn’t right, it’s just good business for the agency to walk away and leave millions of dollars in potential billings on the table.
That’s what happened in 2006, when GSD&M (now known as GSD&M Idea City)’s nineteen-year relationship with its client Wal-Mart was challenged in a client-initiated review for their business. In one of the first review meetings the incumbent agency had with its longstanding client, GSD&M agency president Roy Spence played a clip from the movie Dumb and Dumber, in which the romantically challenged character played by Jim Carrey is told by the girl of his dreams the chances they will be together are one in a million. Carrey replies, “So…you’re telling me there’s a chance?”“Wal-Mart, Please Don’t Leave Me,” Business Week, October 9, 2006, http://www.businessweek.com/magazine/content/06_41/b4004076.htm (accessed July 16, 2008).
Spence’s attempt at lightheartedness hid a hard truth: there was no salvaging the relationship. GSD&M was unsuccessful in its pitch for the business, which included a poorly received report suggesting that Wal-Mart’s declining reputation was at the root of its struggle for higher share prices. In an interesting turn of events, the agency that “won” the business, Draft FCB/Chicago, was dropped in a matter of months, and Wal-Mart once again invited GSD&M to pitch its business. This time, GSD&M swallowed hard and passed on a chance at the \$580 million assignment. Like the song goes, you gotta know when to hold ’em and know when to fold ’em.
Who Conducts the Pitch?
Marketers who work on the brand for the client are the ones who initiate the pitch process when they make the decision that they would like to search for an agency. The person within the organization who generally leads the search is the chief marketing officer or the vice president of marketing.
Some marketers choose to partner with a search consultancy whose job is to conduct the search. They use different methods to determine which agencies are the most appropriate fit for their client’s pitch. They also work as liaisons between the client and the competing agencies to handle questions and logistics and to structure the pitch.
The Pitch Process
The pitch process can be short or long, depending on the information the client requests in order to make the decision. There is usually a series of steps, including but not limited to these:
• Filing the RFP. A client will send out the RFP, which will include some basic background information and preliminary statements of what the agency will be tasked to solve. The agency in turn will fill out the RFP with an introduction about themselves, as well as answers to any other questions the RFP asks.
• Chemistry meeting. Based on the responses to the RFP, the client will invite select agencies to meet in person. This meeting is generally called a chemistry meeting, as it is designed to allow the companies to determine how well they like each other and if there is “chemistry” between them.
• Initial strategic thinking. Before agencies are given a specific creative assignment, there is a step to discuss the approach to the problem. This discussion can sometimes be part of the chemistry meeting but can also be a next step. The initial strategic thinking allows the agency to demonstrate the tools it keeps in its shed without putting them all to use until the client agrees to the strategic approach.
• Creative presentation. If an agency is given a creative assignment, this meeting is where it presents its recommendations to the client.
How do agencies demonstrate to clients they are the right choice for the job? In a recent interview well-known account planner Jon Steel noted, “I have always believed that the best new business weapon in an agency’s armory is the quality and effectiveness of the work it produces for its existing clients.” However, another way that agencies have demonstrated their creative ability is to present “spec” (speculative) creative work in pitches. Spec work is developed based on the agency’s best guess as to what might appeal to and work best for a client and presented in a form that is very close to “finished.”
Dig Deeper
The problem with spec work is that many in the industry feel it devalues skills such as design, art direction, and copywriting—as it forces agencies to give away for free (or at a substantially reduced cost) their most valuable product: their creativity. In the end, ownership of the ideas presented during pitches can be contested; clients who have had a number of agencies pitch creative work have been known to pick and choose among the best of all the pitching agencies’ ideas while awarding the business to just one. As a result, the American Association of Advertising Agencies (AAAA) created a Positioning Paper outlining best practice guidelines for the use of “spec” creative in the new business process: www.aaaa.org/eweb/upload/6712_att.pdf.
What’s your opinion? Should agencies be compensated for “spec” work even if they don’t win the account?
key takeaway
You can’t work on an account until you’re awarded the business. To win a client you have to present a pitch, usually along with several other agencies. Although the client doesn’t (or shouldn’t) expect to see a finished campaign, it will look for evidence that your team has put a lot of creative thought and effort into fleshing out its vision of what the advertising will look like. Preparing a pitch can be an expensive, grueling, and nail-biting experience, so an agency shouldn’t throw its hat into the ring unless it’s willing to make a commitment to go all out in order to win the business.
exercises
• Define the terms “pitch” and “request for proposal (RFP).” According to material found in this chapter section, why is the pitch such a big deal?
• List and describe the four-step pitch process that SS+K must go through to win the msnbc.com account.
• How does an agency such as SS+K demonstrate to clients that it is the right choice for a communications job? Be specific in your discussion. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/01%3A_Meet_SSK_-_A_Real_Agency_Pitches_a_Real_Client/1.03%3A_The_Pitch_-_Win_the_Account.txt |
learning objective
After studying this section, students should be able to do the following:
1. Discuss the background and primary employees (characters) of msnbc.com, a well-known media brand in search of its identity.
Established in 1996 as a joint venture between Microsoft and the National Broadcasting Corporation (NBC), ten years later msnbc.com finds itself in an increasingly crowded field of news providers and hopes to add new users to its twenty-five million unique visitors a month. As msnbc.com’s VP of marketing, Catherine Captain, says, “I am particularly concerned about distinguishing ourselves in a market where every new site is starting to look a lot alike.”
It is important to understand that the client is msnbc.com the Web site and not MSNBC the cable channel. Although the Web site msnbc.com and the cable channel MSNBC were launched together in 1996, they have always maintained separate corporate structures and news operations. NBC and Microsoft remain fifty-fifty partners in msnbc.com, but Microsoft has reduced its stake in the television network to 18 percent. And msnbc.com is editorially and financially separate from MSN, the portal site and online service operated by Microsoft, although it acts as that site’s primary news provider.
In addition to original content from its staff, which is based out of the newsroom in Redmond, Washington, msnbc.com is the news Web site for the NBC News family. It also features content from the cable television news channel MSNBC, NBC shows such as Today, NBC Nightly News, and Dateline NBC, and partners such as the New York Times and the Washington Post. In addition, msnbc.com made its first acquisition in late 2007 when it bought Newsvine, a Web site with community-driven news stories and opinions.
In its history as a company, msnbc.com never pursued or launched a branding campaign until Ms. Captain arrived just shy of the site’s tenth anniversary. In her quest for the right agency, Ms. Captain sent RFPs “to a whole slew of potential agencies.”
SS+K’s Pitch to Win the msnbc.com Account
Objective: Win the msnbc.com account!
I knew that SS+K was the perfect agency for her, because we come from the same philosophy.
Danielle Tracy, SS+K vice president
Video Spotlight
Michelle Rowley and Russell Stevens
(click to see video)
Russell describes the response from the SS+K perspective and how they approached the RFP from msnbc.com.
Victory! SS+K Lands the msnbc.com Account
You can guess the outcome: Catherine Captain chose SS+K to reintroduce msnbc.com to the world. Her goal was to maximize the impact of her modest \$7 million marketing budget. Instead of choosing an interactive agency, which she said would “predetermine her plan,” Captain preferred the “media-agnostic” approach of SS+K. And so, in March of 2006, a decade-old msnbc.com announced it would soon launch its first branding campaign.
The idea of integrated marketing communications has been around for a long time. But the independently held SS+K embraced the concept in a way that only people from a disparate number of camps could: there are no well-populated traditional territories in the agency. Instead, it is home for a multidisciplinary cast of communication experts as well as a collection of “formers”—former actors, scientists, journalists—galvanized by a combined passion for strategic innovation and, as Captain observes, challenging the status quo. There is no allegiance to method or medium; advertising doesn’t get preferential treatment over public relations or other buzz boosters.
Video Spotlight
Catherine Captain
(click to see video)
Catherine describes what made SS+K the right fit, and the importance of understanding the consumer.
key takeaway
SS+K’s team developed its pitch by doing its homework about the types of people who visit Web sites to get their information. The agency also wasn’t afraid to think creatively about using a variety of media to capture their interest. As a result of this effort the agency won the msnbc.com account. Now the work really starts.
exercise
• What were the key contributing factors that allowed SS+K to win the msnbc.com account? Be sure to comment on the roles played by Joe Kessler, Danielle Tracy, and Catherine Captain. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/01%3A_Meet_SSK_-_A_Real_Agency_Pitches_a_Real_Client/1.04%3A_Let%27s_Meet_the_Potential_Client.txt |
tie it all together
Now that you have read this chapter, you should be able to understand how a real advertising agency pitches a real client:
• You understand that Unnamed Publisher is an innovative, open source publishing company that has produced Launch! Advertising and Promotion in Real Time.
• You have been introduced to Shephardson, Stern and Kaminsky (SS+K), a creatively-driven strategic communication firm, and their future client msnbc.com, a well-known media brand in search of an identity.
• You are able to identify SS+K’s distinctive communications approach called Asymmetric Communications.
• You are able to recognize the pitch process and the resulting request for proposal (RFP) SS+K used.
• You can recall that the objective of the SS+K pitch was to win the msnbc.com account.
use what you've learned
1. As you have read in the chapter, SS+K is a multifaceted organization that specializes in helping clients with their unique communication problems. Review the listing of SS+K personnel. Once you have completed this review, link to the SS+K Web site http://www.ssk.com for more information on the company.
Agency Statement: “With offices in New York, Boston, and Los Angeles, SS+K has become a magnet for refugees and misfits from the most potent pillars of American society: politics, creative, entertainment, and technology. We believe that when smart, talented people from different backgrounds sit down to solve a problem, the solutions are bigger, more unpredictable and more effective. We believe it is more important to understand your business issues, delve into consumer insights and work with you to find the best solution for the brand regardless of channel. At SS+K, we don’t care what media or discipline we use to solve a client’s problem; it’s about delivering the right message at the right time in the right medium.”“Shepardson Stern + Kaminsky (SS+K),” O’Dwyer’s Database of PR Firms, http://www.odwyerpr.com/pr_firms_database/prfirm_detail.htm?prid=d7df07ef171a403c34e195e0ef90e0c2 (accessed February 10, 2009).
Using the SS+K Web site (or other search engines), review the agency’s past work. Carefully examine one of the following campaigns that SS+K has created: the Lance Armstrong Foundation, Delta Airlines, Qwest Communications, UNICEF, or the Bill & Melinda Gates Foundation. Based on your review, comment on how SS+K seems to have applied its Asymmetric Communications model to the selected client’s communication problems. Try, if possible, to pinpoint the Asymmetric Idea SS+K developed that seems to be the focal point of communications. What do you think of SS+K’s approach for the selected client?
2. SS+K has made a pitch to secure the communications business of msnbc.com. Beyond material supplied in the chapter, what do you really know about proposed client msnbc.com? Visit http://www.msnbc.com to gain additional insight.
As you review the msnbc.com Web site, list three msnbc.com offerings that impress you. Additionally, cite any features that either don’t impress you or are missing from the Web site. Once you have completed this task, visit rival news service CNN at http://www.cnn.com. Again, list three services that impress you and cite any features that either don’t impress you or are missing from the CNN Web site. As you make your evaluations, remember to review only the Web sites of the two organizations and not their televised news broadcasts. How does msnbc.com stack up against its rival? How could SS+K use your evaluation to improve the msnbc.com Web site? Be specific in your comments. As we go forward in our discussion of SS+K’s communication and advertising strategy for msnbc.com, see how many of your suggestions are recognized and addressed.
digital natives
• Almost all teens have difficulties with acne. Acne is not only a health issue but a social one as well. If you ever had difficulties with acne, what would you have given to rid yourself of those unsightly blemishes? To examine a new solution to this age-old problem, visit the Zeno Web site at http://www.myzeno.com.
Zeno is, according to its Web site, “the new secret weapon in the war against pimples.” Consider the following facts as you explore how Zeno works. The Zeno device looks like a cell-phone. It is a hand-held battery-operated device that is designed with a tip that heats to a preset temperature. Once the tip is heated properly and applied to the skin, the blemish disappears in a relatively short time. Much of the procedure is customized to the user and his or her skin type. The level of heat does not cause skin damage.
After exploring the Zeno Web site and learning about the application procedure and facts about the product, develop a brief “pitch” to present to the Zeno organization. The objective of your agency’s pitch will be to demonstrate the best method for introducing the Zeno product to college-age students. Consider the basic message to be delivered to this target market and the best way to transmit that message to them. What do you perceive to be the keys in reaching the college-age students in your target market? Discuss your pitch idea and conclusions with your peers. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/01%3A_Meet_SSK_-_A_Real_Agency_Pitches_a_Real_Client/1.05%3A_Exercises.txt |
Advertising is in trouble only if you think of the narrow box advertising has traditionally been in, which is getting on TV or in print.
Linda Kaplan Thaler, Founder, Kaplan Thaler Group
This is not a book about advertising.
This is a book about touching consumers where they live—and work and play. Now that we’ve met some of the folks from SS+K and msnbc.com, let’s take a look at the fundamentals the members of these teams have under their belts. We’ll pick back up with them in Chapter 4 "Consumers and the Communications Process: SS+K Gets to Know Its Consumers" to follow how they’ve applied these fundamentals from Chapter 2 "A User’s Manual: Advertising, Promotion, and Marketing Essentials" and Chapter 3 "Advertising and Society".
2.02: Advertising Is Old - and Brand New
learning objectives
After studying this section, students should be able to do the following:
1. Understand how the background and history of U.S. advertising impacts modern advertising and its clients.
2. Define the various types of advertising and promotion agencies employ in today’s marketplace.
Hammers and screwdrivers did the trick for years, but today marketing communications professionals have a whole new box of power tools. The marketing to-do list is long and so is the list of instructions.
Agencies and their clients sorted madly through the box for the past decade as they tried to find the most effective tools for the job. Now, an avalanche of new technology adds to an increasingly daunting pile. It’s hard for some experienced advertising professionals to let go of what they “know.” “There’s still a little fear out there about shifting away from the traditional marketing tactics,” said Doug Scott, executive director for branded content and entertainment for the North American operations of Ogilvy & Mather Worldwide, part of the WPP Group, in 2006.Stuart Elliott, “Nike Reaches Deeper into New Media to Find Young Buyers,” New York Times Online, October 31, 2006, http://www.nytimes.com/2006/10/31/business/media/31adco.html?_r=1&oref=slogin&fta=y&pagewanted=print (accessed January 30, 2009).
But some marketers get it. They understand that advertising is a key driver of popular culture in addition to just reflecting what is going on in our world. Think about Burger King, for example: How does a company that sells dead meat sandwiches and strips of deep-fried potatoes dig its way deep into popular consciousness and (dare we say it?) actually become cool? As CEO John Chidsey (who refers to himself as Chief Whopper Flipper) explains, “We want to stay on the cutting edge of pop culture.” How cool is it to sell more than three million Burger King–branded Xbox video games in two months? Or to get its creepy icon The King included in seventeen skits on Jay Leno in the same amount of time? How about having a highly visited profile on MySpace, or posting your menu as a video on YouTube (www.youtube.com/v/7-QFQOfkZ1k)?Quoted in Bruce Horovitz, “Burger King of Cool?” USA Today, February 6, 2007, http://www.usatoday.com/money/industries/food/2007-02-06- burger-king-usat_x.htm (accessed July 3, 2008). There’s something more than basic burger ads going on here.
Fifteen years ago, we defined advertising agencies by the essential tools they used: television commercials, radio spots, billboards, print ads. But today traditional advertising approaches, even in the hands of our most skilled and lauded practitioners, are no longer good enough.
Before we see how things are changing, let’s back up and start with a traditional definition: Advertising is nonpersonal communication from an identified sponsor that intends to inform, persuade, and/or remind. Now let’s break that down a bit so we understand what advertising is—and how it differs from other forms of marketing communication:
• Advertising is nonpersonal communication: The message gets delivered through one or more forms of paid mass media such as television or billboards.
• Advertising comes from an identified sponsor: Whether or not we pay attention to the message, we know who sent it.
• Advertising informs: Some messages try to make consumers aware of a product, service, or specific brand. You won’t choose a specific MP3 player until you know what it is and believe it’s better than listening to music on a CD player.
• Advertising persuades: Some messages try to change our opinion or motivate us to take action. You might decide to buy a Toyota Scion after you see a cool ad for it while you’re watching American Idol.
• Advertising reminds: Some messages try to encourage us to keep buying what we already like and use. “Got milk?”
Later we’ll talk about other kinds of marketing communication (such as sales promotions) and see how they differ from advertising. For now, suffice it to say that the lines are blurring and the tried and true is no longer so true. For example, while it’s mostly accurate to say that advertising comes from nonpersonal communications sources, today some companies recruit “brand ambassadors” who literally become walking billboards for their brands. They may get a tattoo of the company’s logo, or in some cases (we’re not making this up) name their children after a brand in exchange for some kind of payment. Or, consider the growing use of human directionals, which is what the advertising industry calls people who twirl signs outside restaurants, barbershops, and new real estate subdivisions. Southern California in particular has become a mecca for this new “sport” as locals cook up new moves to out-style their competitors. These include the Helicopter, in which a spinner does a backbend on one hand while he twirls a sign above his head. Then there’s the popular Spanking the Horse, where the human directional puts the advertising sign between his legs, slaps his own behind, and giddy-ups.Alana Semuels, “The Fine Art of Making a Point: ‘Human Directionals’—Those Guys Spinning Advertising Arrows—Can Cost \$60 an Hour. Some of Their Best Moves Are Filed in the Patent Office,” Los Angeles Times, May 1, 2007, www.Latimes.Com/Business/La-Fi-Spinners1may01,0,7358645 (accessed July 8, 2008).
In addition, it’s no longer necessarily crystal clear just who (if anyone) is the sponsor of a message. For example, we’ll learn later about some guerrilla marketing tactics that involve paid performers who impersonate everyday people and endorse products in public places. No, you’re not paranoid—they really are trying to fake you out. Finally, as we’ll see, the Web is in some ways taking the “mass” out of “mass media.” New technologies allow advertisers to customize messages so that (literally) each person who sees an ad actually gets a personalized communication that reflects his or her own unique interests and past purchases.
However, these innovative (and sort of scary) techniques remain in the minority of advertising efforts—at least for now. The reality is that most advertising agencies (and their clients) have been sleeping with their eyes open. According to an online survey of 184 marketers recently cited in the Wall Street Journal, “Less than 24 percent of those polled considered their companies ‘digitally savvy,’ citing several issues, including ‘lack of experience in new media’ and ‘dearth of digital talent.’”Suzanne Vranica, “Password to Marketers’ Meeting: Digital Survey Finds Spending Is Weak Despite Change in Consumer Behavior,” Wall Street Journal, October 11, 2007, B6. Still, the world of advertising is changing rapidly—and you’ll be in the forefront of that change.
What is happening to advertising?
Transformation. A melding of forms and disciplines. Evolution of species.
Despite conventional definitions and expectations, we need to understand that advertising isn’t just about ads. Messages that sell may not originate with marketers or agencies, but rather with you. Marketing messages may not be paid for by advertisers. They are multinational and multidimensional, providing any combination of information, identity, and entertainment.
They don’t stay in place. Today, most any place is ad space (maybe even your own forehead!). By emphasizing the visual and experiential, today’s advertising messages are difficult to analyze critically. By incorporating authentic experience and online collaboration, new marketing is very difficult to predict and control. An old Chinese curse says, “May you live in interesting times.” We do.
There is a fundamental change in the advertising vehicles themselves as media and technology converge. Traditional radio is losing share to digital options, online “television” viewing is increasingly popular, and marketers continue to divert print dollars to online budgets.“Traditional Radio’s Digital Competition Increases in Q4,” http://www.marketingcharts.com/radio/traditional-radios-digital- competition-increases-in-q4-2125 (accessed January 30, 2009). Once thought to be a specialized type of advertising, now interactive/online approaches often are a fundamental way to engage consumers—especially younger digital natives who have grown up on MySpace, IM, and YouTube. Yet in an article on how advertisers seek less intrusive, more measurable ways to deliver online messages, the Wall Street Journal reports, “Many sites and advertisers remain in the throes of experimentation, with mixed or disappointing results to date. Some say the industry hasn’t yet figured out how to make video ads as interactive and effective as they can be.”Kevin J. Delaney and Emily Steel, “Are Skins, Bugs or Tickers the Holy Grail of Web Advertising?” Wall Street Journal, August 13, 2007, B1.
Clients are similarly challenged. They no longer have the luxury of telling you only what they want you to know about their brand. Today, you can ask your neighbor or a Norwegian sitting in an Internet café while he’s vacationing in Majorca about that new bottled water you’ve been thinking about trying—all you need to do is type in a few well-chosen key words on your Google search bar and you’re off to the races.
It didn’t take long for some forward-thinking marketers to ask how they could use blogs for their own purposes. However, as recently as 2006 a poll showed just how far most Fortune 1000 executives have to go to catch up with the consumers with whom they hope to engage in dialogue. Only 30 percent said they understood the meaning of the term Internet blog, while 12 percent reported their companies had resorted to legal action to stop a blog that someone else had posted about their company!“Fortune 1000 Senior Executives’ Opinions Regarding Blogs and Their Company,” goliath.ecnext.com/coms2/gi_0199-6832426/Fortune- 1000-senior-executives-opinions.html (accessed July 3, 2008). The executives know there is a new tool out there. Most don’t understand or use it themselves. But their first instinct is that it must be reined in and controlled.
Like many marketers now, they battle twin fears: being late to the game and lacking the proper skills required to play. The danger is in choosing nontraditional routes uncritically because they have the cachet of being on the “bleeding edge.” According to Marc Schiller, chief executive of the digital-marketing shop Electric Artists, “There is always this pressure of saying we weren’t early enough on MySpace. We weren’t early enough on Facebook.…Suddenly there is this herd mentality and people are doing it because they feel like if they are not there, they are missing out.”Emily Steel, “Marketers Explore New Virtual Worlds. Some Create Own as Second Life Site Loses Some Luster,” Wall Street Journal, October 23, 2007, B9.
A word of caution: in a business like advertising that prides itself on cultural currency, there is always a temptation to choose interactive solutions solely because you can. Sometimes, however, the best answer to a marketing problem is as low-tech and simple as the vivid yellow LIVESTRONG bands on your friends’ wrists. But before we talk about where we’re going, let’s talk about where we’ve been.
It’s time to take a step back and first learn a bit about where advertising came from and how many organizations still do it today.
Some Quick Background and History
Advertising has been with us since the days of ancient Greece, when announcements were etched on stone tablets or shouted by town criers. While Pizza Hut painted its logo on a Russian rocket and delivered a pizza to the Mir Space Station, in reality many of the ad formats we see today haven’t fundamentally changed in hundreds of years.“Cosmonaut to Tee Up for Monster Orbital Golf Shot (Reuters),” NowPublic, November 18, 2006, www.nowpublic.com/cosmonaut_to_tee_up_ for_monster_orbital_golf_shot_reuters (accessed February 13, 2009).
Advertising in the United States began before we were even a nation. Colonial Americans saw ads on posters and in newspapers—the first newspaper ad was for real estate and appeared in 1704. For a comprehensive timeline covering the history of advertising, check out adage.com/century/timeline/index.html. The true rise of modern advertising, however, coincided with the Industrial Revolution for three reasons:
• Technologies enabled mass production of consumer goods, which meant that companies could grow to a larger size and make many more products efficiently. Next, they needed to find ways to sell these goods.
• Railroads linked the nation and provided a way to get newspapers and mass-produced products into towns across America. Quaker Oats—the first mass-marketed breakfast food—was introduced in 1878. Ivory Soap followed in 1879, and in 1888 Eastman began advertising the first hand-held Kodak cameras.
• The same technologies that enabled mass production accelerated the growth of mass media. The invention of the rotary press in 1859 and the process of making paper from wood pulp developed in 1866 enabled mass production of newspapers, which in turn provided the medium to distribute ads to more people.
Early examples of mass media include the New York Times, which published its first issue in 1851 (it was then called the New-York Daily Times). The New York Tribune doubled its advertising between October 1849 and October 1850. The magazines Harper’s Bazaar and Vanity Fair debuted in 1867 and 1868, respectively. By 1870, 5,091 newspapers were in circulation in the United States.
Capitalism also fueled advertising as it created a growing middle class that could afford to buy an array of consumer products. Soon the proliferation of mass-distributed consumer goods sparked the rise of the advertising profession. As competing manufacturers grew and more products were available on the market, the need to distinguish one’s products from the rest of the pack created a need for professional advertising agents, and advertising grew from an emerging to a legitimate profession. In 1890, the J. Walter Thompson Company (the oldest continuously operating advertising agency in the United States) had billings totaling over \$1 million (in those days, a million was still a lot of money!).
Types of Advertising/Promotion
Today, the realm of advertising has expanded vastly beyond newspapers—way beyond. Consider Target’s recent ads that entertained passersby at New York’s Grand Central Station. The retailer showcased its designer apparel in a spooky fashion show that repeated every ten minutes; it used holograms (two-dimensional moving images that give the illusion of having three dimensions) to project images of garments (sans models) prancing down a surreal runway.Ann Zimmerman, “Target Campaign Goes ‘Model-Less,’” Wall Street Journal, October 29, 2007, B4. Yes, we’ve come a long way from stone etchings.
In addition to holograms, take a look at all the media channels available to advertisers today.
Print Advertising
Print advertising includes national, regional, and local newspapers, as well as magazines, which, like newspapers, can be geographical or subject based. For example, Dog Fancy reaches dog lovers across the nation.
Direct Mail
Direct mail is advertising sent directly to people’s homes through postcards, brochures, letters, and catalogs. Sponsored e-mails are a new form of “direct mail.”
Specialty Print Media
Specialty print media include booklets, folders, and CD/DVD inserts developed to provide targeted groups with specialized information on products and services.
Broadcast Media
The broadcast media consist of television and radio.
We subdivide television (TV) according to major networks, independent stations, cable, broadband, and satellite.
Video Highlight
(click to see video)
Check out some of the best TV ads from 2008.
Radio, which was the first broadcast medium (bringing free advertising to American homes from the 1920s onward), can be local or network.
Outdoor Advertising
Also known as out-of-home advertising, outdoor advertising includes billboards on roadsides, and posters on transit (buses, subways, rail, airports, trucks, and taxis), at gas pumps, and on park benches.
Point of Purchase
Point-of-purchase (POP) displays refer to displays next to cash registers or elsewhere in retail environments—we often find them at the point at which people are ready to buy.
Online Advertising
Pop-ups, pop-unders, banners, and text ads associated with Web pages provide targeted online advertising on the Web.
Dig Deeper
U.S. consumers go to the Web 15 percent of the time they spend with all media. This online migration makes the Web where the action is for many advertisers. Most big, traditional companies were very cautious about marketing online, but now they’re cranking up their efforts as this media channel continues to gain legitimacy. According to John Galloway, vice president of sports, media, and interactive marketing at PepsiCo Inc.’s Pepsi-Cola North America unit, “Our job is to invest in where consumers are engaging with media.”
And online is where they’re going. For example, General Mills spends about double on online advertising what it laid out just one or two years ago, while Kraft reports similar numbers. Some media analysts believe the pattern of Web spending will mimic what they saw in earlier times with spending on broadcast and cable TV—both media benefited from huge growth once they reached a tipping point in terms of consumer adoption. This trend bodes well for companies like Yahoo! and Google that make their money from online search and advertising. But these consumer packaged goods (CPG) companies still have some catching up to do: in 2005, consumer packaged goods accounted for more than 11 percent of the \$145 billion in U.S. ad spending, but CPG companies spent just 1.6 percent of their ad dollars online on average, compared with an overall average of 5.8 percent of total ad spending for U.S. advertisers.Kevin J. Delaney, “Once-Wary Industry Giants Embrace Internet Advertising,” Wall Street Journal, April 17, 2006, A1.
Check out some online ads for packaged goods companies like General Mills and Kraft to see how they’re making this transition from traditional media. For example, you can find some nice recipes at Kraft’s http://www.kraft.com/switch-site.htm. What could the company do to increase the appeal of this site? If you wanted to appeal to consumers who spend a lot of time browsing online, what changes might you make?
Sales Promotions
Sales promotions build interest in or encourage purchase of a good or service during a specified period. These activities range from coupons that we receive in our newspapers to contests and sweepstakes to sales competitions a company might host for its own employees.
Specialty Advertising
Specialty advertising involves the distribution of merchandise (called promotional products, premiums, or swag) to promote awareness of a company. These include coffee mugs, pens, jackets, and many items that are usually imprinted with a company’s name, logo, or slogan and given away at trade shows or conferences or in mail campaigns.
User-Generated Content and Word of Mouth (WOM)
These days, many advertisers strive to get consumers to help get the word out about a product or service. The reason is simple: people trust the recommendations of others more than they trust paid advertising. Almost 90 percent of people say they trust recommendations from consumers compared to less than 50 percent who trust radio ads and less than 10 percent who say they trust online banner ads.Forrester Research Inc. and Intelliseek, www.nielsenbuzzmetrics.com/cgm. It’s fair to say that user-generated content is one of the biggest advertising and promotion stories of this decade.
Dig Deeper
How believable are advertisements that big companies sponsor? Is buzz truly more effective than a glitzy ad with a highly paid celebrity who tells you to use a company’s product or service? Find some cool print ads and show them to your friends. Ask them to talk about how effective they think the ads are and why they do or don’t make it more likely that they’ll actually buy the advertised brand.
Ad-Supported Content
Ad agencies are well aware that many consumers watch TV with their TiVo firmly in hand, ready to skip through their wonderful ads. People read fewer newspapers as well (especially college students!). Advertisers lose a lot of sleep worrying about how to get their clients’ brands noticed in this ad-hostile environment. This means moving away from traditional advertising and the model of adding prepackaged ads to precreated content.
Ad-supported content (content that advertisers explicitly create or modify to feature products or services) has grown exponentially in the early twenty-first century. The trend toward integrating advertising messages with program content continues to accelerate, and new variations appear all the time. For example, product placement refers to the insertion of real products in fictional movies, TV shows, books, and plays. Many types of products play starring (or at least supporting) roles in our culture; in 2007, for example, the most visible brands ranged from Coca-Cola and Nike apparel to the Chicago Bears football team and the Pussycat Dolls band.“Top 10 Product Placements in First Half of ’07,” Marketing Daily, September 26, 2007, http://www.mediapost.com (accessed September 26, 2007). This practice has become so commonplace and profitable now that it’s evolving into a new form of promotion we call branded entertainment, where advertisers showcase their products in longer-form narrative films instead of brief commercials. For example, SportsCenter on ESPN showed installments of “The Scout, presented by Craftsman at Sears,” a six-minute story about a washed-up baseball scout who discovers a stunningly talented stadium groundskeeper.Nat Ives, “Commercials Have Expanded into Short Films with the Story as the Focus rather than the Product,” New York Times on the Web, April 21, 2004, http://query.nytimes.com/gst/fullpage.html?res=9402E2DF163 AF932A15757C0A9629C8B63 (accessed February 13, 2009).
Is Traditional Advertising Dead?
We’ve seen that advertisers have many, many more weapons in their arsenal than they used to. With all of these exciting options available, it’s tempting to conclude that traditional methods like a TV commercial or a magazine space ad are history. Is traditional advertising dead?
Don’t write an obituary for traditional advertising—at least not yet. It’s true that fewer people may be watching TV, especially the major networks, but TV is still the medium that reaches the greatest number of people at the same time. That’s why advertisers continue to pay top dollar to make and air TV commercials. But the industry is shifting from the sell-and-tell mindset that traditionally prevailed in broadcast and print media. The new mindset engages people in a conversation. This perspective understands that advertising needs to show customers how a product will satisfy their needs—and do it better than the competition. Broadcast media builds awareness of a brand, but, as SS+K’s Rob Shepardson says, awareness is only “the first step of the process.” Advertising and promotion must now build the relationship, too. Understanding the components of this relationship is part of the marketing discipline. Let’s turn to that next.
Key Takaway
Advertising has been with us for thousands of years. As technologies develop and competition for consumers’ attention increases, advertisers need to keep alert to new media formats in addition to relying on the traditional platforms they’ve used for many years.
EXERCISES
1. Describe the differences between advertising and other forms of marketing communication.
2. Explain how guerrilla marketing can be used to bring advertising to the “street.”
3. It is said that the true rise of advertising coincided with the Industrial Revolution for three reasons. Briefly list and comment on those reasons.
4. Characterize print advertising, broadcast television (TV), radio, and online advertising. Be sure to cite characteristics that distinguish the four terms. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/02%3A_A_User's_Manual-_Advertising_Promotion_and_Marketing_Essentials/2.01%3A_Chapter_Introduction.txt |
learning objective
After studying this section, students should be able to do the following:
1. Describe the four cornerstones of marketing (e.g., the Four Ps—product, price, place, and promotion).
Marketing: Typically when people hear the word marketing they think it means either advertising or selling. Others even think of it in a very negative way, as in, “That’s not really true. It’s just marketing.” In reality, marketing relates to both advertising and selling, but it’s not the same thing as either term. And let’s hope the second perspective isn’t true!
According to the American Marketing Association, “Marketing is the activity, set of institutions, and processes for creating, communicating, delivering and exchanging offerings that have value for customers, clients, partners, and society at large.”MarketingPower.com, “Marketing Definitions,” www.marketingpower.com/content4620.php (accessed April 17, 2008). That’s a pretty long-winded definition—but when you boil it down, it basically means that marketing is about all parties to a transaction walking away with something of value. Thus, marketers ideally try to satisfy everyone involved in the process, including those who make a product or promote an idea, those who advertise it, and those who purchase it or endorse it.
And the process is in many ways the same regardless of what the transaction is about—whether it’s a can of peas, a reggae concert, a blood drive, or a political campaign. In each case marketing is about satisfying needs. A need is the difference between a consumer’s actual state and some ideal or desired state. For example, if you drive a junky old car but you crave a hot ride, you have a need. If you know that a poor child in a third world country goes without proper food and you believe she should have access to healthy meals, you also have a need.
Most successful organizations today practice the marketing concept; marketers first identify customers’ needs and then provide products or services that satisfy those needs. A product delivers a benefit when it satisfies a need. It probably won’t surprise you to learn that a lot of advertising tries to show consumers just how a product, service, or idea will do a good job of satisfying a need as it informs, persuades, or reminds.
Advertising is one important element in the marketer’s strategic toolbox. We call this toolbox the marketing mix, which consists of the tools the organization uses to create a desired response among a set of predefined consumers. These tools include the product itself, the price of the product, the promotional activities that introduce it to consumers, and the places where it is available. We commonly refer to the elements of the marketing mix as the Four Ps: product, place, price, and promotion. The word mix reminds us that no single marketing activity is sufficient to accomplish the organization’s objectives; the key is to blend these together to create the desired impact. Let’s take a closer look at each of these four basic tools.
Product
Product, broadly defined, is a good, service, or idea. Sometimes the “product” can even be a person, such as a political candidate. SS+K’s work for (now President) Barack Obama certainly illustrates that idea. A product may consist of a single item, such as a printer, or a portfolio of interrelated items such as a package that includes a printer, specialized software, and online photo-sharing services.
It’s important to remember that the product you sell is a lot more than the physical item the company manufactures. We also have to think about augmented products; aspects of the product or service that help the consumer to use the core product. These augmented products include components like a warranty for a vacuum cleaner, the soft drinks an airline serves, and the instructions (maybe even written in English) that come with your new camera.
Packaging is a very important augmented product; in addition to the value it provides in terms of storing a product and allowing it to be transported safely, packaging fulfills the important role of making a product visually distinctive to customers. “Consumers are looking for what’s new,” said Kimberly Drosos, director for package development at Unilever North America. “They say, ‘What else do you have for me? That was nice last year, but I want the packaging to be refreshing.’” Unilever’s innovative packaging includes Axe shower gel bottles shaped like video-game joysticks.
Place
Place refers to where you offer your product for sale, whether it’s at your local grocery store, at a big discounter like Wal-Mart, or at a vending machine in your dorm. A key to successful marketing is to make your offering available at a time and location that are desirable to the customer.
Every product requires a channel of distribution—a series of firms or individuals that facilitate the movement of the product from the producer to the final consumer. At minimum, a channel of distribution consists of a producer and the customer. This short producer-to-consumer channel is called a direct channel because the consumer buys directly from the producer. For example, if you buy a peach from a local farmer, you’re using a direct channel. Similarly, when you buy a shirt from the Eddie Bauer catalog or Web site, you’re buying direct.
An indirect channel, by contrast, includes one or more intermediaries—such as wholesalers, agents, brokers, or retailers—who help move the product from the manufacturer to the consumer. For example, a farmer in New Zealand may sell apples to a wholesaler, who in turn sells the apples to several supermarkets in North America. In this case, each supermarket acts as a retailer—the last point in the distribution chain, which sells to the final customer.
SS+K Spotlight
Today, news is ubiquitous, and most people’s preferred mode of delivery no longer includes a bicycle and a strong throwing arm. On services like msnbc.com, the latest headlines greet us when we flip up our cell phones or pop open our laptops. It’s easy and fast to find coverage of the same story from a variety of sources and to tailor news supply from providers for the types of information we want to see. There are thousands of choices among online news sources, with hard copy newspapers competing against the online versions of themselves and losing. Additionally, aggregators further commodify online news information, lumping together “name brand” news and less pedigreed sources by topic. There is an increasingly thin layer of audience spread across the rapidly proliferating URLs of major and start-up news providers.
Follow Up: “Creative Destruction: An Exploratory Look at News on the Internet,” http://www.ksg.harvard.edu/presspol/carnegie_knight/creative_destruction_web.pdf.
Price
Price is the amount that the consumer pays to acquire a product (but you knew that). Setting a price for a product involves a number of considerations. For example, the seller must decide upon a basis for pricing. Products may be priced by the unit (a single TV or computer), by volume (gasoline), by time of use (monthly cable TV or Internet service), by amount of use (utilities or cell phone minutes), or by performance (overnight versus two-day package delivery).
In addition to the list price, producers may offer discounts and allowances to its channel partners—the firms or individuals in its channel of distribution. The producer may offer each channel partner a different price if they buy in different quantities or if the deal includes cooperative advertising, where two or more channel partners agree to pitch in to promote a product. For example, a candy company and a grocery store might agree to share the cost of a Halloween newspaper circular that includes an advertisement featuring party ideas and coupons for trick-or-treaters.
For very expensive items, price may also include a payment period and credit terms. This allows consumers to purchase products, such as new cars, that they otherwise would be unable to afford. In some cases, a seller may offer credit incentives to encourage consumers to buy big-ticket items. For example, furniture stores frequently offer customers up to ninety days of free credit (zero percent financing) when they make large purchases such as a sofa or bedroom suite.
Promotion
Last but definitely not least, the final P is for promotion, which refers to all the activities that inform and encourage consumers to buy a given product. This includes print and broadcast ads, coupons, billboards, personal sales, and online sales. This P is so important that, believe it or not, entire textbooks have been written about it. By the way, you’re reading one now (but you knew that too).
We call a promotional effort aimed at the final customer a promotional pull strategy. The goal is to convince the customers that they want a product, in order to create a “pull” demand in which the customer goes to a store and asks for the product by name. Stores that do not already carry the product may be motivated to carry it in order to satisfy customer demand. So, in this case the customer “pulls” the product through the channel.
Promotion can be targeted at distributors as well as customers. Manufacturers often develop programs designed to motivate channel members to stock certain products. Such a program is called a promotional push strategy. For example, a software manufacturer like TurboTax may propose a cooperative ad campaign with a software retailer such as Office Max, sharing the cost of an ad that says “Buy your TurboTax at Office Max.” Alternately, TurboTax may offer retailers introductory discounts on TurboTax products to encourage them to promote or prominently display TurboTax products in their stores. If TurboTax advertises these discounts in trade publications that office products store managers read, we call that trade advertising. In this case the manufacturer tries to “push” its products through the channel down to the end consumer. Promotional push strategies are often less expensive than pull strategies, so a firm with a smaller promotional budget will likely pursue a push strategy.
“To P or Not to P”: How One P Affects Another
Marketers look not only at each of the four Ps individually, but also at the interaction of product, price, promotion, and place. They fine-tune and adjust each to meet the needs of the market and create the best outcome for the company. For example, a seller may lower the price of a product during a promotional event. Likewise, holding a special promotional event may affect place because the seller must supply stores with enough products to meet the demand that the promotion will stimulate. Finally, the promotion might affect the product’s packaging, such as bundling a shampoo with a free sample of conditioner.
Dig Deeper
A new experiment Microsoft Corporation is running illustrates how different elements of the marketing mix can work together. The company is testing a grocery cart–mounted console that helps shoppers find products in the store, then scan and pay for their items without waiting in the checkout line. As they shop, consumers will see video ads playing on these cart screens. But it gets better: Before they leave home, customers with a ShopRite loyalty card log into a Web site and type in their grocery lists. They go to the store and swipe their card on the cart, and the list appears. As they scan their purchases and put them in their cart, they get a running price tally, and their shopping list automatically checks off these items. The system also can sense where the cart is in the store so it can send ads to shoppers just when they wheel by certain key areas—for example, the cart might offer a discount on Lay’s potato chips at the exact moment they walk by the potato chip section.Jessica Mintz, “Cart Console Finds Grocery Items for You,” USA Today, www.usatoday.com/tech/news/techinnovations/2008-01-14-microsoft-shopping-carts_N.htm (accessed February 13, 2009). Price, product, promotion, and place—all in play.
Key Takaway
The marketing process attempts to create value for all parties involved to satisfy everyone’s needs. Marketers use the marketing mix of product, price, place, and promotion to do this.
EXERCISES
1. Demonstrate the differences between a “need” and a “benefit.” How are these concepts used to build the marketing concept?
2. Discuss and characterize the four elements of the marketing mix. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/02%3A_A_User's_Manual-_Advertising_Promotion_and_Marketing_Essentials/2.03%3A_The_Four_Cornerstones_of_Marketing-_The_Four_Ps.txt |
LEARNING OBJECTIVES
After studying this chapter, students should be able to do the following:
1. Identify three types of advertising agencies and discuss when each type of advertising agency might be appropriate for an advertising client.
2. Explain the structure of advertising agency compensation methods.
3. Classify the various types of clients with which advertising agencies might interact.
4. Review the advertising careers mentioned and personally rate the careers.
Types of Agencies
There are several different types of advertising agencies. Each type has its advantages and disadvantages, depending on the client’s needs and budget and the marketing problem the client is aiming to solve.
Full-Service Agencies
Full-service agencies provide clients with all the services they need for the entire advertising function. This includes planning, creating, producing, and placing the ads, as well as research before the campaign and evaluation after it to assess the campaign’s effectiveness. Full-service agencies have expanded in recent years through consolidation—larger agencies buy them when they want to provide a one-stop shop for their global clients. In the process, the types of services that agencies provide has expanded to include PR, design, and event planning.
Specialized and In-House Service Agencies
Some agencies focus on one aspect of the creative process, such as creative production work or media buying. They refer to themselves as specialized agencies. Some examples will include a company that specializes in media planning and buying, such as The Media Kitchen or Greater Than One. Interactive agencies like BEAM, gaming agencies such as Fuel Games, and search agencies such as 360i will partner up with other agencies to provide services for the full campaign as determined by the client or the lead agency. These agency partners all contributed to the msnbc.com campaign led by SS+K.
Some companies prefer to retain control over advertising and set up in-house agencies within the corporation. An advertising director typically runs the in-house agency; she chooses which services to buy and which to perform internally. For example, the in-house agency could retain creative services in house, create advertisements itself, and then purchase media-buying services from the outside. The inside agency may buy services from a specialized service agency or buy services à la carte from a full service agency.
Why bother to form an in-house agency? The two main reasons are to save the company money and to give the company greater control over the entire process. In addition, internal employees may have a deeper understanding of the company and its customers than would an outside agency. Insiders can also coordinate the promotion better with the firm’s overall marketing program and other functions, such as ensuring that enough products are made and delivered in advance of a promotion. Target works with their in-house agency as well as with outside agencies. They do not have an outside agency of record.
Agencies also clarify their specializations in terms of location; SS+K, for example, is a U.S. agency. Some agencies are considered global agencies, such as JWT, TBWA, BBDO, and others. These agencies have offices worldwide and specialize in clients whose audiences are worldwide, such as MasterCard (McCann Worldwide is the agency).
There are a few holding companies that own a number of agencies to create a network of agencies that can work together in the network. Omnicom Group, WPP, Interpublic Group, MDC Partners are the biggest media holding companies.
Agency of Record
In addition to the types of agencies, there is also the role that the agency plays in the client’s business. The most common and secure relationship is the agency of record, or lead agency. As clients may work with many different agencies for their various needs, the agency of record is the lead agency partner and usually has the majority of the client’s business. SS+K is the agency of record for msnbc.com.
Dig Deeper
The traditional approach to farm out different functions may change if some big clients get their way. Johnson & Johnson and Dell are but two of several major advertisers that are dissatisfied with this strategy. More specifically, they join Procter & Gamble and others to call for more collaboration between the people who do the consumer research and the people who actually create the ads. In most cases, separate companies carry out communications planning and creative functions, so coordination can be difficult, and self-serving biases may color some decisions. For example, an advertising agency might be tempted to suggest a network television campaign because it would be involved in creating the ads (and billing more in the process). Instead, advertisers prefer a media-agnostic approach, where the agency picks whatever medium works best for a specific campaign. We saw earlier that SS+K strongly endorses this philosophy.
P&G reacted to this problem when it shifted all its ad and marketing duties for its Oral B brand to a newly created team at Publicis Groupe that will not work on any other brands. As P&G’s global marketing officer explained, “We find many of our brands are working with lots of agencies who all have their own creative people, their own planners, their own account people, and it gets to be unmanageable.” Only time will tell if other advertisers follow P&G’s lead.Suzanne Vranica, “Ad Houses Will Need to Be More Nimble: Clients are Demanding More and Better Use of Consumer Data, Web,” Wall Street Journal, January 2, 2008, B3; Suzanne Vranica, “J&J Joins Critics of Agency Structure: Consumer Researchers and Creative Teams Shouldn’t Be Separate,” Wall Street Journal, May 11, 2007, B4.
How Do We Get Paid?
Historically, an agency receives a commission or percentage of the cost of the media it buys for the client. Traditionally, mass media has paid advertising agencies a 15 percent commission on all business brought to them. The commission covers the agency’s copywriting, art direction, and account service charges. Today, this compensation model makes less sense because many advertising services no longer include a traditional media buy.
The straight 15 percent commission is still used in some cases, but some agencies charge less than 15 percent, or have sliding scales based on how much the client spends (the more money spent, the lower the percentage fee). Some agencies offer flat-fee arrangements that clients and the agency agree upon, while others charge on an hourly basis. Others will do a combination of a flat base fee plus smaller percentages per media. Interactive media currently charges the highest commission because it requires the most management time from agency personnel.
Other innovative models include licensing fees or royalties for ideas. Some even use performance fees, in which the agency’s fee depends on the success of the campaign. The client and the agency define what they mean by “success” at the start; they might measure this by looking at how well consumers recall the ads or might measure actual product sales. Agencies using performance-based models can earn much more—or much less—than the standard 15 percent commission. The rationale, however, is that the compensation would be tied to the value of the ideas. As we’ll see later, the question of just how—and whether—we should quantify the effect of advertising is one of the burning issues the industry faces.
Types of Clients
We group clients into three main categories:
1. Manufacturers and service providers (like Boeing and Bank of America)
2. Trade resellers (namely, retailers like Best Buy or Starbucks, as well as wholesalers and distributors)
3. Government and social organizations (such as local, state, or federal governments and their specialized offices like tourism boards; and social organizations from national groups like the United Way or local hiking clubs)
Account Managers
Account managers (with titles like account executive, account supervisor, or account manager) work with clients to identify the benefits a brand offers, to whom it should focus its messages (the target audience), and the best competitive position. They then develop the complete promotion plan.
Account Planners
On the market research side, account planners from the agency work with clients to obtain or conduct research that will help clients understand their markets and audiences.
Creative Services Staff
Creative services staff (such as an art director or copywriter) work with clients to develop the concepts and messages that will catch consumers’ interest and attention.
Media Buyers
Media buyers and media planners evaluate the multitude of options available for ad placement—now greatly expanded by the Internet. They decide how best to allocate the client’s budget to use the best media to most effectively reach the target audience.
Job Functions Sometimes outside the Agency
A variety of ancillary companies support ad agencies by providing specialized services.
Art Studios and Design Firms
Art studios and design firms create a company’s logo, stationery, business cards, and packaging design for products.
Film/Video Companies
Film/video companies produce film and video for TV and the Web, including infomercials.
Web Designers
Web designers create Internet media for advertising.
Printers
Printers produce printed material for a variety of media channels.
Sales Promotion Agencies
Sales promotion agencies handle price discounts, sampling, rebates, premiums, trade shows, in-store merchandising, and point-of-purchase displays.
Research Companies
Research companies assess channel viewership, ad response, consumer attitudes, and trends.
Careers in Advertising
If you’re interested in advertising, you can work at an ad agency, at an advertising client (manufacturer, trade reseller or service firm), or in the media. Jobs in ad agencies (including in-house agencies) typically fall into four main categories:
Account Services
Account managers act as the client’s representative at the agency, getting the best work from the agency for the client while still generating a profit for the agency. Account managers must be good at working with people and acting as leaders or strategists to communicate the client’s needs to the agency team. The best account managers learn as much as they can about the client’s business. The career ladder of position titles in account services is assistant account executive, account executive, senior account executive, and accounts supervior or accounts manager.
Creative Services
The creative department generates the ideas, images, and words of the advertising message. Art directors (assistant art director, junior art directors, art directors, senior art directors) develop the artistic strategy of the creative campaign, often presenting several concepts for the client to choose among. Copywriters (junior copywriter, copywriter, senior copywriter, copy chief) are responsible for developing the words of the campaign. Production staff (layout workers, graphic artists, production managers) select photos, choose the print size and type, and oversee the actual printing, filming, or audio recording of the campaign.
Media Services
Media planners gather information about people’s viewing or reading habits and combine it with information about specific media vehicles (such as a specific magazine’s target audience, circulation size, and advertising space costs) in order to find the best placement for the advertising. They use their judgment to balance reaching the greatest number of people in the target group versus keeping the client’s costs to a minimum. Media buyers purchase the advertising space and negotiate prices. They must be good with numbers but also skilled negotiators—they’ll be working with budgets and responsible for spending their client’s money wisely.
Market Research
Market researchers learn all they can about the target customer—their wants, desires, fears, and goals. They use focus groups and one-on-one interviews, test reactions to campaigns, and purchase secondary information (such as the total market size in a given location). Job titles include public opinion researcher, research supervisor, project director, associate research director, research director, and executive research director.
Media Jobs
Advertising jobs in the media include the advertising director, who heads the advertising sales department and oversees advertising rate policies, promotion, and the sales staff, including sales planners and sales reps.
Corporate Advertising
Within a company, the jobs of the advertising department typically parallel those in ad agencies, but there is an additional category: brand manager. Brand managers are responsible for all the advertising and marketing for their product or brand. This includes the marketing strategy, business planning, and market research associated with the brand. The brand manager works closely with account services and creative staff to develop and implement campaigns best suited for that brand. Brand managers oversee the selection and work of any outside ad agencies used by the corporation.
SS+K Spotlight
SS+K needs to have a formal management structure, and this is what it looks like. However, the agency doesn’t tend to pay much attention to formalities, so these little boxes aren’t as solid as they look.…
Key Takaway
The advertising industry is complex, and many different types of skills are required to create a successful ad campaign. Career possibilities abound for people who are artistic, good at writing, analytical, and creative.
EXERCISES
1. What type of advertising agency would a marketer be most likely to choose if that marketer wanted to introduce a new product on a nationwide scale? Explain your rationale.
2. Briefly explain how advertising agencies link to clients. In your explanation, focus on the management and planning staff found in agencies. Be specific with your terms.
3. Pick one of the careers mentioned in the chapter and describe how you could get more information on the career, find potential employers, and secure an interview. Be creative in your response. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/02%3A_A_User's_Manual-_Advertising_Promotion_and_Marketing_Essentials/2.04%3A_Advertising_Industry_Structure.txt |
Tie it All Together
Now that you have read this chapter, you should be able to understand the advertising, promotion, and marketing essentials necessary to win the msnbc.com account:
• You can define the term advertising.
• You can differentiate advertising from other marketing communication forms.
• You have reviewed the colorful history and background of advertising.
• You can classify the various types of advertising and promotion in use today.
• You can identify the four cornerstones of marketing (e.g., the Four Ps).
• You can recall how the advertising industry is structured and recognize the different types of advertising agencies found in today’s marketplace.
• You can describe how agencies have been compensated historically and in present times.
• You can indicate the type of clients that are available to advertisers and their agencies.
• You can list the different careers in advertising available to students and professionals.
USE WHAT YOU’VE LEARNED
1. If you were to build the perfect laptop computer, how would you design it? This is the very question faced by any company that wishes to compete in today’s highly competitive laptop computer market. Two heavyweight competitors, Lenovo and Apple, are betting that their products will win the market share race in the laptop market. Lenovo has the superthin ThinkPad X300 positioned against Apple’s MacBook Air. Comparison tables show that each of these highly desirable products has very similar features and characteristics with a slight positive edge going to the ThinkPad X300. Prices are also similar. Considering the facts you have been given and the types of advertising and promotion discussed in this chapter, recommend the forms of advertising and promotion that Lenovo should use to exploit its slight advantage over Apple’s product. Be sure to consider whom you would address with your message and the best way to reach them as you write your recommendation.
2. Let’s assume that you and a few close friends have just invented a new video game that has all the people you know raving about it. It’s a spin-off from the wildly popular Guitar Hero concept where the music player can become a keyboardist (keyboard sold with game unit), bass player, or drummer (complete with drumsticks and simulated drumhead pad). Given what you know about the video game market and buying video games, take a position and defend it with respect to whether it would be better for your company and partners to pursue a promotional push or promotional pull communication strategy to present your “Rock Man” to the video game market. Explain and support your position.
DIGITAL NATIVES
Most consumers are familiar with the term advertising agency; however, most would be hard pressed to explain exactly what an advertising agency does or even name some of the most prominent agencies. Surprisingly, most advertising agencies do not toot their own horns to the general public. The exact opposite is true with respect to courting potential clients. Advertising agencies are extremely competitive with one another and have different ways of communicating their messages to prospective clients. Today, a solid Web presence is a necessity for any advertising agency. Some take the familiar “listing of services” approach and others take a more creative approach.
Go to the JWT (formerly the J. Walter Thompson advertising agency) Web site (http://www.jwt.com) and compare its client contact and promotion approach with that of the Texas-based Stevens FKM public relations and advertising agency (http://www.stevensfkm.com). Can you tell which (if either) agency would be characterized as a full-service agency? Explain. If you were a prospective client, which agency’s Web approach would you prefer? Explain your thoughts and rationale for your preference.
AD-VICE
1. Based on your review of the two SS+K organizational charts presented in the final SS+K Spotlight in the chapter, compare the organizational structure to the work structure. List and explain any perceived advantages or disadvantages of the two structures.
2. Based on information supplied by your review of the chapter and any outside research you may have conducted, take one of the two following positions and write a three-paragraph defense of your position. Position #1—Traditional media (such as radio, newspapers, and television) are adapting sufficiently to the “wired world” and will most likely retain their strength as the primary choice for advertising dollars. Position #2—Internet advertising and other maverick forms of promotion (such as viral and guerrilla marketing) are now the media of choice and will most likely continue to push traditional media into the background in market share competition.
3. Pick any two products or services to illustrate a direct and indirect channel of distribution. In each instance explain the advantages and disadvantages of the channel configuration.
4. Our marketing world is filled with product placements. Explain what a product placement is, how it can be used by marketers and advertisers, and what you believe to be the likelihood of success for this form of marketing. Use a real product placement example to illustrate your discoveries and research.
ETHICAL DILEMMA
Traditionally, the mass media has paid advertising agencies a 15 percent commission on all business brought to them. The advertising agency also represents a client and may receive fees from that client. Since the advertising agency receives a commission on the amount billed from a client from the mass media, some believe that a conflict of interest exists—two masters are being served. While the advertising agency is supposedly cutting the best deal they can with the mass media for their client in terms of media prices, they may also be receiving commissions based on billing where more money is made by the advertising agency as billing revenues for the agency and mass media increase.
After considering the ethics of this situation, take a position on the practice and make comments. Remember to try to see the issue from the viewpoint of all parties—the mass media, the client, and the advertising agency. Be prepared to discuss your thoughts and position. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/02%3A_A_User's_Manual-_Advertising_Promotion_and_Marketing_Essentials/2.05%3A_Exercises.txt |
Advertising is part of the glue that holds our culture together. It allows us to share a common experience in a landscape populated (for better or worse) by brands, images, logos, and even silly jingles. We define who we are by what we buy and wear because we know that others judge us by what we buy and wear. And advertising influences those judgments. “We understand each other not by sharing religion, politics, or ideas. We share branded things. We speak the Esperanto of advertising, luxe populi,” says advertising professor and commercial culture observer James Twitchell.James Twitchell, Living It Up: Our Love Affair with Materialism (New York: Simon & Schuster, 2002), xv.
Advertising is a sort of “commercialized gossip,” a collection of stories that companies tell customers about their products in order to make them distinguishable from one another. Some brands do such a good job of holding our attention that they become cultural icons in their own right—Apple, Nike, even the lowly Charmin (where would we be without Mr. Whipple?), and the Keebler Elves. And in collectively listening to the commercialized gossip and buying the associated products, consumers align themselves with the images and stories, knowing that other consumers will know those same stories.
The cultural dimension of advertising came of age in the 1920s. Agencies and publicists no longer sought merely to convey objective facts about the products—they sought to link products with a particular lifestyle, imbue them with glamour and prestige, and persuade potential consumers that purchasing an item could be, as historian Alan Brinkley describes it, “a personally fulfilling and enriching experience.”Alan Brinkley, American History: A Survey (New York: McGraw-Hill, 1991), 648. The images of ads sought to both resonate with and help define the lifestyles of those who bought the products.
People seek to differentiate themselves, so much so that a particular kind of advertising—called dog whistle advertising—targets a group with messages only that group can hear and appreciate. Like an inside joke, these ads reinforce a sense of belonging to the group and show that the advertised company “gets it” too. For example, Apple’s “Rip, Mix, Burn” campaign, which targeted young computer users with a message of ease-of-use of its iTunes music software, alluded to the prevailing (and illegal) practice of music sharing among that group.
Video Highlight
Rip, Mix, Burn
(click to see video)
This commercial for iTunes speaks directly to the target audience with words only they understand.
In many ways—for better or for worse—modern advertising may be the most significant U.S. contribution to global culture. Sociologist Andrew Hacker calls advertising “this country’s most characteristic institution.”Quoted in Stephen Fox, The Mirror Makers: A History of American Advertising and Its Creators (Champaign: University of Illinois Press, 1997), cover quote. But, to say the least, this contribution is not without controversy. Critics claim that ads manipulate the public into wasting money on unneeded products. Some say advertising has corrupted holidays like Christmas and Thanksgiving, making the season a time of materialism rather than a deeper celebration of thankfulness. There’s even a common rumor that Coca-Cola invented the modern-day Santa Claus (http://www.snopes.com/cokelore/santa.asp). Others just want to hide from the commercial messages that bombard them at every turn and enjoy some peace and quiet. Let’s take an objective look at advertising, warts and all. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/03%3A_Advertising_and_Society/3.01%3A_Chapter_Introduction.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Recognize the key role advertising plays in our economy.
2. Discuss the economic rationale for creating, accepting, and using advertising.
Advertising Is a Major Industry
Advertising supports the core principles that shaped our nation: free speech, competition, and democracy. Since colonial times, advertising has provided a source of vital information about our open, market-based economy. Two Nobel Laureates in economics, Dr. Kenneth Arrow and the late Dr. George Stigler, praise the value of advertising: “Advertising is a powerful tool of competition. It provides valuable information about products and services in an efficient and cost-effective manner. In this way, advertising helps the economy to function smoothly—it keeps prices low and facilitates the entry of new products and new firms into the market.”Kenneth Arrow and George Stigler, paper for the Advertising Tax Coalition, quoted in House Subcommittee on Select Revenue Measures of the Committee on Ways and Means, Miscellaneous revenue issues: hearings before the Subcommittee on Select Revenue Measures of the Committee on Ways and Means, 103rd Cong., 1st sess., 1994, http://www.archive.org/stream/miscellaneousrev02unit/miscellaneous rev02unit_djvu.txt (accessed February 4, 2009).
U.S. advertising accounts for about 2.5 percent of the country’s \$14 trillion gross national product. American consumers rely heavily on advertising to influence how they spend some \$9 trillion annually on various goods and services. A 1999 study by one of the country’s premier econometric modeling firms, the WEFA Group, and Nobel Laureate in economics Dr. Lawrence R. Klein further underscored this economic impact. The study found that advertising played a key role in generating 18.2 million of the 126.7 million jobs in the United States in that year. The report further concluded that advertising expenditures contributed between 12 and 16 percent of private sector revenues throughout the country, in rural as well as urban areas.
A later study, conducted in 2005 by the financial analysis firm Global Insight, demonstrated that advertising helps to generate more than \$5.2 trillion in sales and economic activity throughout the U.S. economy annually. That represents 20 percent of the nation’s \$25.5 trillion in total economic activity. This economic stimulus provided support throughout the economy for more than twenty-one million jobs, or 15.2 percent of the U.S. workforce. The purpose of the study was to quantify the economic and employment impacts of advertising. The study removed intervening effects (like consumers simply buying a product to replace an old one or a depleted one) to measure the role of advertising itself.
Advertising plays a strong role in the economy:
• It provides useful information to consumers that tells them about product and service choices, as well as comparing features, benefits, and prices. With more complete information, consumers and businesses often choose to purchase additional products and services.
• It “causes an economic chain reaction that (a) generates a net gain in direct sales and jobs due to the promotion of the industries’ products and services, (b) generates indirect sales and jobs among the first level suppliers to the industries that incur the advertising expenditures, and (c) generates indirect sales and jobs among all other levels of economic activity as the sales ripple throughout the economy.”Global Insight, “The Comprehensive Economic Impact of Advertising Expenditures in the United States,” www.naa.org/Resources/Articles/Public-Policy-The- Comprehensive-Economic-Impact-of-Advertising-Expenditures-in-the-United-States/Public-Policy-The-Comprehensive-Economic-Impact-of-Advertising-Expenditures- in-the-United-States.aspx (accessed November 1, 2007).
Advertising also plays a significant role in the business cycle. As the broader economy shifts between periods of growth and recession, advertising shifts its focus. During downturns, like the one we’re in now, ads may focus on the price of a product or service. If one company curtails advertising in order to cut costs during a downturn, another company might boost ad spending to grab customers and grow its market share. Advertising helps stimulate economic growth. In a country in which consumer spending determines the future of the economy, advertising motivates people to spend more. By encouraging more buying, advertising promotes both job growth and productivity growth both to help meet increased demand and to enable each consumer to have more to spend.
Economic Rationale to Create Advertising
Companies spend money on advertising because it increases sales of existing products, helps grow adoption of new products, builds brand loyalty, and takes sales away from competitors. Although the exact return on investment (ROI) varies tremendously across industries, companies, campaigns, and media channels, studies have found that a dollar spent on advertising returns \$3–20 in additional sales. To compete and grow in today’s diverse, ever-changing marketplace, businesses must reach their target customers efficiently, quickly alerting them to new product introductions, improved product designs, and competitive price points. Advertising is by far the most efficient way to communicate such information.
Economic Rationale to Accept Advertising
The economics of advertising extends to the media channels that depend on advertising revenues. Many forms of advertising support the creation of content and make that content available at a much lower price (or free). For example, roughly 75 percent of the cost of a newspaper is supported by advertising. If newspapers contained no advertising, they would cost four times as much to buy on the newsstand. Broadcast radio and TV rely exclusively on ads—people get news, music, and entertainment for free while advertisers get an audience. Forms of media that the public takes for granted would be extremely expensive to the reader or viewer or would simply be out of business without the revenues advertising produces. The demand created by advertising helps the economy to expand.S. William Pattis, Careers in Advertising (Blacklick, OH: McGraw-Hill Professional, 2004), 9.
Advertising supports the arts. Advertisers need music that calls attention to the brand. Musical artists visit ad agencies to meet with directors of music and pitch songs to them that they can use in ads. They come to agencies because they know that companies spend tens of millions of dollars on media buys. “The major record labels don’t have that kind of money,” says Josh Rabinowitz, senior vice president and director of music at Grey Worldwide. What’s more, “TV ads give you the kind of heavy rotation you can’t get on MTV anymore. In the very near future, some of the best bands will produce jingles.”Cora Daniels, “Adman Jangles for a Hit Jingle,” Fast Company, July 2007, http://www.fastcompany.com/magazine/117/fast-talk-rabinowitz.html (accessed February 4, 2009).
Video Highlight
(click to see video)
Yael Naim became an overnight sensation when her song “New Soul” was used in this MacBook Air commercial.
For example, Jonny Dubowsky, lead singer and guitarist for Jonny Lives! uses corporate sponsorships to get exposure for his indie band. The band debuted a single on an EA video game and launched a video at nine hundred American Eagle stores.Cora Daniels, “Band Plays a Brand-New Game,” Fast Company, July 2007, http://www.fastcompany.com/magazine/117/fast-talk-dubowsky.html (accessed February 4, 2009). For those with (slightly) different musical tastes, it’s worth noting that “rock star” Barry Manilow wrote advertising jingles before he crossed over to recording songs. His credits include the Band-Aid song (“I am stuck on Band-Aid, cuz Band-Aid’s stuck on me”) and the theme for State Farm insurance (“And like a good neighbor, State Farm is there”).AllExperts, “Manilow, Barry,” en.allexperts.com/q/Manilow-Barry-511/Manilow-TV-jingles.htm (accessed July 17, 2008).
Economic Rationale to Use Advertising
The perspective called the economics of information shows how consumers benefit from viewing advertising. By providing information, advertising reduces consumers’ search costs (time spent looking for products) and reduces disutility (unhappiness or lost value) from picking the wrong products. Advertising performs the following functions:
• Describing new products and what they do
• Alerting consumers to product availability and purchase locations
• Showing consumers what to look for on store shelves
• Helping them differentiate among competitive choices
• Advising them of pricing information and promotional opportunities
• Saving consumers money by encouraging competition that exerts downward pricing pressures
Key Takaway
Advertising is a major industry. It contributes to the economy directly (via the jobs it creates to produce ad messages) but also indirectly as it stimulates demand and provides information about other products and services.
EXERCISES
1. Advertising is “the glue that holds our culture together.” Evaluate this statement and decide whether you are in agreement with it or not. State and defend your position.
2. Describe the economic rationale for creating, accepting, and using advertising.
3. List and describe the six information subjects relevant to consumers that advertising addresses. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/03%3A_Advertising_and_Society/3.02%3A_Economic_Effects_of_Advertising.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Describe the prosocial aspect of advertising and advertising institutions.
2. Explain the concept of green marketing and its impact on contemporary advertising.
Advertising is part and parcel of the daily world in which we all live—it’s the lifeblood of popular culture. It’s also an incredibly powerful mirror that reflects our values, aspirations, and fears (whether of social rejection, financial hardship, or just plain body odor). True, we may not always like what we see in this mirror. And it may not deliver a totally accurate reflection—like the looking glass in a funhouse, it may be distorted to magnify our noblest dreams as well as our basest desires. It’s a formidable weapon that people, businesses, and countries can harness for good or exploit for evil.
Advertising Is Culture Is Advertising
Advertising’s cultural impact is hard to overlook, although many people do not seem to realize how much these pervasive messages influence their preferences for movie and musical heroes, the latest fashions in clothing, food, and decorating choices, and even the physical features that they find attractive or ugly in men and women.
For example, consider the product icons that companies use to create an identity for their products. Many imaginary creatures and personalities, from the Keebler Elves to the Burger “King,” have at one time or another been central figures in popular culture. Although these figures never really existed, many of us feel as if we “know” them. Check out the Icon Advertising Museum that will soon open in Kansas City to learn more. Even better, visit the museum’s Web site to see how many icons you recognize: http://advertisingiconmuseum.org.
To give you a head start, here are the most popular spokescharacters of 2008, according to research done by the research company Marketing Evaluations, which measures the public familiarity and appeal of more than six hundred characters featured in advertising campaigns:
1. Mars’ M&Ms characters
2. The GEICO Gecko
3. The AFLAC duck
4. Poppin’ Fresh (aka the Pillsbury Doughboy)
5. Tony the TigerLacey Rose, “America’s Most-Loved Spokescreatures,” Forbes, July 9, 2008, http://www.forbes.com/home/2008/07/08/advertising-mars-geico-biz- media-cx_lr_0708spokescreatures.html (accessed July 17, 2008).
Advertising pervades all of our lives, and its presence only continues to grow as advertisers expand the formats they use to reach us and as we try to slake our growing appetites for information and entertainment. The average adult is exposed to about 3,500 pieces of advertising information every single day—up from about 560 per day thirty years ago.
Here’s a statistic to chew on: American Internet users ages twelve and older spend an average of 6.1 hours per day interacting with video-based entertainment. About four of these hours are devoted to television viewing (live and recorded), while the rest goes to video games, Web and PC video, DVDs, and video on mobile devices. This sizeable chunk of time is projected to grow to eight hours per day by 2013. Where will the growth come from? One answer is online video; Nielsen tells us that in 2007 Americans watched 7.5 billion streams and 16.4 billion minutes in total of online video, and children ages two to eleven spend almost one-third of their online time watching videos. Expect advertisers to follow suit.eMarketer, “Video to Consume One-Third of Each Day” June 25, 2008, http://www.Emarketer.Com/Article.Aspx?Id=1006381&Src=Article1_Newsltr (accessed June 25, 2008); Brian Stelter, “Whichever Screen, People Are Watching,” New York Times Online, July 8, 2008 (accessed July 8, 2008).
So, is advertising a vapid cloud of superfluous fluff, or is it an efficient and entertaining process that enriches our lives? Obviously that depends on whom you ask. Let’s focus (first) on the reasons we should regard advertising as a glass half full. Then we’ll deal with the negative stuff.
Prosocial Advertising
Can advertising save lives? Let’s investigate a recent project that answers a resounding “yes!” A public health professor named Val Curtis spent years in the developing world fighting what seems like a simple problem but turns out to be a frustrating battle: get people to wash their hands regularly with soap (sound like your mother?). It turns out that dirty hands spread diseases like diarrhea that kill a child somewhere in the world about every fifteen seconds, and about half those deaths could be prevented with the regular use of soap.
Dr. Curtis, an anthropologist then living in Burkina Faso, was almost ready to throw in the towel (pardon the pun). Then she decided to ask some consumer goods companies how they would convince people to wash their hands using the same techniques they rely upon to sell vitamins or deodorant that people tend to consume out of habit. As she observed, “There are fundamental public health problems, like hand washing with soap, that remain killers only because we can’t figure out how to change people’s habits. We wanted to learn from private industry how to create new behaviors that happen automatically.”Charles Duhigg, “Warning: Habits May Be Good for You,” New York Times Magazine, July 13, 2008, http://www.nytimes.com/2008/07/13/business/13habit.html? pagewanted=1&sq=Warning%20-%20Habits%20May%20Be%20Good%20 for%20You&st=cse&scp=1 (accessed July 17, 2008). These companies know very well how to create and reinforce such habits. For example, a century ago it was rare for anyone to brush her teeth twice a day, but efforts by Colgate and others changed all that.
Public health campaigns have had limited success in changing unhealthy habits. For example, evidence suggests that antidrug campaigns actually increase drug use, presumably because they remind people about the drugs to which they’ve become attached. It’s sort of like telling someone, “Whatever you do, don’t think of an elephant.” Did that work?
Procter & Gamble, Colgate-Palmolive, and Unilever accepted Dr. Curtis’s challenge and joined an initiative called the Global Public-Private Partnership for Handwashing with Soap. The group’s goal was to double the handwashing rate in Ghana, a West African nation where almost every home contains a soap bar but only 4 percent of adults regularly lather up after they use the toilet.
When participants started to look into the issue, they had the insight that the problem resembled one Procter & Gamble first encountered when it introduced Febreze, a product it developed to remove odors from smelly clothes and furniture. Its ads initially focused on smelly situations, like pets, sweaty teenagers, and stinky minivan interiors. The launch flopped, and P&G was ready to kill the product. Then its researchers found that consumers liked Febreze when they used it, but that many customers simply forgot that it was in the house. P&G’s ads needed to give them the right cues to use the product. The company identified one: the act of cleaning a room. So, it created commercials showing women spraying Febreze on a perfectly made bed and on freshly laundered clothing instead of in smelly areas. The ads worked well—and the more people sprayed Febreze, the more automatic the behavior became. Now consumers buy \$650 million of the stuff each year.
Back to handwashing in Ghana: studies showed that while about half of the people washed their hands before they ate or after they used the bathroom, only about 4 percent of Ghanaians included soap in this process. They also found that mothers often didn’t see symptoms like diarrhea as abnormal but instead viewed them as a normal aspect of childhood. But they also unearthed an interesting tidbit: Ghanaians did use soap when they felt that their hands were dirty, for example, after they cooked with grease. This habit was prompted by feelings of disgust, and they applied soap to eliminate this bad feeling.
So the team came up with a big idea: create a habit to instill a feeling of disgust when people use the toilet, so that the emotional reaction would cue the use of soap. While many of us don’t hesitate to grimace at the thought of a less-than-sparkling bathroom, in many places in the developing world any toilet is a symbol of cleanliness, because flush toilets have replaced pit latrines. So the task was to create commercials to teach the audience to feel disgust after they went to the bathroom. The solution: the team shot ads of mothers and children walking out of bathrooms with a glowing purple pigment on their hands that contaminated everything they touched. These spots didn’t sell soap use, but rather disgust. Soap was almost an afterthought—one fifty-five-second television commercial only showed soapy hand washing for four seconds. Still, the link between disgust and its removal via soap was clear: the team’s follow-up research showed a 13 percent increase in the use of soap after the toilet, while the number of Ghanaians who reported washing their hands with soap before they eat rose by an impressive 41 percent.Charles Duhigg, “Warning: Habits May Be Good for You,” New York Times Magazine, July 13, 2008, http://www.nytimes.com/2008/07/13/business/13habit.html?pagewanted=1&sq=Warning%20-%20Habits%20May%20Be%20Good%20for%20You&st=cse&scp=1 (accessed July 17, 2008). This is no soap opera: advertising can save lives when it’s used creatively and when it thoughtfully applies what social scientists understand about human behavior.
PSAs
The Advertising Council, a private, nonprofit organization, is one of the most important and influential organizations in the advertising industry. The Ad Council coordinates advertisers, advertising agencies, and media in its efforts to create effective public service messages and other forms of advertising and deliver those messages to the public.S. William Pattis, Careers in Advertising (Blacklick, OH: McGraw-Hill Professional, 2004), 13.
Advertising agencies enhance society’s well-being when they create (usually pro bono, or for free) public service announcements (PSAs) like the “Friends don’t let friends drive drunk” campaign. PSAs intend to change the society’s culture as they focus awareness on specific issues that address the public as a whole. For example, after the anti–drunk driving campaign, its creators reported that 70 percent of people said that the ad helped them to stop someone from driving drunk.
SS+K Spotlight
On May 29, 2008, SS+K launched a PSA they’d produced pro bono (for free) in support of United Nations Peacekeepers.
Video Highlight
UN Peacekeepers
(click to see video)
The spot, featuring U.N. Messenger of Peace George Clooney, is entitled “Peace Is Hard.” It is being distributed primarily online via social media outlets such as YouTube, Facebook, MySpace, and others.
Advocacy Advertising
Like PSAs, advocacy advertising intends to influence public opinion about an issue relevant to some or all members of a society. However, advocacy ads espouse a particular point of view that not everyone may share, so they tend to be more strident in tone. For example, while virtually everyone advocates designating a driver to abstain from drinking (even the alcohol industry), not all of us agree with messages that exhort us to practice safe sex or avoid eating meat.
The organization People for the Ethical Treatment of Animals (PETA) is a good example of a group that employs graphic messages to drive home its agenda, whether it’s advocating an end to using lab animals for product testing or urging a boycott of the fur industry. PETA has used former Baywatch actress Pamela Anderson and ex-Beatle Paul McCartney in spots to protest the handling and killing of poultry, and most recently the group even involved the Pope in its efforts. The group’s KentuckyFriedCruelty.com Web site featured the Pope’s photo next to a quote it attributed to him: “Animals, too, are God’s creatures.…Degrading [them] to a commodity seems to me in fact to contradict the relationship of mutuality that comes across in the Bible.” (Note: PETA didn’t ask for or receive the Catholic Church’s permission to use the photo or the quote.)Richard Gibson, “PETA Uses Religion in Boycott,” Wall Street Journal Online Edition, April 11, 2007, http://online.wsj.com/article/SB117625218878365729.html (accessed April 11, 2007).
Nonprofit Advertising
Many not-for-profit organizations, including museums, zoos, and even churches, rely on advertising to recruit members, attract donations, and promote their activities. Churches aggressively brand themselves to fill empty pews. For example, the “megachurch” Willow Creek Community Church near Chicago uses sophisticated marketing techniques (including selling copies of sermons on CDs) to attract over twenty-five thousand worshippers.
Local governments use advertising to attract new businesses and industries to their counties and cities. Even states are getting into the act: We’ve known for a long time that I ♥ NY, but recently Kentucky and Oregon hired advertising agencies to develop statewide branding campaigns. The official state motto of Oregon is now “Oregon. We love dreamers.”Stuart Elliott, “Introducing Kentucky, the Brand,” New York Times Online, June 9, 2004 (accessed July 19, 2008). A publicity campaign to select a state slogan for New Jersey generated a lot of questionable entries, including “It’s Jersey: Got a problem with that?” “New Jersey: We’ll look the other way,” and “New Jersey: Be sure to pick up a complimentary chemical drum on your way out.” The state went with something a bit less colorful: “New Jersey, Come See For Yourself.” Mister Snitch!, “Top Ten Rejected Jersey State Slogans,” October 28, 2005, http://mistersnitch.blogspot.com/2005/10/top-ten-rejected- jersey-state-slogans.html (accessed July 19, 2008); “Governor’s Call to Action,” January 12, 2006, www.state.nj.us/slogan (accessed July 19, 2008).
Dig Deeper
How far should nonprofit organizations go to promote their agendas? The Nationwide Children’s Hospital in Columbus, Ohio (a \$50 million donation from the Nationwide Insurance Company prompted this name) recently came under fire for its embrace of corporate sponsors. In 2008 the hospital announced plans to rename its emergency department the Abercrombie & Fitch Emergency Department and Trauma Center in exchange for a \$10 million donation from A&F. Citing A&F’s racy ads that feature (apparently) underage models, an advocacy group called The Campaign for a Commercial-Free Childhood vigorously protested the name and submitted a letter signed by more than a hundred doctors and child welfare advocates. A spokesman explained, “A company with such cynical disregard for children’s well-being shouldn’t be able to claim the mantle of healing.”Quoted in Natalie Zmuda, “Children’s Hospital in Hot Water over Corporate Sponsorships: Critics Dismayed by Association with Racy Retailer Abercrombie & Fitch,” Advertising Age, March 12, 2008, adage.com/abstract.php?article_id=125672 (accessed March 12, 2008). What do you think: is this use of corporate sponsorship over the top, or would forbidding it be throwing out the baby with the bathwater?
SS+K Spotlight
SS+K regularly engages in philanthropic work through an informal organization it calls David’s Work. This is named after David McCall, the creative founder who was on the board of SS+K before his untimely death while on a mission with his wife. After leaving the ad biz, David donated his time and effort to doing good, so SS+K does something in his honor every few months; typically this involves fundraisers for local schools.
Green Marketing
In the early twenty-first century, we are witnessing a profound shift in priorities as people clamor for products and services that are good for their bodies, good for their community, and good for the earth. Some analysts call this new value conscientious consumerism. They estimate the U.S. market for body-friendly and earth-friendly products at more than \$200 billion.
In particular, some marketers single out a type of consumer they call LOHAS—an acronym for “lifestyles of health and sustainability.” This label refers to people who worry about the environment and spend money to advance what they see as their personal development and potential. These so-called “Lohasians” (others refer to this segment as cultural creatives) represent a great market for products such as organic foods, energy-efficient appliances, and hybrid cars, as well as alternative medicine, yoga tapes, and ecotourism. One organization that tracks this group estimates they make up about 16 percent of the adults in the United States, or 35 million people; it values the market for socially conscious products at more than \$200 billion.http://www.lohas.com (accessed February 1, 2009).
Just how widespread is conscientious consumerism? In a 2007 survey, eight in ten consumers said they believe it’s important to buy green products and that they’ll pay more to do so. Corporate responsibility is now one of the primary attributes shoppers look for when they decide among competing brands. Consumer research strongly suggests that this awareness often starts with personal health concerns and then radiates outward to embrace the community and the environment. Predictably, advertisers have been quick to jump on the green bandwagon. Green marketing, which emphasizes how products and services are environmentally responsible, is red hot. Established agencies are setting up divisions to specialize in green campaigns and a host of new agencies (with names like The Green Agency and Green Team) are opening to meet the demand.
The advertising industry has the potential to radically change people’s attitudes and (more importantly) their behaviors as we face the real consequences of environmental contamination. Unfortunately, there’s also the very real potential that it will “poison the well” as it jumps onto the bandwagon a bit too energetically. It’s almost impossible to find an ad for virtually any kind of product, service, or company that doesn’t tout its environmental credentials, whether the focus of the ad is a detergent, a garment, a commercial airplane, or even an oil company. As a result, complaints about greenwashing, or misleading consumers about a product’s environmental benefits, are skyrocketing. One egregious example is an ad for a gas-guzzling Japanese sport utility vehicle that bills the car as having been “conceived and developed in the homeland of the Kyoto accords,” the international emissions-reduction agreement.
To prevent a greenwash backlash, it’s imperative for advertisers to act responsibly. There’s nothing wrong with trumpeting the environmental value of your product—if the claims are accurate and specific. Or you can suggest alternative methods to use your product that will minimize its negative impact—for example, Procter & Gamble runs an ad campaign in the United Kingdom that urges consumers of its laundry detergents to wash their clothing at lower temperatures.Suzanne Vranica, “Ad Houses Will Need to Be More Nimble: Clients Are Demanding More and Better Use of Consumer Data, Web,” Wall Street Journal, January 2, 2008, B3; Eric Pfanner, “Cooling Off on Dubious Eco-Friendly Claims,” New York Times Online, July 18, 2008, http://www.nytimes.com/2008/07/18/business/media/18adco.html? scp=1&sq=Cooling%20Off%20on%20Dubious%20Eco-Friendly%20Claims&st=cse (accessed July 19, 2008). The FTC (Federal Trade Commission) provides guidelines to evaluate green advertising claims; for example, it suggests that “if a label says ‘recycled,’ check how much of the product or package is recycled. The fact is that unless the product or package contains 100 percent recycled materials, the label must tell you how much is recycled.”“Sorting Out ‘Green’ Advertising Claims,” Federal Trade Commission, April 1999, http://www.ftc.gov/bcp/edu/pubs/consumer/general/gen02.shtm (accessed July 19, 2008).
The advertising industry can help us heal our toxic environment: please don’t poison the well.
Key Takaway
Advertising creates awareness and persuades people to change their opinions or behaviors. The same principles that advertisers use to sell cameras and cars apply to conservation or even contraception. Prosocial messages can significantly influence consumers’ daily lives in positive ways. Of late we see a huge emphasis on green messages; these can help to galvanize the world to take action in order to save the environment—if they don’t turn us off first by bombarding us with insincere claims.
EXERCISES
Advertising has been described as being the good and the bad (and sometimes ugly).
1. Explain the “good” perspective by naming some benefits that advertising conveys to society.
2. Explain the role played by the Advertising Council and how it uses public service announcements (PSAs) to influence public opinion. Give an example.
3. Characterize the green movement in advertising. Evaluate its success in changing advertising’s view of environmental issues and causes. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/03%3A_Advertising_and_Society/3.03%3A_The_Good_-_Advertising_Enhances_Our_World.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Identify the dark side of advertising and advertising practice.
2. Review the practice of behavioral targeting and appraise its validity.
3. Compare arguments for and against materialism.
We’ve considered some of the good that advertising can do. Now let’s check out some of the bad—and the ugly. It’s certainly not hard to identify the hot buttons—a lot of people slam advertising for a lot of different reasons. Some objections may be a bit paranoid, as when the social critic Vance Packard wrote more than fifty years ago, “Large-scale efforts are being made, often with impressive success, to channel our unthinking habits, our purchasing decisions, and our thought processes by the use of insights gleaned from psychiatry and the social sciences.”Quoted in William Leiss, Stephen Kline, and Sut Jhally, Social Communication in Advertising: Persons, Products and Images of Well-Being (Scarborough, Ontario: Nelson Canada, 1990), 11. Still, there are plenty of valid reasons to question the methods and goals of the advertising industry. Forewarned is forearmed. Here are some common objections we hear:
• Ads make us feel bad about ourselves as they constantly throw images of perfect, beautiful people in our faces.
• Ads reinforce insulting ethnic and racial stereotypes.
• Ads invade our privacy.
• Ads create false needs that make us crave brand names and material possessions.
Let’s examine these charges one by one.
The Ugly
Ads make us feel bad about ourselves as they constantly throw images of perfect, beautiful people in our faces.
You are how (you think) you look. Our physical appearance is a large part of our self-concept. Body image refers to a person’s subjective evaluation of his or her physical self. The key word here is subjective—your image of your body may not be what your body looks like to other people. You might have an exaggerated notion of the bulge of your muscles or the bulge of your thighs. Knowing that people’s body images are often distorted, some marketers exploit our insecurities and suggest that purchasing their product will help alleviate the “problem.”
Indeed, advertising can affect a person’s self-esteem when it takes advantage of our powerful instinct to gauge our physical and mental states relative to others. Numerous studies have noted that female college students compare their physical appearance to that of models in ads. Participants who viewed ads with beautiful women expressed lower satisfaction with their own appearance afterwards than did women who didn’t see these ads. Another study showed that as little as thirty minutes of TV programming can alter young women’s perceptions of their own body shape.Cited in Michael R. Solomon, Consumer Behavior: Buying, Having and Being, 7th ed. (Upper Saddle River, NJ: Prentice Hall, 2005).
One of the prevailing arguments in the history of advertising is whether advertising merely reflects existing cultural values and views of gender or whether it constructs and creates those views. Some analysts believe that advertising is merely a “mirror” of culture. Others argue that advertising is a “distorted mirror” that both reflects and shapes our culture.Richard W. Pollay, “The Distorted Mirror: Reflections on the Unintended Consequences of Advertising,” Journal of Marketing 59 (1986): 18–36, and Morris B. Holbrook, “Mirror, Mirror, on the Wall, What’s Unfair in the Reflections on Advertising?” Journal of Marketing 51 (1987): 95–103. The advertising industry likes to say that ads simply reflect existing values because this view absolves advertisers of blame for perpetuating unreal standards. Denise Fedewa, senior vice president and planning director for the LeoShe subsidiary of the Leo Burnett agency, presented an updated, unified view when she said, “Advertising is so fascinating, because it’s both a mirror of the culture and it moves culture forward. I think the best advertising…taps into a direction that we are moving in, but we are not there yet, and it helps take us there…I think we’ve gotten a lot better at doing that…in tapping into where they [women] are moving next.”Eileen Fischer, “Interview with Denise Fedewa,” Advertising and Society Review 4, no. 4 (2003), http://muse.jhu.edu/journals/advertising_and_society_review/toc/asr4.4.html.
Dig Deeper
A provocative advertising campaign by Dove features underwear-clad women with imperfect bodies to call attention to the unrealistic messages about our bodies that some marketing messages communicate. Unilever (which makes Dove soap) initiated the Campaign for Real Beauty after its research showed that many women didn’t believe its products worked because the women shown using them were so unrealistic.Erin White, “Dove ‘Firms’ with Zaftig Models: Unilever Brand Launches European Ads Employing Non-Supermodel Bodies,” Wall Street Journal, April 21, 2004, B3. The marketers decided to focus the campaign’s message on reassuring women about their insecurities by showing them as they are—wrinkles, freckles, pregnant bellies, and all. Taglines ask “Oversized or Outstanding?” and “Wrinkled or Wonderful?” Dove even has a Web site (campaignforrealbeauty.com) where visitors can view the ads and cast their votes. For a real treat (and to appreciate how much “postproduction editing” goes into the fashion business), see how experts morph an average woman into a billboard beauty on this Dove Web site: www.boardsmag.com/screeningroom/commercials/3421.
Perhaps because of the success of the Dove campaign, other companies also are turning to ordinary people instead of professional models when they advertise. As an extension of its “I’m lovin’ it” campaign, McDonald’s held a casting call for consumers (as opposed to professional models) who will appear on its world cup and bag packaging. Nike and Wal-Mart also have run advertisements with average-looking employees.Laura Petrecca, “More Ads Star Regular People,” USA Today Online, April 3, 2006, http://www.usatoday.com/money/advertising/2006-04-02-mcdonalds-usat_x.htm (accessed February 13, 2009).
Will this emphasis on “keeping it real” continue, or will it give way to consumers’ desires to aspire to perfection (and buy the products they think will help them get there)?
So, which way is it? Is advertising a mirror or an idealized picture? It’s likely that advertising both reflects and affects gender roles in our daily lives. Since the 1970s, researchers have investigated the extent to which American advertising portrays women in stereotypical roles. Most report that ads do tend to portray women as subservient to men, as preoccupied with physical attractiveness, and as sex objects who are preoccupied with their appearance, and they tend to minimize depictions of women in positions of authority. To rub salt into the wound, this media exposure can indeed influence real women’s self-concepts and aspirations.Earl D. Honeycutt, Jr., “Gender Role Portrayals in Japanese Advertising: A Magazine Content Analysis,” Journal of Advertising, March 22, 1998, www.accessmylibrary.com/coms2/summary_0286-391205_ITM (accessed February 10, 2009).
James Twitchell, in his book Twenty Ads that Shook the World, takes a more positive view. Using the example of the ads for Charlie perfume in the 1970s and 1980s, he shows how this advertising provided the imagery of the new woman in the workplace: striving, not strident, proud of her accomplishments and not afraid to say so, but not the dour “make room for me or else” feminist that the press portrayed at the time. Twitchell’s view is that Madison Avenue is not immoral in imposing stereotypes but amoral in reflecting prevailing roles; that is, advertising follows whichever way the wind is blowing. The point is that if stereotyped roles didn’t sell products, advertisers would gladly use different imagery.James Twitchell, Twenty Ads that Shook the World: The Century’s Most Groundbreaking Advertising and How It Changed Us All (New York: Three Rivers Press, 2001).
One celebrated ad campaign—Nike’s “If You Let Me Play”—challenged stereotypes about women while at the same time achieving Nike’s advertising objective of enticing more women to buy its shoes. This effort successfully blended statistics with a powerful story that showed how exclusion and outdated norms concerning girls’ participation in school sports hurt their self-esteem and even their health. The campaign included lines like these:
“If you let me play sports, I will like myself more. I will have more self-confidence, if you let me play sports. If you let me play, I will suffer less depression.…If you let me play, I will be more likely to leave a man who beats me. If you let me play, I will be less likely to get pregnant before I want to. I will learn what it means to be strong. If you let me play sports.”Jean Grow and Joyce M. Wolburg, “Selling Truth: How Nike’s Advertising to Women Claimed a Contested Reality,” Advertising & Society Review 7, no. 2 (2006): 1.
And what about guys—is what’s good for the goose good for the gander? Let’s not forget that advertising also can influence how boys and men feel about themselves. In addition to “cheesecake” ads that show plenty of female skin, there are plenty of “beefcake” ads. That helps to explain why men spend \$7.7 billion on grooming products globally each year. In Europe, 24 percent of men younger than age thirty use skincare products—and 80 percent of young Korean men do.Vivian Manning-Schaffel, “Metrosexuals: A Well-Groomed Market?” http://brandchannel.com (accessed May 22, 2006).
Ripped abs aside, even a casual analysis of TV commercials for products from laundry detergent to computers turns up no shortage of spots that depict men as incompetent, bumbling idiots. Organizations like Stand Your Ground and the U.K.-based Advertising Standards Authority object to misandry (the male counterpart of misogyny, which means a hatred of women).Advertising Standards Authority, “Taste and Decency—The Depiction of Men,” www.asa.org.uk/asa/focus/background_briefings/Taste+and+ Decency+-+the+depiction+of+men.htm (accessed July 19, 2008); http://www.standyourground.com (accessed July 19, 2008). They protest ad campaigns that show men acting as buffoons who do nothing but ogle cars and women and who can’t perform the simplest household tasks.Courtney Kane, “Men are Becoming the Ad Target of the Gender Sneer,” New York Times Online, January 28, 2005, http://www.nytimes.com/2005/01/28/business/media/28adco.html (accessed February 13, 2009).
Uncle Ben or CEO Ben?
Ads reinforce negative ethnic and racial stereotypes.
Advertisements have a long history of relying on stereotypical characters to promote products. For many years Aunt Jemima sold pancake mix and Rastus was a grinning black chef who pitched Cream of Wheat hot cereal. The Gold Dust Twins were black urchins who peddled a soap powder for Lever Brothers and Pillsbury hawked powdered drink mixes using characters such as Injun Orange and Chinese Cherry—who had buck teeth.
These negative depictions began to decline in the 1960s as the civil rights movement gave more power to minority groups and their rising economic status began to command marketers’ respect. Frito-Lay responded to protests by the Hispanic community and stopped using the Frito Bandito character in 1971, and Quaker Foods gave Aunt Jemima a makeover in 1989. As part of its fiftieth-anniversary celebration for Crest toothpaste, Procter & Gamble reintroduced its “Crest Kid,” who first appeared in 1956 as a “white bread,” apple-cheeked girl painted by artist Norman Rockwell. It’s telling that the new Crest Kid is Cuban American. Similarly, a recent campaign gives a radical makeover to the black Uncle Ben character who appeared on rice packages for more than sixty years dressed as a servant. (White Southerners once used “uncle” and “aunt” as honorary names for older African Americans because they refused to address them as “Mr.” and “Mrs.”) The character is remade as Ben (just Ben), an accomplished businessman with an opulent office who shares his “grains of wisdom” about rice and life on the brand’s Web site.Marty Westerman, “Death of the Frito Bandito,” American Demographics, March 1989, 28; Stuart Elliott, “Uncle Ben, Board Chairman,” New York Times Online, March 30, 2007 (accessed March 30, 2007); http://www.unclebens.com (accessed February 1, 2009).
These positive steps are motivated by both good intentions and pragmatism. Ethnic minorities spend more than \$600 billion a year on products and services. Immigrants make up 10 percent of the U.S. population, and California is less than half Caucasian. Advertisers and their agencies couldn’t ignore this new reality even if they wanted to.
Multicultural advertising is a major force in today’s industry. Like the green-marketing phenomenon, the changing environment motivates both well-established agencies as well as those that specialize in talking to racial and ethnic segments to redouble their efforts. The Advertising Research Foundation, for example, sponsors a Multicultural Research Council to promote a better understanding of relevant issues.Advertising Research Foundation, www.thearf.org/assets/multicultural-council (accessed July 19, 2008). We still have a way to go to overcome stereotypes—not all African Americans are into hip-hop and not all Asian Americans are studious—but many agencies are working hard to address these issues, especially as they aggressively try to add diversity to their organizations.
We Know Where You Live
Ads invade our privacy.
Behavioral targeting is a fancy way to describe the growing number of techniques that allow advertisers to track where you surf on the Web so that they can deliver relevant ads to you. As we’ve discussed elsewhere in this book, that’s very convenient, and it’s clear that ads tailored to your interests are going to be both less intrusive and more valuable to you—but at what cost?
For example, cable and phone companies say their growth increasingly depends on being able to deliver targeted advertising to their Internet and TV customers. But privacy advocates are not happy about this, and due to their vocal protests some companies are backpedaling on plans to integrate advanced ad-targeting technology. NebuAd, one particularly controversial form of tracking software, tracks users wherever they go on the Web. Company executives claim the data can’t be traced back to individuals; instead, the software categorizes consumers as they surf the Web. Marketers then buy ads to appear online before certain subgroups of consumers when the technology recognizes their encrypted identity. Categories can be made quite specific; for example, you could come to the attention of an appliance manufacturer if you searched for “microwave ovens” within the past month.Emily Steel and Vishesh Kumar, “Targeted Ads Raise Privacy Concerns: Pressure Could Imperil Online Strategy Shared by Phone and Cable-TV Firms,” Wall Street Journal, July 8, 2008, B1.
At the end of the day, just how important is this privacy issue? Scott McNealy, CEO of Sun Microsystems, famously observed at a 1999 press conference, “You already have zero privacy—get over it.”Quoted in Edward C. Baig, Marcia Stepanek, and Neil Gros, “The Internet wants your personal info. What's in it for you?” BusinessWeek, April 5, 1999, http://www.businessweek.com/1999/99_14/b3623028.htm (accessed February 1, 2009). Apparently many consumers don’t agree; one survey reported that consumers are more worried about personal privacy than health care, education, crime, and taxes. People are particularly concerned that businesses or individuals will target their children. Nearly 70 percent of consumers worry about keeping their information private, but according to a Jupiter Media Metrix survey, only 40 percent read privacy policies posted on business Web sites. And many consumers seem more than happy to trade some of their personal information in exchange for information they consider more useful to them. A 2006 survey on this issue reported that 57 percent of the consumers it polled say they are willing to provide demographic information in exchange for a personalized online experience.“Consumers Willing to Trade Off Privacy for Electronic Personalization,” http://www.mediapost.com (accessed January 23, 2007).
Dig Deeper
Let’s bring the argument a bit closer to home: how private is your Facebook page? The popular social networking site ignited a huge controversy after it rolled out a marketing tool it calls Beacon in 2007. Facebook users discovered that their off-Facebook Web activities—such as purchases at online retailers, reviews at other sites, and auction bids, among other things—were being broadcast to their friends. The idea behind Beacon is to offer “trusted referrals”; if my Facebook friends see that I’ve been buying stuff at Alloy, they’ll be more likely to check out the site as well. Unfortunately, the folks at Facebook neglected to ask users if they would consent to share this information. In response to heated criticism, founder Mark Zuckerberg was forced to post a shamefaced apology, and Facebook now allows users to opt out of Beacon completely. But some privacy advocates still see this event as only the tip of the iceberg.Jacqui Cheng, “Facebook Reevaluating Beacon after Privacy Outcry, Possible FTC Complaint (Updated),” Ars Tecnica, November 29, 2007, http://arstechnica.com/tech-policy/news/2007/11/facebook-reevaluating-beacon-after-privacy- outcry-possible-ftc-complaint.ars (accessed July 19, 2008); Mark Zuckerberg, “Thoughts on Beacon,” The Facebook Blog, December 5, 2007, http://blog.facebook.com/blog.php?post=7584397130 (accessed July 19, 2008). Do you?
Living in a Material World
Ads create false needs that make us crave brand names and material possessions.
The validity of this criticism depends on how you define a “need.” If we believe that all consumers need is the basic functional benefits of products—the transportation a car provides, the nutrition we get from food, and the clean hair from a shampoo—then advertising may be guilty as charged. If, on the other hand, you think you need a car that projects a cool image, food that tastes fantastic, and a shampoo that makes your hair shine and smell ever so nice, then advertising is just a vehicle that communicates those more intangible benefits.
Critics say that advertising makes us buy products that we don’t need—or even want—but that we think we must have. In his seminal book The Affluent Society, economist John Kenneth Galbraith portrayed advertising as “manipulating the public by creating artificial needs and wants.”John Kenneth Galbraith, The Affluent Society (Boston: Houghton Mifflin, 1958), as cited in William M. O’Barr, “What Is Advertising?” Advertising & Society Review 6, no. 3 (2005): 11. He charged that radio and TV manipulate the masses. His view was that ads created new desires, encouraging consumers to spend their scarce resources buying highly advertised products rather than on basic items that fulfilled actual needs.
Galbraith voiced a common fear—that marketers link their products to desirable social attributes so that people feel measured by what they buy and guilty or anxious if they don’t measure up. As an example, when the eminent psychologist John Watson joined the J. Walter Thompson (now JWT) advertising agency, he worked on a campaign for Johnson’s baby powder. In a 1925 lecture, he explained how he increased sales of the baby powder by making the mother who did not use it “feel bad, that she was less of a mother, not really a good mother.”John Watson quoted in Humphrey McQueen, The Essence of Capitalism (Montreal: Black Rose Books, 2003), 157.
But is advertising really all-powerful? The reality is that 40 percent to 80 percent of all new products fail. Advertising can’t magically make a product succeed (at least for very long) if it doesn’t have some merit. Johnson’s baby powder would not still be on store shelves after more than 110 years if it didn’t provide some benefit. As one former advertising agency president noted, “The fact of the matter is we are successful in selling good products and unsuccessful in selling poor ones. In the end, consumer satisfaction, or lack of it, is more powerful than all our tools and ingenuity put together. You know the story: we had the perfect dog food except for one thing—the dog wouldn’t eat it.”Association of National Advertisers, “The Role of Advertising in America,” www.ana.net/advocacy2/content/advamerica (accessed February 4, 2009). The heart of the matter is: does advertising give people what they want, or does it tell them what they should want?
In fact, we can even make the argument (one that advertisers such as high-end stores like Neiman-Marcus, Prada, or Tiffany surely will welcome) that we should want things we can’t afford. According to author James Twitchell, not everyone can buy a \$200 cashmere sweater from Saks for their baby—but we can always dream of owning one. He claims that such a collective dream life is important to the continuing vigor of a culture. In the bigger scheme of things, advertising is a simple reflection of an age-old drive: “Human beings did not suddenly become materialistic. We have always been desirous of things.”James Twitchell, Living It Up: Our Love Affair with Luxury (New York: Columbia University Press, 2002).
Luxury products are not a bad or wasteful thing (goes this argument) because history shows that one generation’s decadent indulgence becomes the next generation’s bare necessity. Former luxury products that are now in daily use include buttons, window glass, rugs, door handles, pillows, mirrors, combs, and umbrellas, not to mention cars, electric lights, and indoor plumbing. The phenomenon of striving to afford “luxury” is the driving force for a rising standard of living. When we buy a luxury good, we increase the demand for it, which leads companies to produce more of it, ultimately leading to lower prices that make it affordable to the masses. At the same time that each new luxury creates new demand, it also creates the potential for a new industry with new jobs that enable people to afford the new luxuries. People become individually and collectively richer as they strive to buy new products and create new businesses to make these products. Advertising accelerates this cycle by both stimulating demand and helping suppliers communicate with customers.James Twitchell, Living It Up: Our Love Affair with Luxury (New York: Columbia University Press, 2002).
Numerous organizations such as Adbusters and The Campaign for a Commercial-Free Childhood work to counteract what they view as the debilitating effects of commercial messages in our culture.http://www.commercialfreechildhood.org (accessed July 19, 2008); http://www.adbusters.org (accessed July 19, 2008). Adbusters sponsors numerous initiatives, including Buy Nothing Day and TV Turnoff Week, intended to discourage rampant commercialism. These efforts, along with biting ads and commercials that lampoon advertising messages, are part of a strategy called culture jamming that aims to disrupt efforts by the corporate world to dominate our cultural landscape.”Adbusters Media Foundation, “Adbusters,” June 27, 2002, http://www.adbusters.org (accessed July 19, 2008).
Is Adbusters right? Does advertising encourage us to be shallow, or to value material rewards over spiritual ones? The jury is still out on that question, but there is little doubt that ads reinforce the things our society values. Images of happy (and popular) people who drive gas guzzlers and eat junk food surround us.
Key Takaway
Because it’s so powerful, advertising can hurt as well as help us. A consumer would have to live in a deep hole not to be affected by the images of “shiny happy people” (to quote from the REM song of the same name) that constantly bombard us. To decide whether advertising causes us to feel insecure about our bodies, engage in self-destructive behaviors, or covet others’ possessions is to raise a chicken-and-egg question that elicits strong feelings on both sides (just ask your professor). Nonetheless, whether they create the problems or merely perpetuate them, advertising practitioners certainly need to remind themselves (preferably every day) of the power they wield. Hopefully, if you go into the biz, you’ll remember that too.
EXERCISES
1. List and briefly discuss four common objections to advertising and its practice in our society.
2. Briefly trace the history of how advertising has reflected and affected gender roles and racial and ethnic stereotypes in our culture since 1970.
3. Evaluate the practice of behavioral targeting. Take a position on whether or not this practice invades privacy in a positive or negative way. Support your position.
4. We can see materialism as a “drain on society” or a “promoter of prosperity.” Pick one of these views and support your choice with an effective argument. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/03%3A_Advertising_and_Society/3.04%3A_The_Bad_-_Ethical_Hot_Buttons.txt |
LEARNING OBJECTIVE
After studying this section, students should be able to do the following:
1. List the primary government and industry regulatory agencies that control advertising and the advertising industry.
Government Regulation
The United States government has numerous agencies whose mandates include regulating advertising and other marketing activities. These include the Federal Trade Commission, the Federal Communications Commission, the Food and Drug Administration, the Securities and Exchange Commission, the Environmental Protection Agency, and the Department of Agriculture.
The Federal Trade Commission
The Federal Trade Commission (FTC) was established in 1914 to promote “consumer protection” and to monitor “anticompetitive” business practices. Within the FTC, the Bureau of Consumer Protection works to protect against abuses in advertising as well as other areas such as telemarketing fraud and identity theft. The bureau is also responsible for the United States National Do Not Call Registry, which allows consumers to opt out of receiving telemarketers’ calls on their home or mobile phones (https://www.donotcall.gov).
The FTC’s Division of Advertising Practices enforces federal truth-in-advertising laws. Its law enforcement activities focus on the accuracy of claims for foods, drugs, dietary supplements, and other products promising health benefits; advertising to children; performance claims for computers and other high-tech products; tobacco and alcohol advertising; and related issues. FTC investigations may pertain to a single company or an entire industry. If the results of the investigation reveal unlawful conduct, the FTC may seek voluntary compliance by the offending business, or its lawyers may choose to take the case to court.Federal Trade Commission, “A Guide to the Federal Trade Commission,” www.ftc.gov/bcp/edu/pubs/consumer/general/gen03.shtm (accessed July 19, 2008).
The Federal Communications Commission
The Federal Communications Commission (FCC) was established by the Communications Act of 1934. It regulates interstate and international communications by radio, television, wire, satellite, and cable.
The FCC monitors the proper use of broadcast media. As an example of a current issue that could have major repercussions for the advertising industry, the FCC recently initiated a formal inquiry into the degree to which networks have to disclose whether advertisers have paid to have products embedded in TV shows and movies (a widespread practice the industry calls product placement).
According to the FCC, as product placement becomes more widespread, its rules must “protect the public’s right to know who is paying to air commercials or other program matter on broadcast television, radio and cable.” But it added that the rules must be considered in light of “the First Amendment and artistic rights of programmers.” One possible outcome is that the agency will mandate that when a sponsored product appears on the screen this placement will have to be disclosed simultaneously—perhaps with lettering that covers at least 4 percent of the screen and lasts for at least four seconds. Also up for debate is whether disclosures should be required before or perhaps even before and after a show that includes product integrations.David Goetzl, “Game-Changer: FCC Considers Product Placement Disclosures,” Media Daily News, June 30, 2008, www.mediapost.com/publications/index.cfm?fa=Articles.showArticle&art_aid=85685 (accessed July 19, 2008).
The National Advertising Review Council (NARC)
To discourage the need for the government to pass additional legislation that would restrict its activities, advertising agencies vigorously police themselves to minimize abuses. To do this, the advertising industry created the National Advertising Review Council (NARC—no, not that kind of narc) in 1971. This group is a strategic alliance among four major trade organizations: the AAAA (American Association of Advertising Agencies), the ANA (Association of National Advertisers), the AAF (American Advertising Federation), and the Council of Better Business Bureaus Inc.
This system maintains two bodies that investigate claims of abuse or deception: the National Advertising Division (NAD) and the Children’s Advertising Review Unit (CARU). If an advertiser disagrees with NAD or CARU decisions, it can appeal to the National Advertising Review Board. The system covers advertising in traditional media as well as on the Internet. The large majority of cases get settled through this route—95 percent, in fact.American Association of Advertising Agencies, “Working with the Industry,” www2.aaaa.org/advocacy/industry/Pages/default.aspx (accessed July 19, 2008); National Advertising Review Board, http://www.narbreview.org (accessed July 19, 2008); Federal Communications Commission, “About the FCC,” http://www.fcc.gov/aboutus.html (accessed July 19, 2008).
A 2007 case involving a very public dispute between two online dating services illustrates how the NAD works to insure that advertising is as fair and accurate as possible. One site, Chemistry.com, claims in its advertising that answers to questions like “Do you watch people kissing in public?” and “Is your ring finger longer than your index finger?” can predict whether the people it matches up are likely to have “dating chemistry.” The site’s rival eHarmony.com objected to this claim and brought its charge to the NAD. After investigating the scientific basis for the claim, the division ruled that indeed Chemistry could not support its argument. As a result, the matchmaker has to find other ways to compete for the \$700 million Americans spend each year to find their dream mate online.Jessica E. Vascellaro, “Regulators Say Love Ain’t ‘Chemistry’ After All: Scientific Claim by Dating Service Comes Under Fire,” Wall Street Journal, September 17, 2007, B5.
The Interactive Advertising Bureau (IAB)
The Interactive Advertising Bureau was founded in 1996 to represent over 375 companies that conduct business in cyberspace. Its members sell about 86 percent of the online advertising that gets placed in the United States. The IAB evaluates and recommends standards and very specific practices to govern what interactive ads can and cannot do. For example, it mandates that an advertiser wishing to use a pop-up ad can show the message only one time during a person’s visit to an online site. Furthermore, the pop-up must be clearly labeled with the name of the network, the advertiser, and the publisher; there are limits on how big the image can be, and it must offer a “close box” so the user can choose to shut it down.Interactive Advertising Bureau, “Pop-Up Guidelines,” http://www.iab.net/iab_products_and_industry_services/1421/1443/1461 (accessed July 19, 2008).
Word of Mouth Marketing Association (WOMMA)
The Word of Mouth Marketing Association (WOMMA) is the official trade association for the word-of-mouth marketing industry. The organization promotes “best practices” and sets standards to regulate how “buzz marketers” interact with consumers. This has been an important issue due to some early buzz campaigns in which professional actors pretended to be everyday consumers in public places like tourist areas and bars, where they told other people about the advantages of using a particular product or service. Today WOMMA’s members must adhere to a code of ethics that the group summarizes as the Honesty ROI:
• Honesty of Relationship: You say who you’re speaking for.
• Honesty of Opinion: You say what you believe.
• Honesty of Identity: You never obscure your identity.Word of Mouth Marketing Association, “WOMMA’s Practical Ethics Toolkit,” http://www.womma.org/ethics/code (accessed July 19, 2008).
The Direct Marketing Association (DMA)
The Direct Marketing Association represents more than thirty-six hundred companies, based in forty-seven countries, that employ direct marketing tools and techniques. It provides information to help consumers recognize fraudulent practices as well as to remove themselves from mailing or call lists.Direct Marketing Association, www.dmachoice.org/consumerassistance.php (accessed July 19, 2008).
Key Takaway
Numerous organizations monitor the advertising industry to detect instances of false or deceptive advertising. The government enforces rules regarding content through federal agencies such as the FTC and the FCC. In addition, the industry vigorously polices itself to try to head off problems before the legal authorities must deal with them. As new media platforms continue to evolve (such as product placement and word-of-mouth marketing), the industry needs to be vigilant about tracking these applications to prevent additional abuses.
EXERCISES
1. List and briefly characterize the major governmental and industry “watchdogs” that regulate and influence advertising and the advertising industry.
2. Describe how the National Advertising Review Council processes complaints. Illustrate your description with a summary of the 2007 case (described above) concerning “dating chemistry” and “kissing in public.” | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/03%3A_Advertising_and_Society/3.05%3A_Advertising_Regulation-_Who_Looks_Out_for_Us.txt |
Tie it All Together
Now that you have read this chapter, you should be able to understand how the economic effects of advertising are constantly being spread throughout the economy:
• You can recognize that advertising is the glue that holds our culture together.
• You can identify the various economic effects of advertising with respect to overall size and impact.
• You can interpret the economic rationale for creating, accepting, and using advertising.
• You can describe the positive effects of advertising and how it enhances our world.
• You can discuss the ethical hot buttons that engage our social institutions in critical discussions of advertising.
• You can recall the various federal and industry regulators that monitor advertising and advertising practice in the United States.
USE WHAT YOU’VE LEARNED
1. Picture yourself driving your electric car down the highway of tomorrow looking for a place to refuel. Though this vision might be optimistic at this point in time, electric and alternative-fuel cars are realities just over the horizon. Refueling stations for electric cars will most likely not resemble the corner or freeway gas station. Instead, refueling sites are more likely to look like roadside parks. Refueling stations that recharge batteries may have solar roofs that provide the current for the refueling. Since refueling is expected to take several minutes, refueling stations will provide for rest and activities. If advertising is the “glue of a nation” with respect to its culture, explain what role advertising would play in making electric and alternative fuel cars and their refueling stations become a reality in the future. Consider aspects of social responsibility as you form your explanation.
2. Do you have any idea how often your life is impacted by Bluetooth technology? In case you didn’t know this, it is Bluetooth technology, developed by communication giant Ericsson, that enables all of our electronic and informational devices to talk to one another. For example, Bluetooth technology enables wireless headsets to communicate with other devices. You might have noticed that Aliph has just introduced a new Bluetooth-enabled headset called Jawbone that is smaller, lighter, and cuts wind noise more than any previous headset designs. The headset is about the size of a large rectangular earring or about one-half the size of existing headset models. There is, however, a significant problem that must be addressed before headset communication is advised for everyone. There are reports linking forms of brain cancer to cell phone and headset use. Experts are studying the possibilities and connections. No conclusions have been reached yet. Your task is to assume that you are a member of the Advertising Council and have been asked to design a PSA (public service announcement) that will both quiet fears and encourage information-seeking about the subject as research progresses. Write your message. How do you think those who support headset and cell phone development would respond to what you have to say? Comment.
DIGITAL NATIVES
Being environmentally friendly is one of the objectives valued by many of us today. The “green movement” is being embraced in a variety of ways. One of the ways is through the development of alternative energy sources such as wind power. Wind power has proven to be an efficient method for generating electricity. One of the companies attempting to harness wind energy and make it profitable is Dutch-based Vestas. Since it has 20+ percent market share of the industry and puts up one of its wind towers somewhere in the world about every five minutes, Vestas would have to be considered a growth-oriented company with a bright future. The company recently has expanded its international operations to North America by establishing a U.S. office in Houston, Texas.
Go to the Vestas Web site at http://www.vestas.com and learn more about the company, wind power solutions, and what Vestas plans to do in the future. Once you have gathered background information on the company and wind industry, use the six-item list found in the “Economic Rationale to Use Advertising” section of the chapter to determine what informational strategy (or strategies) would be best for introducing Vestas to U.S. consumers. Write your ideas down. Remember to focus your suggestions on the main themes of the list.
AD-VICE
1. Assume that you are a representative of the advertising industry who has been asked to debate a leading economist on whether advertising is wasteful and manipulative or not. Develop four reasons to support your contention that advertising serves a useful function in our society. Your reasons should anticipate the comments that would be made by your adversary—the economist.
2. Based on your understanding of how advertising assists in defining “who you are” with respect to your body image and self-esteem, take three market segments—teens, thirty- to forty-year-olds, and seniors (sixty- to seventy-year-olds)—and demonstrate how advertising provides “definition” to these segments. In your opinion, are these “definitions” correct? Be specific in your demonstration, illustration, and assessment.
3. Some critics have claimed that advertising is responsible for perpetuating sexism and poor environmental practices. How would you respond to such criticism? Summarize and support your position. Present your position during an open class discussion of such criticism.
4. Advertisers aim to present advertising messages to those who want the messages or would be open to new information. One of the ways to accomplish this objective is to use product placements in strategic positions in movies, video games, communications, and our daily lives. Evaluate product placement by listing the pros and cons of the practice. Cite illustrations to match your assessment of the practice. Does the practice need more or less regulation? Explain and comment.
ETHICAL DILEMMA
According to media and advertising critics, one of the chief causes of negative body image among teens and younger adults is the models used to display everything from cars to fashions to makeup. As indicated in the chapter, body image “refers to a person’s subjective evaluation of his or her physical self.” The key word is “subjective.” Messages are open to different interpretation. Critics claim advertising messages by their very nature cause consumers to reject their current situation or status quo and embrace change toward some ideal state as specified by the advertiser. If true, this could have a negative impact on those who read or view commercials, especially those who are younger and more impressionable.
To illustrate the ethical difficulty in dealing with body image, prepare two collages using pictures from contemporary magazines. One of your collages should illustrate unrealistic body images displayed in commercials that are, in your opinion, ethically questionable. The other collage should illustrate what you perceive to be a more realistic and ethical way to deal with the presentation of body image. Once they are completed, compare your collages; comment on where you think this debate over body image might be headed in the next few years. Be prepared to discuss your collages, thoughts, and position. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/03%3A_Advertising_and_Society/3.06%3A_Exercises.txt |
We are now twelve months from the launch of the msnbc.com campaign. The SS+K team needs to start thinking seriously about how it’s going to make consumers crave the msnbc.com brand of news. Before they can do that, however, they need to take a step back to understand how advertisers “talk” to customers—what works and what doesn’t, and what determines what works. This means we need to take a look at communications and break down a complicated process into simpler elements. Does it matter exactly what we say? Who says it? Where people get the message? How about others’ opinions—to what extent are our own preferences shaped (consciously or not) by what we believe others like or dislike? And, with the magical world of technology, how might the advertiser/consumer relationship evolve?
4.02: From Talking to Consumers to Talking with Consumers
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Describe the traditional linear communications model.
2. Describe the new interactive, nonlinear, multivocal communications model.
The Traditional Linear Communications Model
For most of history, advertisers talked to consumers—the traditional communications model was a one-way street. It was pretty simple, really: The source (such as an advertising agency) created a message (the advertisement) and selected the medium (newspaper, TV, outdoor, etc.) that carried it to the receiver (the consumer). The consumer may have given feedback to the source about the message (typically only indirectly, namely by buying the advertised product or service or not)—and of course she may have ignored it, just as people often do today—but the line of communication was clearly drawn. The producer called the shots and the message was univocal (one voice).
A New Interactive, Nonlinear, Multivocal Communications Model
Flash forward to a more dynamic—and chaotic—picture. Today, advertising messages come from many sources simultaneously through different media that target different receivers (consumers, business partners, stockholders, even government officials). At the same time, receivers talk with one another and they may initiate their own communication with the sender, whether that organization wants to hear it or not.
The updated communications model is interactive, nonlinear, and multivocal (many voices). In addition, consumers now may choose to opt out of listening to a particular message—they often get to decide which messages they see or hear, and when. In the old days, opting out meant getting up to make a sandwich when a TV commercial came on, but today many of us have a lot more control to determine what messages will appear for us to consider in the first place. For marketers, this permission marketing strategy makes sense (even though some may be indignant that they’re losing control over the situation). The rationale is very simple: A message is more likely to persuade consumers who have agreed to listen to it in the first place.
Seth Godin, founder of direct interactive marketing agency Yoyodyne (which Yahoo! later acquired) explains the importance of permission marketing: “We’re getting good at avoiding spam: e-mail spam, newspaper spam, TV spam, calling-me-at-home-over-dinner spam. The point of advertising shouldn’t be to interrupt more people who don’t want to talk to us.” To be heard above the noise, advertisers should seek permission from people to tell their story and begin a private, personal conversation that revolves around mutual interest and respect.Quoted in “Expert Tells Marketers: To Be Memorable, Get Permission” InformationWeek, May 18, 2007, http://www.informationweek.com/news/internet/showArticle.jhtml?articleID=199602077 (accessed May 18, 2007).
Understand Communication to Create Effective Advertising
If we understand the communications model, we appreciate how messages affect people, how people make purchase decisions, and what influences these choices. These issues can help advertisers understand why people accept some messages while they ignore others. After all, it’s frustrating to be ignored—but in the world of advertising it’s also expensive.
Key Takaway
We are used to thinking about communication as a one-way process that moves from a source who chooses what to say, how to say it, and where to say it to a receiver who either absorbs the message or not. That basic assumption is no longer valid in many cases, as consumers today become more proactive in the communications process. This creates many more interesting advertising possibilities, but it’s also harder to control the process once the inmates run the asylum.
EXERCISES
1. Describe the traditional communications model. How does it differ from the updated communications model?
2. Explain why permission marketing is so important to today’s marketer and advertiser. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.01%3A_Chapter_Introduction.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Identify the components of communication that one must master to successfully communicate with consumers.
2. Compare and contrast one-sided versus two-sided messages.
Elements of who, how, and where an advertiser sends a message significantly affect how—or if—the audience receives it.
Source Effects
Who communicates the message (the source) has a big impact on whether a receiver will accept the message. You’re a lot more likely to download the latest Rihanna cut if your buddy recommends it than if you get the same advice from your kindly old uncle (unless he happens to be Jay-Z). The power of source effects, in fact, underlies the millions that celebrities make when they agree to endorse products. Obviously, advertisers feel it’s worth the substantial expense to pay a movie star or athlete to associate themselves with a certain brand’s message. Indeed, the pairing of a well-known person with a product is hardly new: Mark Twain’s image appeared on packages of flour and cigars in the late 1800s, while Buffalo Bill Cody hawked Kickapoo Indian Oil and Elvis was the face of Southern Maid Doughnuts. What makes an effective source? The important characteristics are credibility and attractiveness.
Source Credibility
Source credibility means that consumers perceive the source (the spokesperson) as an expert who is objective and trustworthy (“I’m not a doctor, but I play one on TV”). A credible source will provide information on competing products, not just one product, to help the consumer make a more informed choice. We also see the impact of credibility in Web sites like eBay or Wikipedia and numerous blogs, where readers rate the quality of others’ submissions to enable the entire audience to judge whose posts are worth reading.
Source Attractiveness
Source attractiveness refers to the source’s perceived social value, not just his or her physical appearance. High social value comes partly from physical attractiveness but also from personality, social status, or similarity to the receiver. We like to listen to people who are like us, which is why “typical” consumers are effective when they endorse everyday products.
So, when we think about source attractiveness, it’s important to keep in mind that “attractiveness” is not just physical beauty. The advertising that is most effective isn’t necessarily the one that pairs a Hollywood hottie with a product. Indeed, one study found that many students were more convinced by an endorsement from a fictional fellow student than from a celebrity. As a researcher explained, “They [students] like to make sure their product is fashionable and trendy among people who resemble them, rather than approved by celebrities like David Beckham, Brad Pitt or Scarlett Johansson. So they are more influenced by an endorsement from an ordinary person like them.”Quoted in “Celebrity Ads’ Impact Questioned,” BBC News, 27 February 2007, http://news.bbc.co.uk/1/hi/england/somerset/6400419.stm (accessed October 31, 2007).
Still, all things equal, there’s a lot of evidence that physically attractive people are more persuasive. Our culture (like many others) has a bias toward good-looking people that teaches they are more likely to possess other desirable traits as well. Researchers call this the “what is beautiful is good” hypothesis.Karen Dion, Ellen Berscheid, and Elaine Walster, “What Is Beautiful Is Good,” Journal of Personality and Social Psychology 24 (1972): 285–90. Unfortunately, in many cases, while beauty is only skin deep, “ugly is to da bone.”Some of the material in this chapter was adapted from Michael R. Solomon, Consumer Behavior: Buying, Having and Being, 8th ed. (Upper Saddle River, NJ: Prentice Hall, 2008).
Is It Better to Be an Expert or Hot?
Is source attractiveness more important than source credibility? The answer depends on the product or service you sell.
When to use credibility. If the product is utilitarian and complex (that is, consumers may not know much about how to use it), then a credible expert will be the most effective at persuading people to buy the product or service.
When to use attractiveness. If, on the other hand, the item is simple to understand (like clothing) but has a high social risk (that is, we’re concerned about the impression we’ll make on others if we’re seen with this item) then an attractive source will be more persuasive.
Sometimes you’re lucky enough to have a spokesperson who is both credible and attractive. This was the case for SS+K’s pro bono campaign for the United Nations peacekeepers when ads featured hunky UN messenger for peace George Clooney.
Message Effects
How the message is said or presented is just as important as who communicates the message. Emotional messages appeal to, resonate with, or attempt to create an emotional response in the receiver. One common emotional message style is the fear appeal, which depicts the consequences of not using the product (e.g., social ostracism due to body odor). Another advertising strategy is to use humor. A study by Mediamark Research Inc. found that humor is the element in advertising that most appeals to kids.Mark Dolliver, “Critical Beer Drinkers, Confident Eaters, Etc.” Adweek, January 8, 2007, 24.
Rhetorical questions engage the receiver, don’t they? The question makes the receiver an active participant even if the medium of the message is passive or one-directional.
Examples versus statistics. Although examples and statistics can convey the same information, they do so in very different ways. Examples help put a human face on the product or its use, which creates an emotional connection and helps the receiver see how the product might influence his or her life. Statistics provide cold, hard numbers that may provide a rationale for purchase but not an emotional bond with the brand or product.
Interestingly, even among products whose purchase you might expect to be more rationally driven, such as pharmaceuticals, consumers are persuaded more by words and pictures from people who have had good results using the drug. Having Mrs. Jones’s picture with the words “Acme Sleep gave me my first restful night in fifteen years!” turns out to be more persuasive. Indeed, a study that included television ads for seven of the top ten best-selling prescription drugs for 2004 found that 95 percent of them used a positive emotional appeal (such as a character who’s happy after taking the product).Alicia Ault, “Drug Ads Play on Emotions,” Family Practice News, February 15, 2007, 45; Steve Smith, “Mastering the Direct Appeal,” Sleep Review 8, no. 4 (2007): 54.
One-sided messages present only the positive attributes of the product—they provide one or more objective reasons to buy the product. These often include objective variables such as price, performance, size, and power.
Two-sided messages present both positive and negative information about the product. Although most advertising messages are one-sided, research indicates that a two-sided message is very effective. Although it seems counterintuitive that an advertiser would want to publicize negative attributes of a product, doing so actually builds credibility by making the message more balanced. People who hear only one-sided arguments may be more skeptical of the message, wondering what hasn’t been said. Refutational arguments, therefore, which raise a negative issue and then refute it can be quite effective if the audience is well educated and if the receivers are not already loyal to the product. (If they are already loyal to the product, then discussing possible drawbacks has little merit and may actually raise doubts.)
Comparative messages explicitly trumpet a brand’s virtues vis-à-vis one or more named competitors. To promote its latest line of chicken sandwiches, the Arby’s fast-food chain aired TV commercials that took direct aim at rivals McDonald’s and Wendy’s. In one spot, a young man stands in a (fictitious) McDonald’s boardroom as he tries to convince McDonald’s executives to serve a healthier type of chicken. Framed against a familiar golden arches logo, he proclaims, “I propose that McDonald’s stops putting phosphates, salt and water into its chicken. Consider replacing your chicken, that is only about 70 percent chicken, with 100 percent all-natural chicken.” Board members break out in laughter. At the end of the spot, a voice-over chimes in: “Unlike McDonald’s, all of Arby’s chicken sandwiches are made with 100 percent all-natural chicken.”Suzanne Vranica, “Arby’s TV Spots Play Game of Fast-Food Chicken,” Wall Street Journal, July 5, 2006, A16. This messaging strategy is more common in the United States than in other cultures like Japan, where it is extremely rare because some people consider it a rather abrupt and even rude way to communicate.
SS+K Spotlight
SS+K developed a comparative message in recent work for its client My Rich Uncle to draw attention to the different options that parents and students have to pay for college. See the ad below and listen to the radio spot, titled “Ahem.” At the beginning of the spot you’ll hear a man’s voice stating an ISCI code, agency, and title of spot. This is called a slate, and it is used by radio stations to ensure they are playing the correct spot.
Audio Clip
“Ahem”
http://app.wistia.com/embed/medias/0dd16a8843
The radio spot “Ahem” features a humorous voice of a brain to continue the comparative approach of the campaign.
Situational Effects
Where a message is said—that is, our physical and social environment—affects how receptive we are to the advertising message. What’s part of the physical environment? Surroundings and decor, for example. Our arousal levels rise when we’re in the presence of others. This arousal can be positive or negative. Watching a funny movie is often more enjoyable in a full movie theater where everyone else is laughing, too. But if we feel uncomfortably crowded, we may put up our guard.
Intangibles like odors and even temperature affect our ability and desire to listen to messages. Indeed, a growing number of marketers are counting on scents to turn into dollars as they invest in costly new technologies to create scented ads (a magazine ad with a scent strip costs four to eight times as much as an odorless version). Sure, we’re used to a bombardment of perfume smells when we open a fashion magazine, but today the boundaries have widened considerably. Kraft Foods promoted its new DiGiorno Garlic Bread Pizza with a scratch-and-sniff card (good to carry with you if you plan to encounter vampires). On behalf of its client the pay-cable Showtime network, TV Show Initiative (a unit of Interpublic Group) promoted the popular show “Weeds” by adding the scent of marijuana to strips in magazine ads. (So far, no reports of anyone trying to roll up the page and smoke it.)Stephanie Kang and Ellen Byron, “Scent Noses Its Way into More Ad Efforts,” Wall Street Journal, October 8, 2007, B7.
Finally, the message has to stand out from the clutter of competing messages and stimuli, which can be a challenge given the multiple stimuli vying for our attention at any one time. Consumers often are in a state of sensory overload, where they are exposed to far more information than they can process. The average adult is exposed to about 3,500 pieces of advertising information every single day—up from about 560 per day thirty years ago.
Getting the attention of younger people in particular is a challenge—as your professor probably knows! By one estimate, 80 percent of teens today engage in multitasking, where they process information from more than one medium at a time as they attend to their cell phones, TV, instant messages, and so on.Jennifer Pendleton, “Multi Taskers,” Advertising Age, March 29, 2004, S8. One study observed four hundred people for a day and found that 96 percent of them were multitasking about a third of the time they used media.Sharon Waxman, “At an Industry Media Lab, Close Views of Multitasking,” New York Times, May 15, 2006, www.nytimes.com/2006/05/15/technology/15research.htm (accessed May 15, 2006). Advertisers struggle to understand this new condition as they try to figure out how to talk to people who do many things at once.
Key Takaway
How a message is said can often be as important as what is said. Key elements to consider include the nature of the message’s source, how it’s structured, and the environment in which people see or hear it.
EXERCISES
1. Explain how advertisers use source credibility and source attractiveness to communicate more effectively.
2. List and describe the various types of messages that advertisers can use to communicate with their markets. Use specific terms in your description. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.03%3A_Is_the_Medium_the_Message_Components_of_Communications.txt |
LEARNING OBJECTIVE
After studying this section, students should be able to do the following:
1. Discuss the diffusion of innovations process and its various stages.
Communications often involves new ideas, new products, and new information. Whether people adopt a new idea or product depends on many factors. The communications model for advertising (discussed above) is affected by the forces that govern the diffusion of innovation.
The Diffusion Model
The Burger “King.” The GEICO gecko. “Bounty, the quicker picker upper.” “Where’s the beef?” The “swoosh.” Most of us are very familiar with these advertising characters and phrases—in fact, some days it seems everyone we know sends us the same hilarious YouTube clip to check out the latest spot. Did you ever wonder why a phrase you hear for the first time one day suddenly comes out of everyone’s lips a week later? How does this process work, and why should we care? The latter question is easy: Advertising depends on the transmission of information among members of a society to spread the word about new ideas, products, and services.
A lot of cutting-edge advertising strategies depend on our willingness—and enthusiasm—to share information and ideas that appeal to us with others. Indeed, this is the backbone of viral marketing, which we’ll talk about in detail later—basically this term refers to a process where people pass on a phrase, a joke, a slogan, or perhaps a URL to their network of friends, who in turn pass it on to others until thousands or even millions of us see it (think about how often more than one friend or acquaintance sends you the same e-mail joke). Each of these little pieces of information is a meme, a unit of cultural information (the biologist Richard Dawkins coined this phrase in his book The Selfish Gene).Richard Dawkins, The Selfish Gene (London: Oxford University Press, 1978).
Today memes travel at ferocious speeds as they bounce around in cyberspace. For example, the Web site http://www.4chan.org is one of the most prolific launchers of new memes. Its progeny include LOL (laugh out loud) cats (humorous images of cats with loud text beneath them in a fake language called “LOLspeak”; this meme also spawned the popular Web site icanhascheezburger.com), the phrase “So I herd u like mudkips” (a reference to a sea creature from the animated show “Pokémon” that generated thousands of tribute videos on YouTube), and the practice of “Rickrolling” (where a friend e-mails you to check out an online video; when you open the link expecting to see something amazing, instead you’re sent to a video of Rick Astley’s 1988 hit “Never Gonna Give You Up”—dude, you’ve been Rickrolled).Jamin Brophy-Warren, “Modest Web Site is Behind a Bevy of Memes,” Wall Street Journal Online, July 9, 2008, http://online.wsj.com/article/SB121564928060441097.html (accessed July 10, 2008); http://icanhascheezburger.com (accessed July 10, 2008).
An innovation is any idea (whether a LOL cat or a new religion), product, or service that consumers perceive to be new (whether it actually is or not!). Diffusion of innovations refers to the process by which an idea spreads through a population. To grasp how this works, think about the way a cold spreads through a dorm or office. One person “imports” the germ, and sure enough, some of those in his immediate vicinity start to hack away. They in turn transmit the cold to others so that before you know it almost everyone in the building is yearning to breathe free. Hence the viral in viral marketing. To check out (and probably share with your friends) a great new viral site, visit http://www.elfyourself.com.
Who Spreads the “Cold”?
An idea spreads in much the same way as a cold or other virus (hopefully with more pleasant results). The process begins with a small group of people, and then if it’s appealing enough it spreads (diffuses) into a larger market. We define the “spreaders” in terms of the relative speed with which they pick up the new idea:
Innovators (about 2.5 percent of the population) adopt the idea first. These are usually people who are the hard-core members of a taste culture (e.g., “tuners,” enthusiasts of hopped-up cars, or “gamers,” who closely follow the blogs about a new videogame still under wraps at a studio).
Early adopters (about 13 percent of the population) often are influential people (including those in the media, such as advertising columnists) who build buzz around a new idea, ad campaign, or product.
The early majority (about 34 percent of the population) adopt a product once it has become known. They like to be “up” on things, but only after they’ve already started to make their way into the mainstream.
The late majority (another 34 percent) are skeptical of new products and take even longer to adopt them. Together with the early majority, this is your true “mass market” consumer.
Laggards (about 16 percent of us) are the last to adopt. In fact, they may never try a new variation—“if it ain’t broke, don’t fix it.” Ironically, sometimes they stick with the tried-and-true for so long that it becomes fashionable again (e.g., Hush Puppy shoes, overalls, or farm caps).
SS+K Spotlight
The memes and trends are constantly morphing, and new influencer groups are constantly emerging, so as your career goes on as an advertising or marketing professional, you will need to stay ahead of these types of changes and understand how to apply them to your or your client’s business.
Communication professionals stay on top of things individually, but SS+K also does a few extra things to ensure that its staff is ahead of the curve. The agency conducts a Monday meeting for all three offices, where different account teams present the latest work they’ve launched for a client. Noelle Weaver, vice president, also coordinates Friday Fodder, an event where outside professionals come to speak about their business offerings. The msnbc.com team was inspired by a Friday Fodder presentation from the Brand Experience Lab that ultimately resulted in a piece of the msnbc.com campaign (which you’ll learn about later).
SS+K also uses resources like PSFK, Iconoculture, and The Intelligence Group’s Cassandra Report; their latest report is available to the public: www.trendcentral.com/WebApps/App/SnapShots/Article.aspx?ArticleId=7276.
Key Takaway
Information including new ideas, phrases, and brand names diffuses through a culture as memes. These memes tend to get adopted by certain types of people initially, who spread them to others much like a cold gets transmitted among members of a group. Advertisers need to understand who is more or less likely to “catch” a meme.
EXERCISE
Pick an example of a new style, product, or idea and demonstrate how the diffusion of innovations can spread an idea through society and the marketplace. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.04%3A_Diffusion_of_Innovations.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Demonstrate an ability to match the decision process model with a purchase decision.
2. Describe the various consumer behavior models based on motivation.
Understanding how we make decisions helps advertisers choose the right message to send at the right time.
The Decision-Making Process
The decision to purchase a product has five stages, each of which implies the need for a different type of communication. The five stages are:
1. Need recognition: first, we realize we have a need for a product. Advertising for this stage may highlight an unmet need, a common life problem, or a desirable new capability.
2. Information search: we seek out information about the product by searching the Web or asking friends. Informative advertising can demonstrate product performance or superiority.
3. Evaluation of alternatives: we compare the choices available based on various attributes. Comparative ads and two-sided messages spell out the pros (and to a lesser extent the cons) of an advertiser’s brand versus competing brands.
4. Purchase: we choose the option we like best and buy it. Ads facilitate purchase by telling us where or how to buy, or perhaps they announce a price reduction for the product.
5. Postpurchase satisfaction or dissatisfaction: we use the product and we’re either satisfied with the purchase or not. Postsale communications, such as feedback and social networks, help consumers confirm their choices or resolve issues.
Advertisers can help consumers through the decision-making process. Some ads intend to create awareness that a need exists (it was an adman, not a doctor, who invented the term “halitosis” to describe bad breath!). Other ads provide information to facilitate information search and comparisons. Progressive Insurance, for example, lets customers shop online and compare prices among major competitors. The company does not promise to have the lowest price, but it makes clear what its price is in relation to the competition. This is particularly helpful in the “evaluation of alternatives” stage as customers compare different competitive offerings.Nancy Michael, “Customer Loyalty: Elusive, but Critical,” ABA Banking Journal 99, no. 2 (2007): 42.
Who Decides?
The people who make the purchase decision can be individuals, couples, families, or businesses. In businesses, the “buying center” (a group of people tasked with making purchase decisions on behalf of the organization) typically is involved in the decision-making process because organizational decisions are more complex. Each member of the buying center plays a different role in the process, which may require different types of messages. For example, new corporate computer software might advertise how it enhances business performance for managers while it emphasizes technical sophistication for IT professionals.
SS+K’s client, the Blue Cross and Blue Shield Association, has many audiences ranging from individuals to small businesses to national accounts (companies with over five hundred people, sometimes in multiple states). The agency recently designed a campaign to address the needs of national accounts business decision makers (the HR or corporate group in charge of making insurance decisions for a corporation.)
Dig Deeper
Ariba, a provider of procurement and spending management software and services, sells to organizations such as banks. Ariba has learned that marketing to banks means understanding their priorities and challenges. Banks tend to be more conservative in their software purchase decisions because buying software often requires being able to roll it out across different branch locations. Purchasing agents at banks want to know if the manufacturer will support the product across locations and if it can be scaled quickly to other regions or departments. They want to know that the software will improve their bottom line and that others have deployed it successfully.Roger Slavens, “Understand Client Priorities, Then Deliver Solutions” B to B, March 12, 2007, 24.
Interview people whose jobs include the responsibility of purchasing items for their businesses to use. Ask them how they go about making these decisions, and what information sources they consult in this process. How important are criteria such as brand name, reputation, cutting-edge features, and color?
Models of Decision Making
Motivation refers to the processes that lead people to behave as they do. For example, why do consumers decide to buy a timeshare vacation property? An industry survey found that the most important reasons to purchase a timeshare include flexibility, low cost, a desirable resort, and the certainty of quality accommodation.Beverley Sparks, Ken Butcher, and Grace Pan, “Understanding Customer-Derived Value in the Timeshare Industry,” Cornell Hotel & Restaurant Administration Quarterly 48 (February 2007): 28. It’s important that advertisers understand what drives customers so they can design messages to address central concerns rather than minor ones.
Involvement and Perceived Risk
One important driver is a consumer’s extent of involvement with a brand or product category. It’s tempting to assume that we put more thought into purchases that are expensive, but this isn’t necessarily true. We might be motivated to put a great deal of thought and effort into choosing even a relatively cheap product if we feel our choice will reflect something about ourselves to others.
And involvement often is a function of the product’s degree of perceived risk:
• Physical risk. Will the wrong choice endanger my health or that of my family?
• Financial risk. Will the wrong choice cost me too much money?
• Social risk. Will the wrong choice embarrass me or lead to the wrong impression?
Heuristics: Rules of Thumb
Hershey or Nestlé? Coke or Pepsi? Charmin or Bounty? Lil Wayne or Usher? People don’t have the time or desire to ponder endlessly about every purchase. Heuristics are shortcuts or mental “rules of thumb” that we use when we make a decision—especially when we choose among products in a category where we don’t see huge differences or if the outcome isn’t do or die. These rules simplify the decision-making process by making it quick and easy. Common heuristics include these:
• Save the most money. Many people follow a rule like, “I’ll buy the lowest-priced choice so that I spend the least money right now.” Using this heuristic means you don’t need to look beyond the price tag to make a decision. Wal-Mart built a retailing empire by pleasing shoppers who follow this rule.
• You get what you pay for. Others might use the opposite heuristic, namely, “I’ll buy the more expensive product, because higher price often means better quality.” These consumers are influenced by ads alluding to exclusivity, quality, and uncompromising performance.
• Stick to the tried and true. Brand loyalty also simplifies the decision-making process—we buy the brand that we’ve always bought before, and thus we don’t need to spend more time and effort on the decision. It’s hard to downplay the importance of brand loyalty—and of the role that advertising plays in creating and maintaining it. In a study of the market leaders in thirty product categories, twenty-seven of the brands that were number one in 1930 (such as Ivory Soap and Campbell’s Soup) still were at the top over fifty years later.Richard W. Stevenson, “The Brands with Billion-Dollar Names,” New York Times, October 28, 1988, A1. Clearly “choose a well-known brand name” is a powerful heuristic.
Key Takaway
Some purchases matter to us a lot more than others, so it makes sense that we don’t devote the same amount of attention to advertising for every idea, product, or service. An advertiser needs to appreciate how involved her customers are likely to be; we are more likely to search out detailed information for products that are highly involving to us. In other cases we tend to fall back on heuristics, “rules of thumb” that reflect well-learned rules (such as “it must be better if it costs more”).
EXERCISES
1. Take a common product or service and demonstrate the decision-making process that an average consumer would go through when purchasing it.
2. Consumer motivation is very important to marketers and advertisers. Describe how involvement and perceived risk are used to heighten consumer motivation.
3. What is a heuristic? How do marketers and advertisers use heuristics to achieve brand loyalty? | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.05%3A_Decision_Making.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Explain how attitudes influence the information processing element in communication.
2. Define the multiattribute attitude model and the elaboration likelihood model of behavior.
3. Compare and contrast behavioral learning theories versus cognitive learning theories.
4. Illustrate the memory process by relating how things are remembered and forgotten.
Attitudes and Information Processing
An attitude is a predisposition to evaluate an object or product positively or negatively. The attitudes we form about a product or service will affect whether we’re likely to buy that product or not. Attitudes have three components:
1. Cognition: our beliefs about a product
2. Affect: how we feel about a product
3. Behavior: what we intend to do regarding the product
Response Hierarchies: Which Comes First?
Thinking, feeling, and doing can happen in any order. Psychologists originally assumed that we form attitudes through a fixed sequence of these three components: We first think about the object, then evaluate our feelings about it, and finally take action: Cognition → Affect → Behavior.
Research evidence, however, shows that we form attitudes in different sequences based on different circumstances. If we’re not very involved in or don’t care much about a purchase, we may just buy a product on impulse or because we remember a catchphrase about it instead of carefully evaluating it in relation to other products. In that case, action precedes feeling and thought: Behavior → Affect → Cognition.
Conversely, feelings—rather than thoughts—may drive the entire decision process; our emotional reactions may drive us to buy a product simply because we like its name, its packaging design, or the brand image that ads create. In this case, we see the product, have a feeling about it, and buy it: Affect → Behavior → Cognition.
Dig Deeper
Subaru of America’s researchers discovered that Subaru owners were extremely outspoken about their passionate feelings for their cars—that’s the good news. But there was bad news too: while most consumers who didn’t own a Subaru had heard of the company, very few had any strong emotional connections with the cars. In response, Subaru launched a new marketing campaign that targets car buyers who pass through three stages: the heart, the head, and the wallet. The heart stage emphasizes the love owners feel for their cars in ads that tell about taking meaningful trips together or bidding a sad farewell to an old Subaru before driving off in a new model. In the head stage, spots feature rational reasons why someone should buy a Subaru, such as the couple that decides they’d rather sell their boat than get rid of their Subaru. The final wallet stage focuses on (you guessed it) financial reasons to buy a Subaru, and this includes messages from local dealers.Aaron Baar, “New Subaru Campaign Takes Aim with Cupid’s Arrow,” Marketing Daily, April 28, 2008, http://www.mediapost.com (accessed April 28, 2008).
SS+K Spotlight
SS+K worked with the Massachusetts Teachers Association to create television and radio spots that would help the public to understand the issues around education prior to the state’s gubernatorial election. The ads featured actual public school students in Massachusetts schools learning in classroom settings. The voice-over recalled statistics that allowed viewers to understand the impact of their choices on the public school system. The spot wraps with a strong call to action—vote for Deval Patrick (who was eventually elected). What is the order of cognition, affect, and behavior in this example?
Multiattribute Attitude Models
As you can see, attitudes are complex. Because of this complexity, researchers use multiattribute attitude models to explain them. Simply put, multiattribute models say that we form attitudes about a product based on several attributes of that product, our beliefs about those attributes, and the relative importance we assign to those attributes.
The decision to purchase a car like an SUV offers a good illustration of how a multiattribute model affects purchase behavior. On the one hand, the styling and stance of a particular model might evoke feelings of power, confidence, and ruggedness. The vehicle’s high ground clearance and roomy back might be great for the consumer’s intended camping trips. On the other hand, the brand could make the consumer ill at ease—perhaps a friend had a bad experience with that car maker. And the more rational side of a consumer might balk at the high cost and poor gas mileage. Yet the vehicle looks great, so the consumer isn’t sure. And, regardless of his personal feelings about the vehicle, the consumer may also factor in social pressure: will his friends criticize him as a wasteful gas-guzzler if he buys an SUV instead of a compact hybrid? Will he buy or won’t he? The decision depends on how the buyer combines and weights these positive and negative attitude components. The suspense is killing us…
The Gift or the Wrapping? The Elaboration Likelihood Model
So what’s the bottom line for advertising—is it the gift or the wrapping that counts? The research helps us understand how to design the advertising message so that it has the most influence. If we advertise to consumers who are highly involved in the purchase decision-making process, then those consumers will primarily use their thinking to drive the decision. Therefore, strong, rational arguments (the “gift”) will be most persuasive for them.
On the other hand, consumers who are less involved will be more influenced by the “wrapping”—the images, sounds, and feelings they see or remember about the product. For them, it may be more important that Tiger Woods endorsed the car than that it gets better gas mileage than another model.
The elaboration likelihood model summarizes this theory. Under conditions of high involvement, the consumer will be more likely to process the content of the message, form an attitude about it, and make a purchase decision. Under low involvement, the consumer will respond to the style of the message (an attractive package, a popular spokesperson) rather than its substance.
Perceiving Advertising Messages
The perception process refers to the sensory stimuli (sights, sounds, smells, tastes, textures) that enter through our sensory receptors (eyes, ears, nose, mouth, and skin). We select, organize, and interpret these sensations. Promotional messages rely on as many stimuli as possible to get our attention. When creating an advertising message, creatives choose sensory stimuli carefully so that they communicate a particular meaning and feeling. For example, certain colors (especially red) create feelings of arousal and stimulate the appetite, whereas other colors (like blue) are more relaxing.
Sensory Marketing and Advertising Stimuli
Before a stimulus such as an image or sound can elicit a particular reaction in us, we first have to notice it. In today’s cluttered advertising environment, that’s no small feat. How can advertisers break through the clutter and get into the game?
Stimuli that differ from other stimuli around them are more likely to get noticed. Four ways to command a receiver’s attention are size (bigger stimuli tend to command more attention), color that differs from its surroundings, position (right-hand page magazine ads get more attention than left-hand ones), and novelty (ads in places where you don’t expect them, like walls of tunnels or restrooms).
Procter & Gamble decided to use the sense of smell to catch consumers’ attention. P&G put up posters at bus stops in London for its antidandruff shampoo Head & Shoulders Citrus Fresh. The twist: passersby could get a whiff of the scent by pushing a button on the poster.facstaff.bloomu.edu/sbatory/Adoption%20diffusion%208Aug06%20n36%20.ppt (accessed October 31, 2007).
In a very different application, Miller Genuine Draft uses a label on its beers that has special optical brighteners that light up in black light. When a nightclub turns on its black lights, for example, the bottles visually pop off the shelf because the labels glow in the dark.Leah Genuario, “Sensory Packaging: Branding that Makes Sense(s)” Flexible Packaging 9, no. 7 (2007): 12.
Subliminal Advertising
What is the hidden message in that magazine ad you’re looking at? Are you getting brainwashed by innocent-looking TV commercials that “order” you to buy a product? If you believe advertisers are doing their best to place “secret messages” all around you, you’re not alone. Subliminal perception is a topic that has captivated the public for more than fifty years, despite the fact that there is virtually no proof that this process has any effect on consumer behavior. Another word for perceptual threshold is limen (just remember “the secret of Sprite”), and we term stimuli that fall below the limen subliminal. So subliminal perception (supposedly) occurs when the stimulus is below the level of the consumer’s awareness.
A survey of American consumers found that almost two-thirds believe in the existence of subliminal advertising, and more than one-half are convinced that this technique can get them to buy things they do not really want.Michael Lev, “No Hidden Meaning Here: Survey Sees Subliminal Ads,” New York Times, May 3, 1991, D7. They believe marketers design many advertising messages so the consumers perceive them unconsciously, or below the threshold of recognition. For example, several authors single out beverage ads as they point to ambiguous shapes in ice cubes they claim are actually women’s bodies or erotic words. Most recently, ABC rejected a Kentucky Fried Chicken (KFC) commercial that invited viewers to slowly replay the ad to find a secret message, citing the network’s long-standing policy against subliminal advertising. KFC argued that the ad wasn’t subliminal at all because the company was telling viewers about the message and how to find it. The network wasn’t convinced—but you should be.Ron Ruggless, “2006 the Year in Review: Even as High Costs, New Regulations and Health Concerns Test Operators, Industry Moves forward with Innovative Products, Proactive Strategies and Big Business Deals,” Nation’s Restaurant News, December 18, 2006, www.accessmylibrary.com/coms2/summary_0286-29087275_ITM (accessed February 13, 2009).
Like this KFC ad, most examples of subliminal advertising that people “discover” are not subliminal at all—on the contrary, the images are quite apparent. Remember, if you can see it or hear it, it’s not subliminal; the stimulus is above the level of conscious awareness. Nonetheless, the continuing controversy about subliminal persuasion has been important in shaping the public’s beliefs about advertisers’ and marketers’ abilities to manipulate consumers against their will.
Although some research suggests that subliminal messages can work under very specific conditions, this technique has very little applicability to advertising even if we wanted to resort to it. For one, an advertiser would have to send a message that’s very carefully tailored to each individual rather than to a large audience. In addition, there are wide individual differences in threshold levels (what we’re capable of consciously perceiving); for a message to avoid conscious detection by consumers who have low thresholds, it would have to be so weak that it would not reach those who have high thresholds.
However, a new study surely will add fuel to the long-raging debate. The researchers reported evidence that a mere thirty-millisecond exposure to a well-known brand logo can in fact influence behavior; specifically the study found that people who were exposed to a quick shot of Apple’s logo thought more creatively in a laboratory task (mission: come up with innovative uses for a brick) than did those who saw the IBM logo.Thomas Claburn, “Apple’s Logo Makes You More Creative than IBM’s,” Informationweek, March 19, 2008, http://www.Informationweek.Com/News/Internet/Showarticle.Jhtml?Articleid=206904786 (accessed March 19, 2008). Apple will no doubt love the implication, but most other advertisers are too focused on efforts to persuade you when you’re aware of what they’re up to.
Learning and Memory for Advertising
Subliminal messages aside, the reality is that consumers have to remember the name of a product or recognize it on the shelf if they are to buy it. Snappy lyrics, unusual colors, or a distinctive logo can help consumers remember. Using a spokesperson like a talking gecko for the similar-sounding GEICO insurance company may be unique and visually appealing enough to make it memorable.
Learning
Learning is a relatively permanent change in behavior caused by experience. The learner need not have the experience directly; we can also learn by observing events that affect others.Robert A. Baron, Psychology: The Essential Science (Boston: Allyn & Bacon, 1989). We learn even when we don’t try: Consumers recognize many brand names and they can hum many product jingles, for example, even for products they themselves do not use. We call this casual, unintentional acquisition of knowledge incidental learning.
Theories of learning range from those that focus on simple stimulus-response connections (behavioral theories) to perspectives that regard consumers as solvers of complex problems who learn abstract rules and concepts as they observe others (cognitive theories). Basic learning principles are at the heart of many advertising efforts.
Behavioral Learning Theories
Behavioral learning theories assume that learning takes place as the result of responses to external events. For example, if a song we remember fondly from high school gets repeatedly paired with a brand name, over time our warm memories about the tune will rub off onto the advertised product. This process works even when the product’s name initially has no meaning at all—think about the likes of Marlboro, Adidas, and Exxon, which we have learned to respond to with strong emotions.
According to this perspective, the feedback we receive as we go through life shapes our experiences. Similarly, we respond to brand names, scents, jingles, and other marketing stimuli because of the learned connections we form over time. People also learn that actions they take result in rewards and punishments; this feedback influences the way they will respond in similar situations in the future. Consumers who receive compliments on a product choice will be more likely to buy that brand again, but those who get food poisoning at a new restaurant are not likely to patronize it in the future.
Learning about Brands
What’s more, the reactions we learn to one object tend to transfer to other, similar objects in a process psychologists term stimulus generalization. That explains why a drugstore’s bottle of private brand mouthwash deliberately packaged to resemble Listerine mouthwash may evoke a similar response among consumers, who assume that this me-too product shares other characteristics of the original. Indeed, consumers in one study on shampoo brands tended to rate those with similar packages as similar in quality and performance as well.James Ward, Barbara Loken, Ivan Ross, and Tedi Hasapopoulous, “The Influence of Physical Similarity of Affect and Attribute Perceptions from National Brands to Private Label Brands,” in American Marketing Educators’ Conference, ed. Terence A. Shimp and others (Chicago: American Marketing Association, 1986), 51–56.
Stimulus generalization is the basic idea underlying numerous branding strategies that share this approach: (1) Create a brand name that consumers learn to associate with positive qualities; (2) paste that brand name on other, reasonably similar products; (3) stand back and let the positive associations transfer to the new item.
This approach explains the success of these branding strategies:
• Family branding. Many products capitalize on the reputation of a company name. Companies such as Campbell’s, Heinz, and General Electric rely on their positive corporate images to sell different product lines.
• Product line extensions. Marketers add related products to an established brand. Dole, which we associate with fruit, introduced refrigerated juices and juice bars, whereas Sun Maid went from raisins to raisin bread.
• Licensing. Companies often “rent” well-known names. Christian Dior licenses the designer’s name to products from underwear to umbrellas.
Cognitive Learning Theories
According to the behavioral learning perspective, to a large extent the same principles that animal trainers use to teach dogs to dance (i.e., rewarding some movements with a treat while discouraging others with a loud no) operate to condition our preferences for brands. OK, it’s a little insulting—but the sad truth is it’s often true!
Of course (you respond indignantly), many things we learn are far more complex than a simple association between a stimulus and a response—and many powerful ads succeed because they tell complicated stories or convey abstract meanings. In contrast to behavioral theories of learning, cognitive learning theory approaches stress the importance of internal mental processes. This perspective views people as problem solvers who actively use information from the world around them to master their environments. Supporters of this view also stress the role of creativity and insight during the learning process.
One important aspect of a cognitive learning perspective is observational learning; this occurs when people change their own attitudes or behaviors simply by watching the actions of others—learning occurs as a result of vicarious rather than direct experience. This type of learning is a complex process; people store these observations in memory as they accumulate knowledge, perhaps using this information at a later point to guide their own behavior. Modeling (not the kind Tyra Banks does) is the process of imitating the behavior of others. For example, a woman who shops for a new kind of perfume may remember the reactions her friend received when she wore a certain brand several months earlier, and she will mimic her friend’s behavior with the hope of getting the same feedback. You should have no trouble thinking of advertisements you’ve seen that encourage you to model an actor’s behaviors at a later point in time. Try teaching that to a lab rat.
How Do We Remember What We’ve Learned?
The most exciting advertisement is worthless if it doesn’t make a reasonably lasting impact on the receiver. So, advertisers need to understand how our brains encode, or mentally program, the information we encounter that helps to determine how we will remember it (if we do at all). In general, we have a better chance of retaining incoming data we associate with other information already in memory. For example, we tend to remember brand names we link to physical characteristics of a product category (e.g., Coffee-Mate creamer or Sani-Flush toilet bowl cleaner) or that we can easily visualize (e.g., Tide detergent or Mercury Cougar cars) compared to more abstract brand names.Kim Robertson, “Recall and Recognition Effects of Brand Name Imagery,” Psychology & Marketing 4 (Spring 1987): 3–15.
The encoding process is influenced by the type of meaning we experience from a stimulus. Sometimes we process a stimulus simply in terms of its sensory meaning, such as the literal color or shape of a package. We may experience a feeling of familiarity when, for example, we see an ad for a new snack food we have recently tasted. In many cases, though, we encode meanings at a more abstract level. Semantic meaning refers to symbolic associations, such as the idea that NASCAR fans drink beer or that cool women have Asian-inspired koi designs tattooed on their ankles.
Advertisers often communicate these kinds of meanings through a narrative, or story. For example, in 2006 SS+K created television spots for the New York Knicks basketball team that featured some of the biggest Knicks fans, including film director Spike Lee, talking about the current state of the team, as well as lifelong Knicks fans who share fond memories of past glories.
Much of the social information we acquire gets represented in memory in story form, so constructing ads in the form of a narrative can be a very effective technique to connect with consumers. Narratives persuade people to construct mental representations of the information they view. Pictures aid in this construction and allow for a more developed and detailed mental representation.Jennifer Edson Escalas, “Narrative Processing: Building Consumer Connections to Brands,” Journal of Consumer Psychology 14, nos. 1 & 2 (2004): 168–80; Rashmi Adaval and Robert S. Wyer, Jr., “The Role of Narratives in Consumer Information Processing,” Journal of Consumer Psychology 7, no. 3 (1998): 207–46.
Types of Memory
Psychologists distinguish among three distinct types of memory systems, each of which plays a role in processing brand-related information:
1. Sensory memory permits storage of the information we receive from our senses. This storage is very temporary; it lasts a couple of seconds at most. For example, a woman walks past the perfume counter in a department store and gets a quick, aromatic whiff of Brit for Women by Burberry. Although this sensation lasts only a few seconds, it is sufficient to allow her to consider whether she should investigate further. If she retains this information for further processing, it passes into short-term memory.
2. Short-term memory (STM) also stores information for a limited period of time, and it has limited capacity. This is similar to working memory in a computer; it holds the information we are currently processing. Our memories can store verbal input acoustically (in terms of how it sounds) or semantically (in terms of what it means). We store it when we combine small pieces of data into larger chunks. A chunk is a configuration that is familiar to the person and that she can think about as a unit. For example, a brand name like Glow by JLo can be a chunk that summarizes a great deal of detailed information about the product.
3. Long-term memory (LTM) is the system that allows us to retain information for a long period of time. Information passes from STM into LTM via the process of elaborative rehearsal. This means we actively think about the chunk’s meaning and relate it to other information already in memory. Advertisers sometimes assist in the process when they devise catchy slogans or jingles that consumers repeat on their own. So, “don’t leave home without it,” “just do it,” or “let your fingers do the walking.”
How Do We Store Information in Memory?
It’s important to understand how we store all of the massive amounts of information we retain in our minds. Just like a really disorganized “filing cabinet from hell,” our memories about brands (not to mention everything else we know) are useless if we don’t know where to find them. Advertisers can structure their communication to make it more likely that subsequent messages will call up the knowledge of a brand we’ve already absorbed.
A popular perspective on this process is an activation model of memory, which proposes that each incoming piece of information in LTM is stored in an associative network that contains many bits of information we see as related. Each of us has organized systems of concepts relating to brands, manufacturers, and merchants stored in our memories; the contents, of course, depend on our own unique experiences.
Think of these storage units, or knowledge structures, as complex spider webs filled with pieces of data. Incoming information gets put into nodes that link to one another. When we view separate pieces of information as similar for some reason, we chunk them together under some more abstract category. Then we interpret new incoming information to be consistent with the structure we have created. This helps explain why we are better able to remember brands or merchants that we believe “go together”—for example, when Juicy Couture rather than Home Depot sponsors a fashion show.
A marketing message may activate our memory of a brand directly (for example, by showing us a picture of it), or it may do so indirectly if it links to something else that’s related to the brand in our knowledge structure. If it activates a node, it will also activate other linked nodes, much as tapping a spider’s web in one spot sends movement reverberating across the web. Meaning thus spreads across the network, and we recall concepts, such as competing brands and relevant attributes, that we use to form attitudes toward the brand. Researchers label this process spreading activation.
How Do We Access Our Memories?
Retrieval is the process whereby we recover information from long-term memory. Each of us has a vast quantity of information stored in our heads (quick: What team won last year’s Super Bowl? Who is the current “American idol”?), but these pieces of data may be difficult or impossible to retrieve unless the appropriate cues are present.
Individual cognitive or physiological factors are responsible for some of the differences we see in retrieval ability among people.S. Danziger, S. Moran, and V. Rafaely, “The Influence of Ease of Retrieval on Judgment as a Function of Attention to Subjective Experience,” Journal of Consumer Psychology 16, no. 2 (2006): 191–95. Some older adults consistently display inferior recall ability for current items, such as prescription drug instructions, although they may recall events that happened to them when they were younger with great clarity.Roger W. Morrell, Denise C. Park, and Leonard W. Poon, “Quality of Instructions on Prescription Drug Labels: Effects on Memory and Comprehension in Young and Old Adults,” The Gerontologist 29 (1989): 345–54. Other factors that influence retrieval are situational; they relate to the environment in which the message is delivered.
Not surprisingly, recall is enhanced when we pay more attention to the message in the first place. Some evidence indicates that we can retrieve information about a pioneering brand (the first brand to enter a market) more easily from memory than we can for follower brands, because the first product’s introduction is likely to be distinctive and, for the time being, has no competitors to divert our attention.Frank R. Kardes, Gurumurthy Kalyanaram, Murali Chandrashekaran, and Ronald J. Dornoff, “Brand Retrieval, Consideration Set Composition, Consumer Choice, and the Pioneering Advantage” (unpublished manuscript, the University of Cincinnati, Ohio, 1992). In addition, we are more likely to recall descriptive brand names than those that do not provide adequate cues as to what the product is.Judith Lynne Zaichkowsky and Padma Vipat, “Inferences from Brand Names,” paper presented at the European meeting of the Association for Consumer Research, Amsterdam, June 1992.
Of course, the nature of the ad itself also plays a big role in determining whether we’ll remember it. We’re far more likely to remember spectacular magazine ads, including multipage spreads, three-dimensional pop-ups, scented ads, and ads with audio components.Erik Sass, “Study Finds Spectacular Print Ads Get Spectacular Recall,” Marketing Daily, February 23, 2007, http://www.mediapost.com (accessed February 23, 2007). Here are some other factors advertisers need to remember:
• State-dependent retrieval. We are better able to access information if our internal state is the same at the time of recall as when we learned the information. If, for example, we recreate the cues that were present when the information was first presented, we can enhance recall. That’s why Life cereal uses a picture of “Mikey” from its commercial on the cereal box, which facilitates recall of brand claims and favorable brand evaluations.Kevin Keller, “Memory Factors in Advertising: The Effect of Advertising Retrieval Cues on Brand Evaluations,” Journal of Consumer Research 14 (1987): 316–33.
• Familiarity. Familiarity enhances recall. Indeed, this is one of the basic goals of marketers who try to create and maintain awareness of their products. However, this sword can cut both ways: Extreme familiarity can result in inferior learning and recall. When consumers are highly familiar with a brand or an advertisement, they may pay less attention to the message because they do not believe that any additional effort will yield a gain in knowledge.Eric J. Johnson and J. Edward Russo, “Product Familiarity and Learning New Information,” in Kent Monroe, ed., Advances in Consumer Research 8 (Ann Arbor, MI: Association for Consumer Research, 1981): 151–55; John G. Lynch and Thomas K. Srull, “Memory and Attentional Factors in Consumer Choice: Concepts and Research Methods,” Journal of Consumer Research 9 (June 1982): 18–37.
• Salience. The salience of a brand refers to its prominence or level of activation in memory. As we have already noted, stimuli that stand out in contrast to their environments are more likely to command attention which, in turn, increases the likelihood that we will recall them. This explains why unusual advertising or distinctive packaging tends to facilitate brand recall.Joseph W. Alba and Amitava Chattopadhyay, “Salience Effects in Brand Recall,” Journal of Marketing Research 23 (November 1986): 363–70; Elizabeth C. Hirschman and Michael R. Solomon, “Utilitarian, Aesthetic, and Familiarity Responses to Verbal versus Visual Advertisements,” in Advances in Consumer Research 11, ed. Thomas C. Kinnear (Provo, UT: Association for Consumer Research, 1984): 426–31.
• Novelty. Introducing a surprise element in an ad can be particularly effective in aiding recall, even if it is not relevant to the factual information the ad presents.Susan E. Heckler and Terry L. Childers, “The Role of Expectancy and Relevancy in Memory for Verbal and Visual Information: What Is Incongruency?” Journal of Consumer Research 18 (March 1992): 475–92. In addition, mystery ads, in which the ad doesn’t identify the brand until the end, are more effective at building associations in memory between the product category and that brand—especially in the case of relatively unknown brands.Russell H. Fazio, Paul M. Herr, and Martha C. Powell, “On the Development and Strength of Category-Brand Associations in Memory: The Case of Mystery Ads,” Journal of Consumer Psychology 1, no. 1 (1992): 1–13.
• Pictorial versus verbal cues. Is a picture worth a thousand words? Indeed, we are more likely to recognize information presented in picture form at a later time.Terry Childers and Michael Houston, “Conditions for a Picture-Superiority Effect on Consumer Memory,” Journal of Consumer Research 11 (September 1984): 643–54; Terry Childers, Susan Heckler, and Michael Houston, “Memory for the Visual and Verbal Components of Print Advertisements,” Psychology & Marketing 3 (Fall 1986): 147–50. Certainly, visual aspects of an ad are more likely to grab a consumer’s attention. In fact, eye-movement studies indicate that about 90 percent of viewers look at the dominant picture in an ad before they bother to view the copy.Werner Krober-Riel, “Effects of Emotional Pictorial Elements in Ads Analyzed by Means of Eye Movement Monitoring,” in Advances in Consumer Research 11, ed. Thomas C. Kinnear (Provo, UT: Association for Consumer Research, 1984): 591–96. But, while ads with vivid images may enhance recall, they do not necessarily improve comprehension. One study found that television news items presented with illustrations (still pictures) as a backdrop result in improved recall for details of the news story, even though understanding of the story’s content did not improve.Hans-Bernd Brosius, “Influence of Presentation Features and News Context on Learning from Television News,” Journal of Broadcasting & Electronic Media 33 (Winter 1989): 1–14.
What Makes Us Forget?
Marketers obviously hope that consumers will not forget about their products. However, in a poll of more than thirteen thousand adults, more than half were unable to remember any specific ad they had seen, heard, or read in the past thirty days.Raymond R. Burke and Thomas K. Srull, “Competitive Interference and Consumer Memory for Advertising,” Journal of Consumer Research 15 (June 1988): 55–68. How many can you remember right now? Clearly, forgetting by consumers is a big headache for marketers (not to mention a problem for students when they study for exams!).
Why do we forget? Some memories simply fade with the passage of time; they decay as the structural changes learning produces in the brain simply go away. But most forgetting is due to interference; as we learn additional information, it displaces the earlier information. Because we store pieces of information in associative networks, we are more likely to retrieve a meaning concept when it’s connected by a larger number of links. As we integrate new concepts, a stimulus is no longer as effective to retrieve the old response. These interference effects help to explain why we have trouble remembering brand information. Since we tend to organize attribute information by brand, when we learn additional attribute information about the brand or about similar brands, this limits our ability to activate the older information.Joan Meyers-Levy, “The Influence of Brand Name’s Association Set Size and Word Frequency on Brand Memory,” Journal of Consumer Research 16 (September 1989): 197–208.
Key Takaway
A major objective of advertising is to create or modify customers’ attitudes toward an idea, product, or service. Advertisers need to be aware of the complex mental processes that relate to this process. These include the factors that determine how we perceive and make sense of external stimuli, how we learn about them, and whether or not we will remember them.
EXERCISES
1. List and briefly describe the three components of attitude. Think of an ad that might illustrate each of the three categories.
2. Take any common product that you have recently purchased and relate that purchase to the response hierarchy described in this chapter section. Which response hierarchy most closely matches your purchase?
3. Create an example involving a low involvement product versus a high involvement product to illustrate the Elaboration Likelihood Model. Explain how your example matches this model.
4. Compare and contrast the behavioral learning theory model with the cognitive learning theory model. Which model seems to be most applicable to the learning process in consumer behavior? Why? | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.06%3A_Internal_Influences_on_Consumers.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Discuss opinion leaders and their impact on the marketing and advertising process.
2. Categorize the various group identifications (e.g., reference groups, subcultures, taste cultures, and brand communities).
As social creatures, human beings like to “fit in” and belong to groups. These group memberships help us define our identity. Both individuals and groups influence our attitudes toward products in profound ways.
Opinion Leaders
Most of us eagerly solicit others’ opinions about brands, but we don’t pay attention to just anyone. An opinion leader is a person who is frequently able to influence others’ attitudes or behaviors.Everett M. Rogers, Diffusion of Innovations, 3rd ed. (New York: Free Press, 1983). Advertisers like to reach opinion leaders when they can, so they can enlist these individuals to help them spread the word on their behalf. For example, the BzzAgent word-of-mouth network identifies people who like to talk to others about products. The company recruits BzzAgents at its Web site (http://www.bzzagent.com), where it invites prospective agents to be “part of a growing international network of over 425,000 consumers” who share their honest opinions about its clients’ products with people they know.www.bzzagent.com/signup/NewAgentSignup.do (accessed July 8, 2008).
In addition, opinion leaders also are likely to be opinion seekers. They are generally more involved in a product category and actively search for information. As a result, they are more likely to talk about products with others and to solicit others’ opinions as well.Laura J. Yale and Mary C. Gilly, “Dyadic Perceptions in Personal Source Information Search,” Journal of Business Research 32 (1995): 225–37. Contrary to an outmoded, static view of opinion leadership, most product-related conversation does not take place in a “lecture” format in which one person does all of the talking. A lot of product-related conversation occurs in the context of a casual interaction rather than as formal instruction.Russell W. Belk, “Occurrence of Word-of-Mouth Buyer Behavior as a Function of Situation and Advertising Stimuli,” in Combined Proceedings of the American Marketing Association, series no. 33, ed. Fred C. Allvine (Chicago: American Marketing Association, 1971): 419–22.
The Market Maven
Opinion leaders tend to “specialize” in a category (e.g., fashion or electronics), while a market maven likes to transmit marketplace information of all types. These shopaholics simply like to stay on top of what’s happening in the marketplace.For discussion of the market maven construct, see Lawrence F. Feick and Linda L. Price, “The Market Maven,” Managing (July 1985): 10; scale items adapted from Lawrence F. Feick and Linda L. Price, “The Market Maven: A Diffuser of Marketplace Information,” Journal of Marketing 51 (January 1987): 83–87. They are likely to strongly agree with statements like “I like helping people by providing them with information about many kinds of products” and “My friends think of me as a good source of information when it comes to new products or sales.” Anyone you know?
The Surrogate Consumer
Unlike an informal opinion leader, a surrogate consumer is a person whom we hire to provide input into our purchase decisions. These include interior decorators, stockbrokers, professional shoppers, and even college consultants who help prospective students identify schools that will be the best match for them. Surrogates can exert a huge influence on consumers’ decisions. Advertisers tend to overlook surrogates when they try to convince consumers to buy their goods or services. This can be a big mistake: they may mistarget their communications to end consumers instead of to the surrogates who actually sift through product information and decide among product alternatives. For example, in many cases (particularly for more affluent people) it’s an interior designer who makes a lot of decisions about the furnishings a client will put into a room; the client just writes the check.Michael R. Solomon, “The Missing Link: Surrogate Consumers in the Marketing Chain,” Journal of Marketing 50 (October 1986): 208–18.
Reference Groups
A reference group is “an actual or imaginary individual or group conceived of as having significant relevance upon an individual’s evaluations, aspirations or behavior.”C. Whan Park and V. Parker Lessig, “Students and Housewives: Differences in Susceptibility to Reference Group Influence,” Journal of Consumer Research 4 (September 1977): 102–10. Reference groups are important because they determine to whom we’ll listen (for example, we’re more likely to heed the advice of friends than strangers). Advertising messages that come from members of our reference group will have more influence over us, because we want to fit in and conform to that group.
Why are reference groups so persuasive? The answer lies in the potential power they wield over us. Social power is “the capacity to alter the actions of others.”Kenneth J. Gergen and Mary Gergen, Social Psychology (New York: Harcourt Brace Jovanovich, 1981), 312. To the degree to which you are able to make someone else do something, regardless of whether they do it willingly, you have power over that person. The experts and beautiful people we discussed earlier tend to possess social power over the rest of us, but for different reasons.
Subcultures
A subculture is a group of people whose members share common beliefs and common experiences. A subculture may be based on religion, age, ethnic background, race, and even on the place where we live. Silicon Valley subculture contrasts with that of the Deep South or Boston’s Back Bay, for example. We’ll get into some of these groups in more detail when we discuss market segmentation.
Taste Cultures
In contrast to larger, demographically based subcultures (which nature usually determines), people who are part of a taste culture freely choose to identify with a lifestyle or aesthetic preference. For example, vegans avoid using or consuming animal products; they choose to avoid eating meat or eggs; wearing fur, leather, wool, or down; and using cosmetics or chemical products tested on animals. These are overt expressions of a lifestyle philosophy (cruelty-free), but adherents also respond to messages that are consistent with their needs. For example, at http://www.mooshoes.com, you can buy vegan shoes that feature faux leather lining and a faux suede exterior.
Brand Communities
A brand community is a group of consumers who share a set of social relationships based upon usage or interest in a product. At the Web site http://www.jonessoda.com, community members submit their own label photos, and they view and rate the forty-three thousand photos other members have submitted.smackinc.com/media/pdf/brand_communities_jones_soda.pdf (accessed July 8, 2008). Unlike other kinds of communities, these members typically don’t live near each other—except when they may meet for brief periods at organized events or brandfests that community-oriented companies such as Jeep, Saturn, or Harley-Davidson sponsor. These events help owners to “bond” with fellow enthusiasts and strengthen their identification with the product as well as with others they meet who share their passion.
A consumer tribe is a similar concept; this term refers to a group of people who identify with one another because of a shared allegiance to an activity or a product. Although these tribes are often unstable and short-lived, at least for a time members identify with others through shared emotions, moral beliefs, styles of life, and of course the products they jointly consume as part of their tribal affiliation. Pontiac opened a community hub on Yahoo! it calls Pontiac Underground (http://pontiacunderground.com, “Where Passion for Pontiac Is Driven by You”). The carmaker does no overt marketing on the site; the idea is to let drivers find it and spread the word themselves. Users share photos and videos of cars using Flickr and Yahoo! Video. A Yahoo! Answers Zone enables knowledge sharing. Meanwhile, a list of Pontiac clubs in the physical world and on Yahoo! Groups allows users to connect offline and online.Laurie Petersen, “Pontiac Goes Underground to Tap Fans,” Marketing Daily, February 8, 2007, www.mediapost.com/publications/?fa=Articles.show Article&art_aid=55227 (accessed February 8, 2007); pontiacunderground.autos.yahoo.com (accessed July 8, 2008).
Dig Deeper
For many years BMW’s advertising has emphasized its sophisticated engineering as it appealed to affluent car enthusiasts. Lately, however, the company is broadening its message to be one of innovation and independence, as it hopes to entice drivers who are more captivated by the style of a car’s interior than the engine that sits under the hood. In one ad, the company highlights the design for a glass-walled new factory in Leipzig rather than a car model. Its strategy is to appeal to what it calls “the idea class”: self-motivated architects, professionals, and entrepreneurs who value authenticity and independent thinking. They buy luxury cars, but they’re not car nuts.
Why the change? An internal study found that of the 1.9 million consumers who bought luxury cars in a recent year, 1.4 million didn’t even consider BMW. About six hundred thousand of those non–BMW purchasers said they were looking for a car that’s fun to drive. A BMW marketing executive noted that for the company, “that is low-hanging fruit.” Still, many of those buyers instead drove home a Saab, Infiniti, Acura, or Lexus. The new ads were created by GSD&M/Idea City, BMW’s ad agency, to convince these people that the values of innovation and independent thinking run deep in the company’s corporate culture (presumably in contrast to larger automakers that aren’t as free to innovate). As this executive observed, “It should appeal to the idea class that we are independent, that we are free to do something.”Quoted in Neal E. Boudette and Gina Chon, “Brawny BMW Seeks ‘The Idea Class,’” Wall Street Journal, August 2, 2006, B1.
Key Takaway
Each of us belongs to many groups—some by birth and some by choice. To a greater or lesser extent these group memberships influence our consumption choices and the types of advertising messages that appeal to us. A product’s (perceived) connection to a group we find desirable often is a key theme in advertising.
EXERCISES
1. Explain the role opinion leaders and market mavens play in shaping communications about new products.
2. List and describe each of the various group identification forms discussed in this section of the chapter. Provide a brief example of each of the forms you have listed. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.07%3A_External_Influences_on_Consumers.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Describe the advantages and disadvantages associated with standardization versus localization in global markets.
2. Explain the concept of semiotics and its impact on communication and marketing.
Culture is the accumulation of shared meanings, rituals, norms, and traditions among the members of an organization or society. We can’t understand advertising unless we consider its cultural context: culture is the lens through which consumers make sense of marketing communications.
Myths and Rituals
In China eight is the luckiest number. The Chinese word for eight is ba, which rhymes with fa, the Chinese character for wealth. It was no coincidence that the Summer Olympics in Beijing opened on 8/8/08 at 8 p.m.Jim Yardley, “First Comes the Car, Then the \$10,000 License Plate,” New York Times Online, April 16, 2006, http://www.nytimes.com/2006/07/05/world/asia/05china.html (accessed April 16, 2006). Virtually every culture believes in “lucky” or “unlucky” numbers (just try to find a thirteenth floor in an American hotel).
Myths and rituals are the stories and practices that define a culture. A myth is a story with symbolic elements that represents a culture’s ideals. Each culture creates its own stories to help its members understand the world. Many companies (and perhaps most advertising agencies) are in a sense in the myth business; they tell us stories that we collectively absorb. Some marketers tell these stories more overtly than others: Disney stages about two thousand Cinderella weddings every year; the princess bride wears a tiara and rides to the park’s lakeside wedding pavilion in a horse-drawn coach, complete with two footmen in gray wigs and gold lamé pants.Merissa Marr, “Fairy-Tale Wedding? Disney Can Supply the Gown,” Wall Street Journal, February 22, 2007, B1; Lauram M. Holson, “For \$38,000, Get the Cake, and Mickey, Too,” New York Times on the Web, May 24, 2003, http://www.nytimes.com/2003/05/24/business/24WEDD.html?pagewanted=2&ei=5007&en=8bd92e1431ff9b1a &ex=1369108800&partner=USERLAND&adxnnlx=1207627760- 9tjoRyeGvDg0tX6caBRguA (accessed February 1, 2009). And the Shrek movies remind us that even the ugliest suitor can land the princess if his heart is in the right place. To appreciate some more of the “popular culture gods” we worship, just tune in to next year’s Macy’s Thanksgiving Day Parade and observe the huge balloon figures floating by.
A ritual is a set of multiple symbolic behaviors that occurs in a fixed sequence and is repeated periodically.See Dennis W. Rook, “The Ritual Dimension of Consumer Behavior,” Journal of Consumer Research 12 (December 1985): 251–64; Mary A. Stansfield Tetreault and Robert E. Kleine, III, “Ritual, Ritualized Behavior, and Habit: Refinements and Extensions of the Consumption Ritual Construct,” in Advances in Consumer Research 17, ed. Marvin Goldberg, Gerald Gorn, and Richard W. Pollay (Provo, UT: Association for Consumer Research, 1990): 31–38. We all engage in private consumer rituals, whether this involves grooming activities that we perform the same way every morning or that obligatory trip to Starbucks on the way to school. And as members of a culture we share public rituals such as Thanksgiving, the Super Bowl, or even tuning in each week to vote on American Idol. Advertisers often create messages that tie in to these myths and rituals, such as selling HDTVs for the Super Bowl and Doritos to share with your friends as you watch the game. Sometimes they deliberately create rituals among their customers, be it an evening cleansing ritual for a beauty product or a nine-step pouring ritual to pour a perfect beer, as Stella Artois showcases on its Web site, www.stellaartois.com.“Stella Artois Launches New, Film-Inspired, Global Brand Website,” Telecomworldwire, September 19, 2007, http://findarticles.com/p/articles/mi_m0ECZ/is_2007_Sept_19/ai_n20513193 (accessed February 1, 2009).
Is the World Flat?
Since a country’s culture is so complex and integral to how we make sense of the world, advertisers constantly grapple with a Big Question: does advertising “travel” from country to country? There are two viewpoints on this important issue.
Yes: Standardize for Greater Efficiency
Some advertisers say that advertising does travel from country to country. Proponents of this viewpoint argue that many cultures, especially those of industrialized countries, have become so homogenized that the same advertising will work throughout the world. By developing one approach for multiple markets, an advertiser benefits from economies of scale because it does not have to incur the substantial time and expense to develop a separate campaign for each culture.Theodore Levitt, The Marketing Imagination (New York: The Free Press, 1983). The 2006 World Cup, which was broadcast in 189 countries to one of the biggest global television audiences ever, illustrates how a standardized approach looks. MasterCard ran ads that appeared in thirty-nine countries, so its ad agency came up with a spot called “Fever,” in which a hundred-odd cheering fans from thirty countries appear. There’s no dialogue, so it works in any language. At the end, the words, “Football fever. Priceless” appeared under the MasterCard logo.Aaron O. Patrick, “World Cup’s Advertisers Hope One Size Fits All: Month-Long Tournament Sets Off Scramble to Reach Huge Global TV Audience,” Wall Street Journal, March 28, 2006, B7.
No: Customize to Appeal to Local Tastes
Other advertisers point to huge variations across cultures. They feel that each culture is unique, with its own value system, conventions, and regulations. This perspective argues that each country has a national character, a distinctive set of behavior and personality characteristics.Terry Clark, “International Marketing and National Character: A Review and Proposal for an Integrative Theory,” Journal of Marketing 54 (October 1990): 66–79. An advertiser must therefore tailor its strategy to the sensibilities of each specific culture.
At a basic level, the need to customize is a no-brainer: Consumers speak many different languages, and intended meanings in one tongue don’t always translate seamlessly to another. It’s unlikely that Bimbo, a popular Mexican bread brand, or Super Piss, a Scandinavian product to unfreeze car locks, would go over well in the United States.
Advertisers have (for the most part) learned the hard way over the years to avoid obvious language gaffes. They often conduct back-translation, where a different interpreter retranslates a translated ad back into its original language to catch errors.Shelly Reese, “Culture Shock,” Marketing Tools (May 1998): 44–49; Steve Rivkin, “The Name Game Heats Up,” Marketing News, April 22, 1996, 8; David A. Ricks, “Products That Crashed into the Language Barrier,” Business and Society Review (Spring 1983): 46–50. Still, mistakes do creep in:
• The Scandinavian company that makes Electrolux vacuum cleaners introduced the products in United States with this slogan: “Nothing sucks like an Electrolux.”
• When Parker marketed a ballpoint pen in Mexico, its claim “It won’t leak in your pocket and embarrass you” came out as “It won’t leak in your pocket and make you pregnant.”
• Fresca (a soft drink) is Mexican slang for “lesbian.”
• Ford also ran into problems in Latin markets. The company had to change the names for its Fiera truck and its Caliente and Pinto cars. In Spanish, a fiera is an ugly old woman and a caliente is slang for a streetwalker; pinto is Brazilian slang for “small male appendage.”
• Buick had to rename its LaCrosse sedan the Allure in Canada after the company discovered that the name comes awfully close to a Québécois word for masturbation.
• IKEA had to explain that the Gutvik children’s bunk bed is named “for a tiny town in Sweden” after German shoppers noted that the name sounded a lot like a phrase that means “good f**.” IKEA has yet to issue an explanation for a workbench it calls the Fartfull.Mark Lasswell, “Lost in Translation,” Business (August 2004): 68–70.
Language aside, there are many instances where cultural sensitivities vary widely, and advertisers that try to export their own symbolism to another country do so at their own peril. In China, an ad for Nippon Paint (a Japanese brand) caused an uproar; it showed a sculptured dragon unable to keep its grip on a pillar coated in smooth wood-coating paint. Dragons are potent symbols in China, and seeing one easily defeated by a Japanese product proved too much.“China Bans Offending Nike Advert,” BBC News, December 6, 2004, http://news.bbc.co.uk/2/hi/asia-pacific/4072203.stm (accessed February 13, 2009).
How Local Do Ads Need to Be?
So what’s the correct answer? Although it feels warm and fuzzy to state that people are people wherever you go, in practice the standardization perspective hasn’t worked out too well. One reason for the failure of global marketing is that consumers in different countries have varying conventions and customs, so they simply do not use products the same way. Kellogg’s, for example, discovered that in Brazil people don’t typically eat a big breakfast—they’re more likely to eat cereal as a dry snack.
True, some large corporations such as Coca-Cola have been pretty successful at crafting a single, international image. Still, even the soft drink giant must make minor modifications to the way it presents itself in each culture. Although Coke commercials are largely standardized, the company permits local agencies to edit them so they highlight close-ups of local faces.J. S. Hill and J. M. Winski, “Goodbye Global Ads: Global Village Is Fantasy Land for Big Marketers,” Advertising Age 58, no. 49 (1987): 22, 36. In their product as well as their advertising, Coke modifies the flavors of its product based on the tastes of the locals. These flavors can be taste-tested at Coke Headquarters in Atlanta or World of Coke at Disney’s Epcot Center in Orlando.
For a standardized approach to work, it needs to appeal to consumers in each market that share a lot in common (other than perhaps language and allegiance to one soccer team or another). Two types of consumers are good candidates: (1) affluent people who are “global citizens” and who come into contact with ideas from around the world through their travels, business contacts, and media experiences; and (2) young people whose tastes in music and fashion are strongly influenced by MTV and other media that broadcast many of the same images to multiple countries.
Semiotics: What Does It All Mean?
Advertising is about communicating meaning—but how do we know what something means? This question is not as obvious (or perhaps as crazy) as it seems. Very often we make sense of a word, phrase, or image because we’ve learned to associate extremely subtle cultural distinctions with it. For example (speaking of standardizing advertising across cultures), some Chinese companies use ancient pictograms to create new corporate logos that make sense both to native consumers and to potential customers elsewhere. The Chinese alphabet uses symbols that stand for the words they signify. For example, China Telecom’s logo features two interlocking letter Cs that together form the Chinese character for China but also represent the concept of “customer” and “competition,” the firm’s new focus. In addition, though, the symbol also resembles the horns of an ox, a hard-working animal. The software company Oracle redesigned its logo for the Chinese market by adding three Chinese characters that signify the literal translation of the word oracle, “writing on a tortoise shell.” The expression dates back to ancient China when prophecies were scrawled on bones. The California firm was enthusiastic about the translation because it conveyed Oracle’s core competency—data storage.Gabriel Kahn, “Chinese Characters Are Gaining New Meaning as Corporate Logos,” Wall Street Journal Interactive Edition, July 18, 2002, n.a.
Semiotics is the field of study that looks at the relationship between signs and symbols and their role in assignment of meaning. Advertisers turn to semiotics to help understand what meanings people assign to specific symbols. These may vary across taste cultures and geographies—a spokesperson in a dark business suit signifies one thing in New York City and another in Silicon Valley.
Why do they bother? Their goal is to create product names, brand names, logos, and visual images that people will naturally interpret as meaning something they hope to convey. For example, advertisers might use the image of a cowboy to signify rugged individualism. The challenge is to come up with continually fresh, new, distinctive images that still both carry the intended meaning and stand out in the clutter of ad images.
This task gets interesting because on the surface many marketing images have virtually no literal connection to actual products. What does a green lizard have to do with an insurance company (GEICO)? How can a celebrity like Morgan Fairchild enhance the meaning of a store like Old Navy? Does supermodel Heidi Klum really eat at McDonald’s? A computer created the name Exxon—just what does that mean anyway?
Components of Meaning
From a semiotic perspective, every marketing message has three basic components: an object, a sign (or symbol), and an interpretant. The object is the product that is the focus of the message (e.g., Burger King’s menu items). The sign is the sensory image that represents the intended meanings of the object (e.g., a funky “King”). The interpretant is the meaning derived (e.g., quirky, cool).
Signs relate to objects in one of three ways: They can resemble objects, be connected to them, or be conventionally tied to them.Arthur Asa Berger, Signs in Contemporary Culture: An Introduction to Semiotics (New York: Longman, 1984); Charles Sanders Peirce, in Collected Papers, ed. Charles Hartshorne, Paul Weiss, and Arthur W. Burks (Cambridge, MA: Harvard University Press, 1931–1958). An icon is a sign that resembles the product in some way (e.g., the Apple logo is literally an apple). An index is a sign that is connected to a product because they share some property (e.g., the Rock of Gibraltar that stands for Prudential Insurance conveys the property of endurable dependability, which is what the company hopes clients will associate with its policies). A symbol is a sign that relates to a product by either conventional or agreed-on associations (e.g., the green Starbucks logo depicting an “earth mother” with long hair conveys environmental responsibility and alignment with nature). A lot of time, thought, and money go into creating brand names and logos that will clearly communicate a product’s image. The Nissan Xterra combines the word terrain with the letter X, which many young people associate with extreme sports, to give the brand name a cutting-edge, off-road feel.
Hyperreality
One of the hallmarks of modern advertising is that it creates a condition of hyperreality. This refers to the process of making real what is initially simulation or “hype.” In other words, advertisers create new relationships between objects and interpretants as they invent new connections between products and benefits, such as when they equate Marlboro cigarettes with the American frontier spirit.
Over time, the true relationship between the symbol and reality is no longer possible to discern in a hyperreal environment. The “artificial” associations between product symbols and the real world may take on lives of their own. Fictional characters routinely cross over from make-believe to the real world—sometimes they even “endorse” other products, as when a talking Mrs. Butterworth’s syrup bottle shows up in a TV commercial for GEICO insurance.
Key Takaway
Advertising is an integral part of culture, and culture is an integral part of advertising. We need to understand the norms, beliefs, and practices of a culture in order to communicate with people who inhabit it. Many advertising messages relate to a culture’s myths and rituals; in some cases they create new ones. Because a culture is so complex, a major strategic question is how much a campaign needs to be customized to each individual country if it is involved in several markets. While some standardized approaches can be effective, overall it is best to take into account local differences to ensure that the meanings the campaign intends to communicate are what the audience receives. Successful execution in these situations requires attention to the semiotics, or meanings, of images and words that represent underlying values and properties.
EXERCISES
1. Identify the arguments for and against standardization versus localization of global products and communications.
2. Define semiotics. Describe how advertisers can use the principles of semiotics to enhance their communications. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.08%3A_Culture_Globalization_and_Advertising.txt |
Tie it All Together
Now that you have read this chapter, you should be able to understand how advertisers study and analyze consumers and construct communication processes to reach them:
• You can compare and contrast the traditional linear communications model with the new interactive, nonlinear, multivocal communications model.
• You can identify the various components of communications that are necessary to establish effective communications.
• You can describe the diffusion of innovations process.
• You can list and explain five stages of the consumer decision-making process.
• You can recognize and recall several models for studying attitudes and information processing.
• You can characterize the external influences on consumers.
• You can explain culture’s role in globalization and advertising.
USE WHAT YOU’VE LEARNED
1. Do you ever get much sleep when you’re on an airplane? Most people don’t, and that’s a problem for airline commuters who travel the globe. With an eye toward serving the public better, Continental Airlines has decided to retrofit many of its planes with new lie-flat seats. The new seats will be in premium sections of aircraft and will allow passengers to lie completely flat. Another feature of the new seats is their size—they will give customers six and a half feet of sleeping space without appreciably impacting cabin space. Continental hasn’t forgotten gadgetry for the new seats and their occupants. Each seat will be equipped with laptop power, headsets, and USB ports.
Considering that Continental wants to introduce its new seats this year, what message format would you suggest? What target customer is likely to receive the first messages about the new seat? Explain how your chosen message format will effectively reach the designated target customer.
2. “Fashions come and go,” as they say; however, with Baby Boomers approaching their sixties, the 1960s seem to be coming back in fashion. AMC’s Mad Men, a stylized adult drama about advertising and ad men (and women) from the 1960s, has grown rapidly in popularity with U.S. television audiences. Period costuming and retro taste cultures have brought back memories and stories to those who grew up in the time period. Smoking, heavy drinking, no seat belts in cars, fascination with early TV, sexism, racism, and sexual harassment in the office are themes that are as common in the program as the ad campaigns that are masterminded by the Mad Men. The uncanny attention to detail in this “period drama” has won the creators critical acclaim.
The viewer of Mad Men will notice rather quickly that 1960s-era Mad Men smoked and encouraged America to smoke. Review information about Mad Men and the 1960s approach to smoking. Review the chapter section on motivation. Assuming the role of a social critic, describe how 1960s-era ad campaigns encouraged smoking. Focus on motivations, involvement, and perceived risk used in these campaigns. Provide illustrations of the motivations if possible.
DIGITAL NATIVES
One of the keys to understanding a consumer’s behavior is to understand how consumers perceive advertising messages. Advertisers often use size, color, position, and novelty to impact consumers’ perception. Inverted Advertising, a Houston-based advertising company, has come up with a new twist on how to reach a mobile population. Consumers often walk, skate, or ride through the organization’s advertising messages. The company uses projected 3-D holograms on sidewalks, ice sheets, walls, ceilings, kiosks, and other smooth surfaces to stimulate consumer perception and gain attention.
Go to the Inverted Advertising Web site at www.invertedadvertising.com and review the features and the ad gallery provided. Your assignment is to construct a brief plan for introducing “Inverted Advertising” to a client of your own choosing. Comment on how you might be able to use inverted advertising to reach a designated target audience. Discuss your concept and plan with peers.
AD-VICE
1. Source credibility and source attractiveness are both extremely important in advertising and communication. Using advertisements as your focal point, list what you perceive to be five credible sources for purchasing products. Comment on the degree of source attractiveness among those sources. Provide examples if possible.
2. Marketers believe that early adopters can make or break a new product launch. Describe the early adopter and his or her function. Pick a new product that has recently been introduced and demonstrate how early adopters could have created, or did create, a “buzz” for the product. How should advertisers reach early adopters with messages? Explain your rationale.
3. How do you learn about brands? The question is not easy to answer. Think for a few minutes about all the information you process about brands during a single day; create a diary that lists that information as you receive it. Keep the diary for a few days. Compare your results with others. What common threads with your peers do you find? What unique ways did brands attempt to communicate with you? Comment on what you observed and your conclusions about your diary.
4. Describe a brand community and a consumer tribe. Discuss similarities and differences. Are you in one of these groups? Describe and comment. How could marketers and advertisers use brand communities and consumer tribes to stimulate acceptance and purchase of their products?
ETHICAL DILEMMA
As the chapter indicates, subliminal persuasion is “a topic that has captivated the public for more than fifty years.” Basically, subliminal persuasion attempts to reach consumers below the conscious thought or awareness threshold. Validity of the technique is, however, open to serious question by scholars and critics. Review material on subliminal persuasion in the chapter section and use a search engine of your own choosing to find additional information. Be sure to review historical work by Wilson Brian Key during your investigation. Once you understand the concept of subliminal persuasion and its colorful history, take an ethical stance either for or against the technique. Support your position. Describe any examples that would help you defend your position. Participate in a class discussion and present your position and findings. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/04%3A_Consumers_and_the_Communications_Process-_SSK_Gets_to_Know_Its_Consumers/4.09%3A_Exercises.txt |
The more information you have the more effective you can be.
Joe Kessler, partner, SS+K/LA
Joe Kessler understands that knowledge is power. In the ad biz, that power comes from knowing as much as you can about your audience. Who is buying what you’re selling? What are their hot buttons? What are their needs, and which of those needs is your client’s product or service equipped to satisfy? For msnbc.com, SS+K needs to figure out what makes consumers of online news tick. After all, you can create the prettiest ad in the world, but if it doesn’t address the right customer you might as well throw your money out the window (or perhaps buy a lottery ticket). Now that we’ve covered a lot of the fundamentals, it’s time to jump in and get our hands dirty as we learn about msnbc.com and who its customers are.
Enter the research department, or as they are called at SS+K, the Asymmetric Intelligence Unit (AIU). It’s their job to gather consumer intelligence that enables everyone else to make intelligent decisions. So, what’s the best way to do that? “Simple,” you might say. “If you want to know something about somebody, just ask them.” If only the world were that simple! Sometimes we can just ask—but we’re never sure we’re getting the correct answer. Imagine being asked to explain your own habits and preferences: Why do you drink what you do? What makes you splash on a certain fragrance? Tune in a certain TV show? Hang out in MySpace versus Facebook? Your answers might or might not be helpful to a prospective advertiser.
To go beyond simple questions, researchers have many tools in their arsenal. In the 1950s a psychoanalyst interviewed a few men, each for several hours at a time, to find out why they “really” liked to drive cars. He concluded that to a man driving is all about sexual conquest—and Esso’s tagline “Put a tiger in your tank” was born.
Today, we find both extremes in consumer research—from “up close and personal” encounters with consumers in their own homes to massive surveys that yield gigabytes of data. SS+K, as we’ll see, relies on both extremes. For example, The Creative Artists Agency is a part owner of SS+K. CAA’s research division, the Intelligence Group, sponsors a one-day event each month it calls Trend School in both New York and Los Angeles. Each session features presentations either by in-house execs or by outsiders who are into cutting-edge popular culture. At one recent seminar, a panel of über-cool sixteen- to twenty-five-year-olds talked to attendees about how they spend their leisure time (including giving them some quick Nintendo Wii lessons), viral-marketing hits, and the best emerging bands and music trends.Beth Snyder Bulik, “Want to Build a Hipper Brand? Take a Trip to Trend School,” Advertising Age, February 19, 2007, http://www.adage.com (accessed February 19, 2007).
Which technique is the one to use? Here’s a clue: don’t be a hammer in search of a nail, where you doggedly choose one favorite research method no matter what the situation. Let’s see what our options are, and how SS+K made use of them for its client. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/05%3A_Know_Your_Audience-_SSK_Learns_All_About_msnbc.com_Inside_and_Out/5.01%3A_Chapter_Introduction.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Recognize that data is the key to understanding the consumer.
2. Describe the various types of data.
Source of the Data: Primary versus Secondary
Data is the key to knowing the customer. An advertiser and its agency can obtain this knowledge from two basic kinds of sources, each with respective advantages and disadvantages. Primary data is new information the company gathers directly from respondents the company talks to, surveys, or researches. Primary research focuses specifically upon the issues that need to be answered to develop the campaign. For example, if a company does a telephone survey of consumers’ opinions of the latest ad campaign, that’s primary research. Although primary data can be expensive to collect, it’s often extremely useful because it’s “just what the doctor ordered” to guide the organization’s thinking.
In contrast, secondary data refers to information that has already been collected for a previous purpose, often by a third party that routinely performs such research. For example, government census data is secondary data—the government collects information about citizens’ household size, ages, and incomes for its own purposes. This information is available free in its raw form, and in addition numerous companies “package” it and sell it in various ways to third parties.
Type of Data: Quantitative versus Qualitative
Primary data and secondary data can be either quantitative (numerical) or qualitative (verbal). Quantitative research is usually based on a large-scale sample of respondents and is typically expressed in numeric terms such as averages, percentages, or statistics. The advantage of quantitative research is its precision in providing a specific answer, such as the number of pizzas sold in March or the percentage of people who say they plan to buy a product in the next three months.
Qualitative research is more open ended in eliciting the stories, anecdotes, and descriptive words people have for products or lifestyle attributes. For example, a survey might ask people to describe a product they see in an ad; the advertiser can then analyze the words and emotions those responses contain. Qualitative data tend to be useful for exploratory work and to help “flesh out” the emotions, attitudes, and values behind the numbers.
SS+K Spotlight
SS+K’s first step in getting to know msnbc.com was to review the existing research the client had already done around their branding, audience, and features. John Richardson and Michelle Rowley immersed themselves in the data provided in order to understand what msnbc.com’s current research was telling them. By reviewing this research first, they were able to identify what information they still needed so they could gain a better understanding of the brand and the audience.
Key Takaway
We broadly describe data along two dimensions: source and type. Source refers to where we obtain the information. Here the important distinction is between primary data that we collect specifically to guide the current campaign and secondary data that already exists in some form. Primary data is often preferable but harder and more expensive to collect; in some cases the information we need is out there if we know where to look. Type refers to the form of the data; is it numerical or verbal or observational? Numerical (quantitative) data can be generalized; we can combine one respondent’s scores with those of many others to obtain a broad (but often shallow) picture. In contrast, verbal or observation (qualitative) data is difficult to generalize because it’s coded in words or based upon a researcher’s subjective impressions. This type of data is useful for generating ideas and drilling down into the underlying reasons for consumers’ reactions to ads or products; it gives us a narrow but deep picture. The ideal is to combine both types of data to yield a broad and deep snapshot of our customers.
EXERCISE
Compare primary data to secondary data. Compare quantitative data to qualitative data. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/05%3A_Know_Your_Audience-_SSK_Learns_All_About_msnbc.com_Inside_and_Out/5.02%3A_Types_of_Data.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Explain why surveys are the most common form of quantitative research.
2. Discuss how focus groups are used to collect data.
3. Explain the value of conducting ethnographic study in advertising.
4. List and discuss the advantages and disadvantages of primary data.
Sources of primary data include focus groups, customer interviews, and surveys the company conducts to understand the needs, behaviors, and reactions of consumers or other stakeholders such as business customers, vendors, or policymakers. Regardless of the data collection method, researchers conducting primary research need to decide whether to target a random sample of the entire population or to screen their participants according to a demographic, psychographic, or behavioral profile.
SS+K Spotlight
After John and Michelle reviewed the existing data, the next step was to speak to the people who know msnbc.com best—their employees. SS+K interviewed the key stakeholders within the organization including the president and representatives from editorial, design, ad sales, and technology. It was important for SS+K to understand how each of them perceived the brand, its challenges, and its opportunities.
After the interviews were conducted, in person by Joe Kessler or Melinda Moore, with Michelle, John, and Amit on the phone in New York taking notes, the AIU team (Michelle and John) started drawing some conclusions from those interviews.
They found that stakeholders agreed on interesting points and what they believed were the differentiators for msnbc.com versus their competitors. The research also showed that they each brought interesting and different ways to communicate this perceived difference. Some suggested approaching the communication through the technological advantages; others suggested touting original and high-quality journalism as the key message. Still other ideas involved better use of NBC personalities and the company’s multimedia experience.
One really encouraging finding from the interviews was the optimism that emerged about the future of the company and the future of the brand. The stakeholders noted that positive elements included the collaborative approaches within their vast organization, the increase in Web traffic, and the new online technologies that enable people to consume more and more information. Blogs, social networks, and other message-board technologies were going to continue to be important as the organization grew.
Surveys
Surveys are the most common form of quantitative research. They can be conducted by mail or telephone, online, or through “intercepts” such as when a market researcher stops shoppers in a shopping mall to answer a few survey questions. Surveys ask consumers about their activities, interests, and opinions. This often sheds light onto which publications or media the target audience reads or watches, which enables the advertising agency to fine-tune its message.
Mail surveys increasingly are giving way to online questionnaires, because this format allows for instantaneous data collection and analysis (rather than waiting for printed surveys to be mailed and returned). Online questionnaires are also more flexible and cost much less. In both cases, however, while respondents are likely to be more honest because they can participate anonymously, we can’t be 100 percent sure who actually responds to the survey or whether the same person is responding multiple times. To design and administer your own surveys (for free!), check out http://www.surveymonkey.com.
Dig Deeper
Many online surveys basically reproduce their boring offline counterparts—scroll down the screen and answer a long series of questions by clicking on a number from 1 to 7. But some researchers take advantage of the Web’s unique capabilities as they create research instruments that are more vibrant and engaging for respondents. For example, an online survey could ask you to watch streaming video of different versions of an advertising execution and then prompt you to select the one you like best. Another might show you color pictures of facial expressions, landscapes, or celebrities and ask you to match them up with different brands. In one creative application, an online research company posted a gift finder on its Web site (http://www.youniverse.com). To come up with gift ideas for a friend, the user chooses from sets of photos to answer questions about the person such as “Their favorite color is…” or “Their house looks like.…” The program then matches the answers with everything from gadgets to books. This kind of technology allows clients like MSN, Vodafone, and others to gauge consumers’ reaction to ad campaigns and identify clusters of consumers that respond most positively to different products.Leila Abboud, “Picturing Web Shoppers: Start-Up Taps ‘Visual DNA’ to Gather Data,” Wall Street Journal, January 23, 2007, B9.
Brand Tags, another ingenious application of Web research, shows visitors the logos of big companies and asks them to type in the first word or phrase that pops into their head when they see the logo. Within a few days after it went live, the site attracted more than thirty thousand visitors. Results of these snap reactions are reported as a tag cloud—a format in which the size of the word corresponds to its frequency among responses. Frequently submitted words are shown in giant type, while rarely submitted ones look tiny on the screen. This type of data is merely suggestive because we can’t be sure who responds, but it can be an eye opener to advertisers. For example, two popular responses for Wal-Mart are cheap and evil, one of Burger King’s largest tags is fat, while people label Toyota with words like quality and reliable—but also boring.Tom Weber, “What Do People Think About Your Brand? Here’s a New Way to Find Out,” Wall Street Journal Online, May 13, 2008, http://blogs.wsj.com/buzzwatch/2008/05/13/what-do-people-think-about-your-brand-here’s-a-new-way-to-find-out (accessed July 21, 2008).
Telephone surveys offer even more flexibility in questioning, but they suffer from higher cost and often have lower participation because respondents screen calls or put themselves on do-not-call lists. Unfortunately, in recent years telemarketers who masquerade as survey-takers poisoned the well for legitimate research companies; in some cases when they call (usually during dinner!) they lure unsuspecting respondents into answering questions until they reveal toward the end that they’re actually selling something.
However, as mobile phones continue to evolve into the “third screen” for many of us (the first two are the TV and the computer monitor), it’s likely that enterprising researchers will discover new ways to collect people’s feedback via their phones. For example, the startup company Mimieo offers an application that enables a client to capture respondents’ emotional reactions to an ad or product on their iPhones.http://www.mimieo.com/corp/home.aspx (accessed July 21, 2008); Laurie Sullivan, “Marketing Feedback Cards Go Digital via Cell Phones,” Marketing Daily, February 27, 2008, http://www.mediapost.com (accessed February 27, 2008).
Face-to-face interviews provide the most flexibility in questioning—it’s clear to the researcher if the respondent is having difficulty understanding the question—but they are time consuming and expensive. They are also less likely to yield truthful results, for two reasons. First, being face to face with the interviewer, respondents may tend to give answers they think the interviewer wants to hear. Second, the interviewer’s biases (none of us is bias free, much as we may wish to think of ourselves that way) may skew the results.
Dig Deeper
The logic behind deprivation research is to figure out how loyal consumers are to a brand by taking it away from them. Dunkin’ Donuts forced a group of its customers to drink Starbucks coffee for a week instead. Verizon Wireless did something even more impressive: the company got a group of teens to give up using cell phones for an entire weekend.
Burger King gets hard-core Whopper fans to go without their burger fixes and keep journals about how they deal with this indignity. This strategy evolved into a recent successful ad campaign the chain’s ad agency Crispin Porter + Bogusky called “Whopper Freakout.” The TV and online ads captured real customers at two Nevada outlets who were informed that the Whopper was no longer on the menu. These were not happy campers: one customer cried, “What are you going to put on the logo now—home of the ‘Whatever we got’?”Suzanne Vranica, “Hey, No Whopper on the Menu?! Hoax by Burger King Captures Outrage,” Wall Street Journal, February 8, 2008, B3. For a closer look at this campaign, check out www.whopperfreakout.com/embed.swf.
SS+K Spotlight
After conducting the internal stakeholder interviews and reviewing the existing data, msnbc.com and SS+K set out to understand the consumer’s point of view and also to test a few hypotheses they’d drawn based on what they currently knew.
These hypotheses revolved around three themes: (1) functional (What role does online news play in consumer’s lives?), (2) attitudinal (How do consumers feel about msnbc.com?), and (3) thematic (Are there certain categories of news to which consumers look?). It was important to understand what need they currently met in their consumers’ lives, and they designed their questions for the group to explore those areas.
They planned to explore these ideas and flesh them out in focus groups, which we’ll discuss next.
Focus Groups
Often, an advertising campaign seeks to understand more subtle (or deeply held) attitudes than a survey can capture. This requires a more exploratory, interactive approach, such as one-on-one interviews between a consumer and a researcher or through a focus group discussion (a discussion with a small group of consumers, led by a trained facilitator). The professional moderator is crucial to this process, preventing vocal members from overwhelming or dominating the group and effectively handling answers that don’t provide meaningful information or answers that a group member gives who is merely trying to impress other members (yes, this happens a lot!). Focus group discussions usually involve six to ten group members, and discussions are sometimes held in a room with a one-way mirror so that agency executives can watch or videotape the discussion—listening to real people talk about their product can be a real eye-opener for these folks!
For example, the city of Las Vegas decided to use focus groups to get a sense of how it should advertise itself in other countries as a tourist destination. The city worried that its “What happens in Vegas stays in Vegas” campaign in the United States might not play well in countries like Mexico, which has a more Catholic and conservative population. To find out, the city held focus groups with travelers. The results of the focus groups showed that Mexicans were comfortable when the Vegas story lines fit with family customs and did not allude to casual sex. In the United Kingdom, in contrast, focus groups showed that the ad campaign needed more sex, not less, to catch the attention of U.K. audiences (who tend to see more provocative and explicit advertising). About a dozen focus groups of middle- and upper-income British men and women under age fifty-five revealed that the American tagline wasn’t compelling enough for irreverent British tastes. “In the U.S. we think our slogan and ads push the envelope, [but in Britain] for our message to have the same impact we discovered that we need to make it edgier,” said Rob O’Keefe, account director at R&R Partners, the agency for the Las Vegas tourism group. “We need a bolder brand statement articulating that you can do things in Vegas you can’t do anywhere else.”Quoted in Joan Voight, “How to Customize Your U.S. Branding Effort to Work around the World,” Adweek Online, September 3, 2007, www.nationaljewelernetwork.com/aw/esearch/article_display.jsp? vnu_content_id=1003634197 (accessed September 3, 2007).
Focus group disadvantages to watch out for are that people may be too tired to think after a hectic day, or that they may say what they think the researcher wants to hear, or that they may even feel pressured to make things up. Also, focus groups take people out of their normal lives and put them into a quiet room, which may lose the context of the real experience. For this reason, individual or group interviews in natural settings may be more desirable. Having a collaborative discussion with consumers in places where people actually use the products in question, such as a bar or laundromat rather than a research lab or an agency’s conference room, may provide more fruitful ideas. Some companies try to get consumers’ input across multiple stages, from focus groups to natural settings like supermarkets (if the product is a packaged food product) to journal entries that consumers record. This multifaceted approach imparts richness to the ideas, rather than just a slice that a phone interview or focus group can yield.
Video Highlight
John Mayer
(click to see video)
Could you give John Mayer your honest opinion about a new song?
SS+K Spotlight
Johanna Steen, who works with Catherine Captain at msnbc.com, was the leader of the focus groups conducted in various locations around the country. Working with the team at SS+K led by Michelle and John, Johanna facilitated the discussion and outlined conclusions so the team could determine what more they knew about the msnbc.com consumers and if they needed anything more.
Ethnography
Finally, qualitative data can be gathered through an ethnographic study, in which a researcher visits a person’s home or business and directly observes how the customer uses a product. For example, when it designed its Quicken software, Intuit sent software engineers to consumers’ businesses to watch how they used accounting software. The program was called “follow me home,” and the reason for watching consumers in their homes was to seek a natural, unscripted setting. Intuit continues to listen to customers through all sorts of channels, including blog posts and feedback buttons on the software itself. The 2006 version of Quicken, for example, included more than 121 customer-recommended improvements.http://www.fastcompany.com/magazine/99/open_customer-intuit.html (accessed on September 9, 2007).
The ad agency Saatchi & Saatchi went even further: when it was working on a new campaign for its client JC Penney, the agency assigned staffers to hang out with more than fifty women for several days. They helped the women clean their houses, carpool, cook dinner, and shop as they observed the women’s behaviors and emotions. This may not be the most glamorous task for the researcher (do they do windows?), but as Saatchi’s global head of strategic planning observed, “If you want to understand how a lion hunts, you don’t go to the zoo—you go to the jungle.”Suzanne Vranica, “Ad Houses will Need to be More Nimble: Clients are Demanding More and Better Use of Consumer Data, Web,” Wall Street Journal, January 2, 2008, B3.
SS+K Spotlight
After gaining some insights from the focus groups, Michelle Rowley and John Richardson considered doing ethnographies in order to further understand what really drives the news junkie, but they, along with Catherine Captain, decided to conduct triad interviews instead. Using this technique, a moderator interviews three people who have been screened to fit the desired demographic, psychographic, and behavioral profile. The interviewers gave these respondents a homework assignment before the interviews: they were asked to change their usual routine by trying different news resources before they returned to discuss their experiences together. The inclusion of three similar respondents makes it easier for the researchers to identify shared themes or feelings versus sentiments that one individual may express that are more idiosyncratic and perhaps not as useful. During the triad interviews, the moderator worked with a guide to help her probe for additional details. This guide was agreed upon by the research company, SS+K, and msnbc.com. The results of this final piece of research informed the next steps in the campaign development process, which is the communications brief.
Advantages and Disadvantages of Primary Data
Primary data often is richer and more directly useful, but it also has its downsides. The following are primary data’s advantages:
• Specific. The company gets to define the goals of the research and focus the research on their own particular product.
• Proprietary. The company can keep the results private.
• Controlled. The company has a say in which consumers it talks to, the methodology it uses, and the analytical tools it employs.
The following are primary data’s disadvantages:
• Costly. The company bears all the expenses itself.
• Time-consuming. The company must wait while its analysts design, execute, and analyze the research.
Key Takaway
Primary data refers to information an agency or its client collects to specifically address the current campaign. There are several ways to collect primary data, ranging from one-on-one interviews to large-scale mail or online surveys.
EXERCISES
1. Describe how surveys can be used to collect information.
2. Discuss how Web research can be used by advertisers to target consumers.
3. Explain how focus group research is conducted. Comment on the advantages and disadvantages of this form of research.
4. List and discuss the advantages and disadvantages of primary data. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/05%3A_Know_Your_Audience-_SSK_Learns_All_About_msnbc.com_Inside_and_Out/5.03%3A_Primary_Data.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Identify several pertinent secondary data sources.
2. List and discuss the advantages and disadvantages of secondary data.
Government Sources
A lot of secondary data is available from the government, often for free, because it has already been paid for by tax dollars. Government sources of data include the Census Bureau, the Bureau of Labor Statistics, and the National Center for Health Statistics.
For example, through the Census Bureau, the Bureau of Labor Statistics (http://www.bls.gov) regularly surveys consumers to get information on their buying habits. These surveys are conducted quarterly, through an interview survey and a diary survey, and they provide data on consumers’ expenditures, their income, and their consumer unit (families and single consumers) characteristics. For instance, of the total money spent on food per household in 2005 (\$5,931), the average family spent \$445 on cereals and bakery products that were eaten at home. Looking at the details of this expenditure by race, Whites spent \$455 on at-home cereals and bakery products, while Asians spent \$492 and African Americans spent \$393. Detailed tables of the Consumer Expenditures Reports include the age of the reference person, how long they have lived in their place of residence, and which geographic region (see MSAs in Chapter 6 "Segment, Target, and Position Your Audience: SS+K Identifies the Most Valuable News Consumer") they live in. See http://www.bls.gov/cex for more information on the Consumer Expenditure Surveys.
Syndicated Sources
A syndicated survey is a large-scale instrument that collects information about a wide variety of consumers’ attitudes and actual purchases. Companies pay to access the parts of this large dataset they find relevant. For example, the Simmons Market Research Bureau conducts a National Consumer Survey by randomly selecting families throughout the country that agree to report in great detail what they eat, read, watch, drive, and so on. They also provide data about their media preferences. So, if a client that makes bowling balls, for example, wants to know more about what bowlers do and what TV shows and magazines they prefer, an agency could buy data relevant to this group rather than going out and polling bowlers on its own.http://www.simmonssurvey.com (accessed July 21, 2008).
Companies like Yankelovich Inc. (www.yankelovich.com) conduct regular large-scale surveys that track American attitudes and trends. Yankelovich goes deeper than the demographic data the government provides to enable clients to identify consumer beliefs and aspirations as well. For example, the Yankelovich Monitor, which is based on two-hour interviews with four hundred people, looks at changes in American values.
Recent Yankelovich Monitor insights include a multinational Preventative Health and Wellness Report that looks at consumer attitudes and behaviors related to physical, mental, emotional, and spiritual dimensions of health and wellness across seventeen countries. The survey was conducted via forty-minute online questionnaires and answered by twenty-two thousand adults over age eighteen. Another report, called Food for Life, followed up with five thousand consumers who had completed an earlier survey and interviewed them in depth to delve into their attitudes about food with respect to preventive healthcare. For example, most consumers agreed with the statement “If it takes a lot of extra work to prepare it, I won’t eat it, no matter how healthful and nutritious it is.” The implication of this finding to advertisers is that healthful foods need to be convenient. Another finding, “I like to show off how healthfully I eat,” suggests that advertisers should emphasize the “badge value” of their health-related products by making it obvious to others what the person is eating.www.iddba.org/0906dig.htm (accessed September 8, 2007).
Other sources of secondary data include reports by Frost & Sullivan, which publishes research across a wide range of markets, including the automotive and transportation and energy industries, or Guideline (formerly FIND/SVP), which provides customized business research and analysis (www.guideline.com). Gallup, which has a rich tradition as the world’s leading public opinion pollster, also provides in-depth industry reports based on its proprietary probability-based techniques (called the Gallup Panel), in which respondents are recruited through a random digit dial method so that results are more reliably generalizable. The Gallup organization operates one of the largest telephone research data-collection systems in the world, conducting more than twenty million interviews over the last five years and averaging ten thousand completed interviews per day across two hundred individual survey research questionnaires.www.galluppanel.com (accessed July 22, 2008).
Internal Secondary Sources
So far, we have discussed examples of secondary data from external sources—sources that are external to the advertiser. But secondary data can also come from internal sources, such as a database containing reports from the company’s salespeople or customers, or from previous company research. This is often an overlooked resource—it’s amazing how much useful information collects dust on a company’s shelves! Other product lines may have conducted research of their own or bought secondary research that could be useful to the task at hand. This prior research would still be considered secondary even if it were performed internally, because it was conducted for a different purpose.
Advantages and Disadvantages of Secondary Data
Like primary data, secondary data offers pros and cons. The following are its advantages:
• Inexpensive. The costs are shared or already paid.
• Rapidly accessible. The data has already been collected and analyzed.
• Large sample size. The pooled resources of the government agency or trade organization allow it to survey thousands or millions of people.
• Reliable. The external research organization may have years of experience in gathering and analyzing a particular type of data.
The following are secondary data’s disadvantages:
• Dated. The secondary research may have been done months or years before.
• Widely disseminated. A company’s competitors have access to the same information when they devise their strategies.
• Generic or off-target. The goals of the external research organization may be different from those of the company.
Key Takaway
Secondary data is information that already exists in some form; we just have to know how to mine it to get answers we need. The government is a good source for secondary data about consumers and businesses. In addition, many syndicated surveys that private companies conduct provide detailed descriptive information about what people think and what they buy. The client itself is often an overlooked source of data; prior experiences in similar situations or with similar campaigns can help an agency avoid making the same mistakes twice.
EXERCISES
1. Identify and discuss the significant sources of secondary data.
2. List and discuss the advantages and disadvantages of secondary data. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/05%3A_Know_Your_Audience-_SSK_Learns_All_About_msnbc.com_Inside_and_Out/5.04%3A_Secondary_Data.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Compare and contrast each of the physiological sources of data.
2. List and discuss the advantages and disadvantages of physiological data.
Conscious versus Subconscious Responses
All of the techniques we’ve reviewed so far ask consumers to tell researchers what they think or feel. But as we’ve seen, people sometimes tell researchers what they think they want to hear. Or they give “socially correct” answers rather than their real opinions. For example, a consumer might claim that “safety” is her top criterion when she chooses a baby’s car seat when in fact she is a bargain hunter who shops for the best deal. Many times, this isn’t because people are dishonest or intentionally misrepresent themselves—they may simply not know or may not be aware of their behaviors and motivations.
Have you ever met someone who puts up a good front about being self-assured and confident—but when you go to shake his hand it’s dripping with clammy sweat? Our bodies sometimes tell truths our words deny. One way to address the gap between our internal reactions and what we say is to use physiological tests—technologies that measure consumers’ physical responses, such as eye movements or galvanic skin response—to identify what consumers look at or how they react to an ad. Researchers usually collect physiological data in a lab or test setting, but the increasing portability of the equipment is making it possible to take it out into natural settings as well.
Eye-Tracking
Eye-tracking technology, as its name implies, tracks where a person’s eyes move and what their pupils do as they look at a particular feature. These tests objectively measure how engaged a person is with an ad and how they react to the images or copy. For example, an abrupt change in a person’s pupil diameter indicates how much mental effort she is exerting. If she’s looking at a Web site, for example, and suddenly her pupil diameter changes, it’s likely she is having difficulty understanding something. What’s more, the eye-tracker can tell exactly where the person was looking, to identify the point of confusion. All of this is more natural and objective than interrupting a person to ask them “How difficult was it for you to complete this task?” or “Did you like Design 1 better than Design 2?”
Advertisers also use the Web to apply eye-tracking technologies that measure how people navigate a Web site, where they look for specific information about an item, how they compare different items, and how they navigate to a shopping cart or other areas of the site. For example, EyeTracking Inc. (ETI) offers its GazeTraces tool that shows the scanning behavior of a person when she looks at a screen display. This helps the advertiser or agency know which features on the page caught the consumer’s attention, which elements she missed, and which elements may have been confusing. ETI uses a patented technique (that the military initially used for training) to estimate cognitive load based on changes in pupil dilation and another tool to estimate the emotional response to television commercials, pictures, and other types of visual displays. ETI will test anywhere from ten to hundreds of people for any given project. The testing usually takes less than thirty to ninety minutes and analysts collect thirty thousand data points each minute.http://www.eyetracking.com/technology/learn (accessed July 22, 2008); Jessica Long, “Eye Tracking Keeps Focus on a Growing Prize,” San Diego Business Journal, July 16, 2007, 1.
Companies like STA Travel use eye-tracking to find out if computer-generated branded content is catching people’s attention in Web sites or in virtual environments like Second Life. Advertisers use gaze trails to determine if viewers look at products placed within TV shows, and if so, for precisely how many seconds. The technology is so precise that it can help an advertiser decide just how to create a set; for example, where would be the best place to put that Coke bottle on the judge’s table during a shoot of American Idol?“Market Research: As Easy as Putting in a Plug?” Marketing Week, September 6, 2007, 29.
Companies like Toyota, Dell, T-Mobile, and Carl’s Jr. use eye-tracking technology to measure the effectiveness of their video-game advertising. A study conducted by Double Fusion (a major player in the video-game advertising space) found that more than 80 percent of gamers notice ads while they play video games. One surprise the study discovered: the size of the ad mattered less than where it was placed. On average, smaller ads placed at eye level attracted a gamer’s attention 38 percent longer than larger, peripheral ads. For example, gamers who played “Rainbow Six” noticed a small Carl’s Jr. ad placed at eye level with the in-game action for 7 percent of the forty-five seconds it was onscreen, but they didn’t notice at all a larger ad for Mazda in the game “Need for Speed” because it was placed toward the top of the screen, away from where they needed to concentrate to play the game.Abbey Klaassen, “Buying In-Game Ads?” Advertising Age, July 23, 2007, 8. Apparently size doesn’t always matter.
Video Highlight
Eye Tracker Technology in Use
(click to see video)
This eye-tracking study shows a user’s eye movements while playing a Nintendo Wii video game.
Galvanic Skin Response (GSR)
Galvanic skin response (GSR) is another physiological measure that advertising researchers have used for a long time. This measure is based on the fact that a person’s skin undergoes a change in its ability to conduct electricity when she experiences an emotional stimulus like fright, anxiety, or stress. Theoretically, the greater the change in electrical resistance, the more positive the subject’s reaction to the stimulus. There is some controversy about the validity of this technique, but proponents believe that GSR, like eye-tracking, is more objective than responses researchers collect during interviews or surveys.Jane Imber and Betsy-Ann Toffler, Dictionary of Marketing Terms, 3rd ed. (Hauppauge, NY: Barron’s Educational Series, 2000).
Sometimes a study will combine several physiological measures to yield better understanding of respondents’ reactions to a commercial or a show. For example, NBC outfitted volunteers with specially designed vests designed to measure their heart rate, respiration, galvanic skin response, and physical activities as they watched a playback of the TV show Heroes. The network wanted to determine if viewers still are affected by commercials that they fast-forward through, even though they aren’t aware of these reactions as the images flicker past. Sure enough, the study found that people’s bodies continue to react to these messages even though they are not consciously aware of these responses. “People did remember brands pretty much to the same extent as they did during real time,” said NBC Universal vice president of news research Jo Holz.Christian Lewis, “Marketers Brainstorm Tactics,” Multichannel News, July 30, 2007, 37.
Neuromarketing
Neuromarketing is the study of the brain’s response to ads and brands. Unlike eye-tracking and GSR, neuromarketing techniques are more cumbersome and invasive (they require the volunteer to lie down in a big machine and look at pictures, rather than to sit comfortably in front of a computer or TV).
Because the techniques measure brain activity, not just eye or skin response, they have also sparked more protest. Gary Ruskin of Commercial Alert (a nonprofit organization that argues for strict regulations on advertising) is lobbying Congress and the American Psychological Association to stop the research, fearing that it could eventually lead to complete corporate manipulation of consumers (or of citizens, with governments using brain scans to create more effective propaganda).
Proponents argue, however, that just because advertising influences consumers doesn’t mean that consumers don’t have free choice. The governmental regulatory bodies to which Ruskin appealed decided not to investigate the neuromarketing issue, and more companies are commissioning neuromarketing studies. For example, Chrysler conducted a functional MRI (fMRI) study to test men’s reactions to cars. Results showed that sportier models activate the brain’s reward centers—the same areas that light up in response to alcohol and drugs.http://www.pbs.org/wgbh/pages/frontline/shows/persuaders/etc/neuro.html (accessed September 9, 2007).
Researchers at Carnegie Mellon University used fMRI on study participants who were given \$20 to spend on a series of products. If participants made no purchases, they would be able to keep the money. As the products and their prices appeared on the screen, researchers were able to see which parts of participants’ brains were activated. A brain region called the nucleus accumbens, associated with pleasure, would light up in anticipation of purchasing a desired product, while the insula, a region associated with pain, would activate when they saw a product whose price was excessive. Based on the interaction of these two brain regions, the researchers were able to successfully predict whether a given participant would purchase the product or not. When the region associated with excessive prices was activated, participants chose not to buy a product.http://www.neurosciencemarketing.com/blog/articles/brain-scan-buying.htm (accessed September 10, 2007).
Advantages and Disadvantages of Physiological Methods
As we’ve seen, physiological measures often can be a useful supplement to other techniques. The following are advantages of physiological methods:
• Remove interviewer bias
• Gather data from the consumer without interrupting them, letting the consumer interact completely naturally with the advertisement or product
• Gather subconscious or hard-to-articulate data (e.g., exactly how many seconds a subject looked at the brand-name pretzels bag on the table during a thirty-minute sitcom)
But these methods can be cumbersome and complicated. The following are disadvantages of physiological methods:
• Costly one-on-one methods that require specialized equipment
• Prone to yielding ambiguous data (e.g., if GSR registers a relaxation response, was it due to pleasure or apathy?)
Key Takaway
Our bodies don’t lie. Physiological measures help researchers to identify emotional reactions to advertising messages. They also can assist in the process of tweaking ads or Web sites to insure that the audience homes in on the important contents (for example, by carefully tracking just where people look in an ad). These measures often are too general to be used in isolation; they might identify a negative emotional reaction to an ad but not yield specifics about just which part of the message is a turnoff. Still, they can be a valuable supplement to more traditional measures of advertising effectiveness.
EXERCISES
1. Compare and contrast conscious versus subconscious responses to physiological data.
2. Characterize the primary methods for obtaining physiological data for advertisers.
3. List and discuss the advantages and disadvantages of physiological data. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/05%3A_Know_Your_Audience-_SSK_Learns_All_About_msnbc.com_Inside_and_Out/5.05%3A_Physiological_Data.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Explain how advertisers use a communications brief to expand idea generation and concept design and testing.
2. Assess the importance of audience profiling to advertisers.
Research plays a role in each of several phases of a successful campaign or product launch. Michelle and John, the account planners on the msnbc.com account, used the information and learnings from the research to compose the communications brief, which is the basis for the entire campaign. Michelle and John worked closely with the internal team at SS+K as well as with Catherine Captain at msnbc.com to ensure that everyone agreed with their conclusions.
You’ll learn more about the communications brief in Chapter 8 "Create a Strategy: SS+K Puts Its Research to Use as the Agency Creates the Brief", but it’s important to note how these elements build on each other. The creative brief (informed by research) is the jumping-off point for any communications or ideas related to the campaign.
Idea Generation
Early on, research can help feed the idea generation phase of the creative process. Research conducted during preconcept development can uncover relevant brand messages by observing purchase behavior, evaluating brand images and profiling customers. Research can help identify unmet needs, changing attitudes, and demographic trends.
For example, Chris Hannigan, director of new ventures at Del Monte, said, “We monitor consumer trends closely, and we’re constantly vetting ideas on what will meet consumer needs. We’ll work closely with the R&D team to develop concepts that we think meet the needs. Then we’ll test them with consumers to determine if they’re appealing.”Quoted in Lisa McTigue Pierce, “Del Monte Foods: Revived, Responsive and Rarin’ to Grow,” Food & Drug Packaging 70, no. 1 (2006): 48.
In addition to using traditional research, some agencies will pull together one-time groups, asking people from diverse backgrounds to join in a few hours of brainstorming to generate ideas. For example, Don Carlton, CEO of Paragraph Project, was working on a campaign to make a regional fast-food company iconic in the Pacific Northwest. An icon in the marketing or advertising context refers to a well-known, enduring symbol of an underlying quality—for example, the Nike swoosh or McDonald’s golden arches. As Carlton explained, “In addition to some traditional research, I pulled together people who I thought would have some good ideas about icons: a professor of architecture from the University of Illinois, to talk about iconic buildings; the founder of Second City in Chicago, to talk about iconic comedians; people who worked on iconic movies like ‘Return of the Jedi’ and ‘Rocky IV,’ to talk about iconic movies.…The whole point was to [identify] the qualities of iconic people and things to help this client understand how to represent what the whole region was about in an iconic way.”Quoted in Jennifer Rooney, “Tapping the Brilliance of Ad Hoc Experts,” Advertising Age 77, no. 36 (September 4, 2006): 18.
Movie studios conduct test screenings of their films to generate ideas for marketing campaigns that run upwards of \$50 million. For example, First Look president Ruth Vitale did a test screening for A Guide to Recognizing Your Saints (Dito Montiel’s Sundance Film Festival entry starring Robert Downey Jr.). The purpose of the screening was not to change the film but “to have a conversation about: Who’s the primary audience? How do we reach them?” Vitale said. Although First Look screened Saints only once, most studios hold three to five screenings for each film. At a cost of \$10,000–20,000 for each screening, one source says, “It is the best money you could spend.”Stephen Galloway, “Test Pattern,” Hollywood Reporter, July 25, 2006, 18.
Concept Design and Testing
Research is important in the concept design phase because it helps determine whether a concept is in line with the intended message and what the likelihood is that the concepts will influence the behaviors and attitudes of the intended consumers.
Concept testing provides a way to get feedback on an advertisement or a specific new product concept. Concept tests involve asking consumers to evaluate a new ad or new product idea, typically asking them if they understand the message, if the ad gets their attention, and if they would consider buying the product (and if so, how much they would be willing to pay for it). The purpose of the concept test is to gather consumer feedback before the advertiser spends large sums of money finishing the product or creating the ad campaign. Research determines whether the concepts are in line with the intended messages and whether they will influence the intended audience.
For example, Kraft wanted to gauge customer response to its planned “Heavenly Angels” TV and newspaper campaign for its Philadelphia Light Cream Cheese. During pretesting of the newspaper ad concepts, the company got valuable feedback from consumers. Consumers liked the ad’s idea of suggesting Philadelphia Light cheese as an ingredient in cooking, not just as a bread spread. The recipes in the ads were seen as “new news” by consumers. But consumers also had suggestions for improvement: they wanted to see recipes for lighter foods (which would also be “more heavenly”), and they suggested brighter and lighter blue colors for the background, which were more evocative of what they envisioned “heaven” to look like. Kraft made these improvements and enjoyed strong sales results from the campaign: the newspaper ads increased the product’s sales volume by 15 percent, and the combined newspaper and TV campaign generated a 26 percent increase in sales.“Newspaper Advertising: Case Study—Philadelphia Light,” Campaign, January 26, 2007, 10.
SS+K Spotlight
While feedback to a concept can sometimes be helpful, it is the brand and the agency experts who are ultimately responsible for deciding whether the campaign works. There is a strong school of thought that opposes concept testing, as we can imagine some of the most brilliant work we’ve seen out there would have been “killed” by a focus group.
At msnbc.com they decided not to test their creative concepts because the brand was making a new statement and everyone involved knew that they had to take a stand. However, there are other situations where a larger consensus is necessary. For example, SS+K’s design team, led by Alice Ann Wilson, collaborated with the creative team Matt Ferrin and Sam Mazur to update the msnbc.com logo. After giving feedback and narrowing it down to a few options, Catherine Captain offered msnbc.com employees a chance to opine and vote on the new identity for the brand. Ultimately, marketers should learn from feedback but rely on their expertise to make the final call.
Audience Definition and Profiling
Defining and targeting your audience is the best way to ensure a match between the company’s product or service and the consumer’s needs. Often, the more a company knows about its audience, the more effective its ads will be—and the company may uncover needs for new products that it didn’t know about. Granular audience profiling includes all aspects of demographics (age, gender, income, ethnicity, geography, industry, and job function) as well as psychographic information (interests, behaviors, and values) coupled with media habits across all media channels (print; online ads, searching, blogging, podcasting, social networking; radio; mobile and SMS; billboards; TV; trains, buses, subway). The goal is to carve out segments within your audience universe and develop target-specific messaging in the media that each target uses.
The more information you can provide to the creatives, the better. For example, consider the differences among the consumer profiles for hiking shoes compared to walking shoes compared to casual sneakers. The consumer of hiking shoes tends to be younger, more rugged, and more outdoorsy compared to the others and is likely to read a magazine like Outdoors. The consumer for walking shoes tends to be older than the other two and more affluent; he is concerned about appearance, comfort, and status. The consumer of casual sneakers is more easygoing, less affluent, and more likely to watch TV. The clearer the picture creatives have of their potential customer, the better they can target the advertising. Thus, the walking shoe customer will be more likely to respond to an ad that touts the health benefits of walking than will a casual sneaker customer.
SS+K Spotlight
After extensive research and data, SS+K and msnbc.com identified a niche for their product, and a newly defined segment of their audience was born. We’ll learn more about that new audience in Chapter 6 "Segment, Target, and Position Your Audience: SS+K Identifies the Most Valuable News Consumer".
Key Takaway
Research provides crucial inputs at several stages of message development. It helps to generate ideas based upon the experiences of real people and how their needs evolve. It provides reactions to concepts so that the agency can choose those that work as it throws a bunch of ideas against the wall to see which stick. And research that profiles potential customers is imperative; insights will help strategists to select the most attractive market and creatives can develop a position for a brand that best meets the needs of that market.
EXERCISES
1. Describe the role research plays in the creation of a successful campaign or product launch.
2. Explain the process of idea generation and provide an example of a new idea you have seen or experienced lately.
3. Explain the process of concept design and testing. Create an example to illustrate how this process might work.
4. Criticize the process of audience definition and profiling. As you review the positives and negatives, remember to comment on what you perceive to be the future of audience profiling. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/05%3A_Know_Your_Audience-_SSK_Learns_All_About_msnbc.com_Inside_and_Out/5.06%3A_Using_Research_to_Guide_a_Successful_Launch.txt |
Tie it All Together
Now that you have read this chapter, you should be able to determine how primary and secondary data are collected and used by advertisers:
• You recognize that data is the key to knowing the consumer.
• You can demonstrate the value of using surveys and focus groups to provide data.
• You can explain why ethnographic study should be done by advertisers.
• You can describe the advantages and disadvantages of primary data.
• You can classify the primary sources of secondary data.
• You can describe the advantages and disadvantages of secondary data.
• You can compare and contrast each of the physiological sources of data.
• You can list and discuss the advantages and disadvantages of physiological data.
• You can construct a communications brief.
• You can recall the importance of idea generation and concept design and testing in developing advertising strategy.
• You can explain how audience definition and profiling can be used in advertising.
USE WHAT YOU’VE LEARNED
1. Gathering physiological data on consumers can be difficult; however, in the future we may all be providing such data every time we enter a store. Imagine entering a store and having your face “mapped” via an infrared sensor. Your face map is then used to match you against a data bank of shopper profiles suggesting whether or not you are in a mood to buy. Does this sound too futuristic?
Face mapping is currently receiving a lot of attention from a variety of quarters. Security experts tell us that face mapping can alert security services to certain profiled behaviors. Dermatologists say face mapping may provide solutions to long-term skin care. Others say that face mapping can be used to insert a person’s picture in real-time advertisements. That’s right—you’ll be in the ad that you see in the store or are viewing on a screen. You could watch yourself flying a helicopter in a U.S. Army ad, see yourself walking across the graduation stage in a college recruitment ad, or check yourself out as you model the latest fashion that the store has to offer.
Research the subject of face mapping via secondary research sources. Think of a new application (i.e., idea generation) for face mapping and describe it. Describe how you would test to see if your new application might work. What ethical and legal issues might face mapping bring if it was practiced on a large scale? Summarize your thoughts on the application and future of this technique.
2. How do you illuminate a world that has increasing difficulties with power generation and transmission? As the cost of electricity rises, rural populations the world over have an even greater difficulty obtaining power for their villages and electricity for their homes. Several innovative manufacturers have found ingenious solutions to the problem. Picture a solar-powered twenty-five-watt lantern that could illuminate a small room when suspended from the ceiling or sit on the floor to serve as a personal reading light. Cosmos Ignite Innovations, d.light design, and Phillips have all produced these simple lanterns. Most of these solar “night light” lanterns can shine for about five hours without being recharged. The companies believe that the simple idea of “recharge by day and shine at night” can be learned quickly by villagers and communities. Currently, the companies are shipping lanterns to India, the Middle East, and Africa.
Assume that you have been assigned the task of informing the target markets about the lantern products. Given the limited media resources in the regions, design a communications brief that will accomplish the information distribution objective. Follow the method described in Section 5.5 "Using Research to Guide a Successful Launch" of this chapter. Discuss your ideas with peers. Critique the various briefs.
DIGITAL NATIVES
Do you wear glasses or some other vision-correction device? Supplying eyewear is a huge industry. Many of the companies that manufacture and distribute eyewear products and services have taken their products and messages to the Web. Let’s examine one of these companies—Eye Glass Guide 2.0 at http://www.eyeglassguide.com. Review the various features of the Web site. Take particular interest in the product videos provided. Remember, it is not necessary to fill out any company solicitation information to view the videos.
Once you have reviewed the eyeglassguide.com videos, design a questionnaire for collecting primary data information in one of the product areas (e.g., kids’ eyewear). The research objective of your questionnaire will be to gain information on those who might be willing to establish contact, buy eyewear, or request an appointment via the company’s Web site. Decide what you want to know and how you will find the information. Discuss your questionnaire with peers. Ask for feedback and criticism on your questionnaire’s design.
AD-VICE
1. Demonstrate your knowledge of primary data by devising a ten-item questionnaire to identify food favorites among adults. Administer your questionnaire to ten people. Tabulate and report the responses.
2. Review the chapter material on the focus group testing done by SS+K for their client msnbc.com. Examine the value propositions tested. Comment on the focus group process as a means to generate data. Critique the SS+K focus group effort. Comment on your conclusions.
3. After reviewing chapter materials on ethnographic studies, design an ethnographic study for examining whether or not ethnicity (or culture) impacts the selection and eventual purchase of an automobile. Remember to include what you want to know, how you will find your data, sample questions, and a plan for reaching the right targets with your study questions.
4. Using any library’s facilities or the Web as your search vehicles, find ten sources that would give you secondary information on consumer taste preferences. You can limit the extent of your secondary research by designating the taste preference (e.g., soft drinks, fast food, beer or wine), or you can generalize in your research. Briefly describe what you learned about researching secondary data sources in this exercise.
ETHICAL DILEMMA
As the chapter states, “Defining and targeting your audience is the best way to ensure a match between the company’s product or service and the consumer’s needs.” It only makes good sense that a market-oriented company would want to know as much as possible about its target audiences in order to serve them better. Today, technology has the capability to provide an increasing volume of data that allows audience profiling to become more targeted. Technology-driven audience profiling includes demographics, psychographics, multimedia preference, and characteristics studies in its analysis arsenal. From an ad agency or marketing organization perspective, the idea is simple: the more information you can supply to the creatives the better.
OK, so what’s wrong with the picture we just presented to you? There are most likely many faults; however, chief among them are concerns about data collection methods and information security. In other words, there is worry about privacy rights. To investigate this ethical issue, conduct research on the privacy rights of consumers. Specifically, examine privacy rights on the Web and company statements about how consumer information is used. Summarize your findings. Once this is done, summarize your thoughts on how researchers seeking audience profiles can honor consumers’ privacy rights and still conduct meaningful research. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/05%3A_Know_Your_Audience-_SSK_Learns_All_About_msnbc.com_Inside_and_Out/5.07%3A_Exercises.txt |
Good advertising is all about hitting customers where they live. But before you can craft a killer message to send, you have to know what address to send it to. Here’s a profound idea: people are different. A message that turns one person on may leave another cold. And, of course, not everybody’s likely to be interested in any idea, product, or service your client wants to sell (OK, maybe eternal youth…).
Before an advertiser can decide what a campaign should say, the advertiser needs to devote a lot of thought to identifying the target of the message. Target marketing is the process of identifying the types of people who are most likely to want your product and then tailoring your efforts to satisfy their unique needs. We do this when we use the STP (Segmenting, Targeting, Positioning) process, which consists of these three steps:
1. Segmenting subdivides the population to help you think about who are and are not the potential customers for your product and the potential audience of the advertising.
2. Targeting picks the segment(s) for the campaign that will be the focus of the advertising.
3. Positioning is how to think about the relationship between your product and the customer/audience, with the purpose of distinguishing your product from the competition.
In short, STP gives you a framework for understanding: Who are your customers? How many customers are there? Where do they live? How do they spend their time? Why do they buy?
SS+K Spotlight
“The key turning point of this whole thing was when we started thinking about explorers and addicts and junkies.”
—Russell Stevens
“Really, all research and planning is telling a good story.”
—Account Planner Michelle Rowley
One of the primary jobs of the account planner is to develop an empathic understanding of the target consumer, to get under their skin and understand their rational and sometimes irrational attractions to brands. This task comes naturally to Michelle, who describes herself as a “failed actor” who fell into her job—and then fell in love with it. Michelle and her colleagues need to identify the most relevant audience for the msnbc.com branding message, get “under their skin,” and then figure out how to align their client with what these viewers want. That’s the segmenting, targeting, and positioning process in a nutshell.
Video Spotlight
Michelle Rowley
(click to see video)
Watch as Michelle Rowley explains her role in the agency and in the campaign process.
6.02: Segment Your Market- Who's Out There
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Recognize the target marketing process that includes segmenting, targeting, and positioning.
2. Describe the key characteristics of market segments by examining the demographic, geographic, psychological/lifestyle (psychographic), and behavioral variables found in those segments.
Segmentation is the process of dividing a larger market into smaller pieces based on one or more meaningful and measurable shared characteristics. It’s crucial to slice up the pie so you can focus your resources on customers whose needs you have the best chance of satisfying. These are the benefits of a segmentation approach.
Segmenting the population gives you a concrete vision of your potential customer. For example, targeting upper-income unmarried men with a college education gives you a more specific vision of the intended audience than does simply advertising to “people.”
Segmenting the population provides focus and specificity on those people most likely to buy your product. It’s better to find the five million people who are 80 percent likely to buy than it is to find the eighty million people who have a 5 percent chance of buying.
Segmenting the population lets you estimate the number of people in a given category (such as “Affluent Retirees”), which gives you an idea of your potential market size. Knowing how many potential customers you’ll have influences your sales estimates, your total marketing budget, and the advertising media you use. For example, if you’ll be targeting Hispanic consumers in Phoenix, your total market size will be 1.36 million people.Kevin Downey, “Phoenix: Ad Budgets Soar in Newly Ensconced 8th-Largest Latino Market, But Immigration Remains a Concern,” Marketing y Medios, October 22, 2007, www.marketingymedios.com/marketingymedios/market_profile/article_display.jsp?vnu_content_id=1003661213 (accessed November 5, 2008).
Demographic Segmentation
Demographics are measurable aspects of a population. Each key variable is usually defined in terms of a small number of categories or ranges. For example, age data might record the number of thirty- to forty-year-olds in aggregate, rather than separately tallying each age group of people who are thirty, thirty-one, thirty-two, thirty-three, and so on.
These are widely used demographic measures:
• Gender of the individual or head-of-household (e.g., Female)
• Age (e.g., 18–24)
• Life stage (e.g., empty-nest parents who have more time for each other now that their kids are in college)
• Household income (e.g., \$30,000–\$40,000 per year)
• Education (e.g., college graduate)
• Occupation (e.g., banker)
• Race/ethnicity (e.g., African American)
• Religion (e.g., Buddhist)
• Socio-economic status or SES (e.g., DINKs—“double income, no kids”)
SS+K Spotlight
While demographics can be an effective way to begin to understand your potential consumers, msnbc.com and SS+K knew that they would need to dig deeper to identify the specific audience for their branding campaign. While some product categories can move forward with demographic information only, services such as news, entertainment, and sports media need more information to fine-tune their targets. For example, the Bravo network, which has successfully created numerous high-style reality shows that revolve around upscale pursuits like gourmet cooking, fashion modeling, or home design, recently developed for advertisers a one-off (that is, one-time publication) magazine it called Bravo Affluencer. Each of the two people on the cover represented a distinct psychographic segment that is key to Bravo’s targeting strategy: an attractive man and woman, both in their late twenties, shopping bags and PDAs in hand, passports visible in pockets, dressed casually but stylishly. These two models are reminiscent of the popular stars of the sitcom Will and Grace—and that’s no accident. Bravo executives actually use the phrase “Will and Grace” to describe two of their key viewer segments: urban gay men and single female professionals. Many of the network’s most popular shows such as Project Runway and Top Chef attract these viewers in large numbers.Susan Dominus, “The Affluencer,” New York Times Magazine, October 30, 2008, http://www.nytimes.com/2008/11/02/magazine/02zalaznick-t.html? partner=rssnyt&emc=rsscc (accessed November 5, 2008). As we learned in Chapter 5 "Know Your Audience: SS+K Learns All About msnbc.com, Inside and Out", SS+K and msnbc.com had done significant segmenting and research to identify their target audience, the News Explorer.
Dig Deeper
MySpace recently launched a separate version of its site to reach twenty-eight million Americans who are Spanish speakers at latino.myspace.com. Users can still become friends with MySpace users across the network of sites. Nielsen//NetRatings reports that MySpace is one of the top five Web sites U.S. Hispanics visit.Emily Burg, “Do You Want To Be My Amigo? MySpace Launches En Espanol,” Marketing Daily, April 26, 2007, http://www.mediapost.com (accessed November 5, 2008). How do U.S. advertisers appeal to non-English speakers on social networking sites? What else might they do to broaden their reach?
Geographic Segmentation
Geography plays three roles in the target marketing process:
1. Customer and market characteristics. Geography defines key aspects of climate, culture, and customer density. Think about where people buy snowshoes, the time of year Midwesterners hold backyard barbecues, or the differences between laid-back Southern Californians and ambitious New Yorkers. News items and ads served on msnbc.com when possible need to be relevant to the geographic profile of a registered user; a web surfer in Florida probably isn’t too interested in today’s ski conditions.
2. Advertising channels. Some advertising strategies, such as newspapers and direct mail, are strongly tied to geography. For example, automobile companies tailor their ads by geography. Automakers purchase TV time on local cable stations and tailor the ads based on where people live. People who live in zip codes located in the suburbs see ads for SUVs, while those in the cities see commercials for cars—during the same programs. As you’ll learn in the media planning chapter, msnbc.com made very strategic geographic media and messaging decisions in order to maximize the value of their buy.“For car marketers, local cable ads are spot-on,” Automotive News, May 28, 2007, 26F.
3. Product distribution: Many companies, especially small and medium-size businesses, have a regional scope. Even national companies like Wal-Mart want to assess how many people live within ten miles of a store that carries a product that they will promote.
Most geographic segmentation schemes use definitions the government created for census, postal, and economic forecasting purposes.
• Zip code. Zip codes, as defined by the U.S. Postal Service, identify each of roughly forty-three thousand neighborhoods. Other countries, too, have analogous postal code systems. Zip codes are often the basis for direct mail advertising. Car dealers use zip code information as a proxy for income, making different offers, such as lease-to-own or cash incentives, to entice potential buyers in different neighborhoods.
Dig Deeper
In addition to other applications, a widely used system called PRIZM helps clients to fine-tune their advertising by directing mailings to specific types of customers based upon where they live (“birds of a feather flock together”). PRIZM (Potential Rating Index for Zip Markets) classifies all U.S. neighborhoods into sixty-two distinct clusters based upon very detailed data about the products and media people who live in different neighborhoods consume relative to the national average. PRIZM offers a little something for everyone, with groups like Urban Gold Coast (elite urban singles and couples), New Empty Nests (upscale suburban fringe couples), and Norma Rae-ville (young families in biracial mill towns).
Visit PRIZM’s Web site and look up your zip code to see what category you fall into. Do you agree with this classification? (www.claritas.com/MyBestSegments/Default.jsp?ID=20&SubID=&pageName= ZIP%2BCode%2BLook-up)
• MSA. Metropolitan Statistical Areas (MSAs) are important for local advertising channels (e.g., newspaper, radio, outdoor, local broadcast TV, and cable). The U.S. Office of Management and Budget (OMB) defines 363 MSAs in the United States. MSAs are defined using census data at a county level (or a group of economically linked contiguous counties) with at least one urbanized area of fifty thousand or more population. One MSA, called the “New York-Northern New Jersey-Long Island, NY-NJ-PA” MSA is the most populous MSA in America and contains approximately nineteen million people.
• Civil boundary regions.
• City. Of U.S. cities, nine have a population over one million, and 254 have a population over one hundred thousand.
• County. There are 3,066 counties in the United States.www.naco.org/Content/NavigationMenu/About_Counties/Data_and_Demographics/Data_and_Demographics.htm (accessed November 15, 2008).
• State. Identifying customers by state can be important because laws may vary from state to state, especially for industries such as financial services (like insurance), tobacco, and alcohol. These regulations can affect advertising strategies. For example, California law heavily restricts distribution of coupons for cigarettes.
• Census regions and divisions. Four broad regions (West, Midwest, Northeast, and South) further divided into nine divisions.
• DMA codes. Designated Market Areas (DMAs) are markets in the United States that are within range of a particular broadcast television station. The term was originally defined by Nielsen Media Research to identify TV stations whose broadcast signals reach a specific area and attract the most viewers. A DMA consists of all counties whose largest viewing share is given to stations of that same market area. Nielsen gathers data to verify DMAs four times a year; there are currently 210 nonoverlapping DMAs in the United States.
• Sales or distribution regions. Many companies create their own geographic subdivisions, which vary by company. For example, a product might be sold through a specialty retailer that only operates in the Northwest.
• Climatic. Some products are specific to or more prevalent in areas with a specific client. For example, Minnesotans buy more snowshoes than do Texans.
Dig Deeper
Like it or not, global warming is here to stay—at least in our lifetimes. Warmer (or at least more unpredictable) temperatures will have many consequences—some you may not have thought about. For example, think about how these changes will affect the \$200 billion American apparel industry. Will we still think about “winter clothes” versus “summer clothes” in a few years? At least a few companies are thinking ahead. Liz Claiborne hired a climatologist to help the company better time the shipments of seasonal garments to retailers.For more information, see http://topics.nytimes.com/top/news/business/companies/claiborne_liz_inc/index.html?inline=nyt-org. Target created a “climate team” to provide advice on what the retailer should sell throughout the year (hint: think lighter-weight fabrics).For more information, see http://topics.nytimes.com/top/news/business/companies/target_corporation/index.html?inline=nyt-org. Weatherproof, a coat manufacturer, went so far as to take out a \$10 million insurance policy against unusually warm weather.Michael Barbaro, “Meteorologists Shape Fashion Trends,” New York Times Online, December 2, 2007, http://www.nytimes.com/2007/12/02/business/02weather.html (accessed July 11, 2008).
How will this new weather reality influence the way seasonal industries like apparel plan their advertising campaigns?
Psychographic Segmentation
While demographics are useful, advertisers often need to slice and dice even further. Traditional demographic segments (such as gender, age, and income) provide only a rough estimate of the attitudes and desires of different groups, so marketers often give consumer groups labels that capture something about their lifestyles and motivations as well.
Imagine an advertiser that defines a segment as recent moms. This label implies that all women who have recently given birth are fairly similar and that they all will respond the same way to an advertising message—how accurate is that assumption? Bloomingdale’s Quotation, a store-within-a-store, instead calls its target market “yummy mummies.” These are women age thirty-five to forty-five who have gained weight after their babies but don’t want to look matronly. They are affluent, suburban, and casual yet fashionable. Bloomie’s research department provided further insight into the target customer: she thinks classic sportswear like Jones New York is too formal but contemporary sportswear like Juicy Couture is too young. The mom wants clothes that look pretty and feminine and have flair but offer a generous, not-too-tight fit.Elizabeth Woyle. “What Do 35-Year-Old Women Want?” BusinessWeek, April 2, 2007, 66.
Psychographics refers to dimensions that segment consumers in terms of personality, values, attitudes, and opinions. While demographics can divide people along specific (often quantitative) dimensions, psychographics captures the reasoning and emotion behind people’s decisions. This information also enables advertisers to capture the themes, priorities, and “inside meanings” that a specific taste culture identifies with. For example, Svedka Vodka targets urban party people who are out drinking until three o’clock in the morning three nights a week. This target market is irreverent, and Svedka’s ads speak their language. The ads feature futuristic imagery and lines like “Svedka says ‘thank you’ for making the gay man’s fashion gene available over the counter in 2033.”Dan Heath and Chip Heath. “Polarize Me,” Fast Company, April 2007, 59.
PRIZM NE classifies psychographic segments based on where they live.
Affluent people who live in wealthy exurban (beyond suburban) areas make up this segment. They like their space and their conveniences. They are typically Baby Boomers who balance their lives between high-powered jobs and laid-back leisure.
They are mostly college-educated Whites between the ages of 35 and 54 with a median household income of \$84,851. They are most likely to travel for business, take a golf vacation, read Skiing magazine, and drive a Toyota Land Cruiser.
Older, middle-class seniors who live comfortably in the suburbs characterize this segment. These retired homeowners are opting to stay in their homes rather than move to a retirement community. The mostly White, college-educated suburbanites have a median household income of \$51,367. They are most likely to shop at Lord and Taylor, belong to a veterans’ club, watch the U.S. Senior Open on TV, and drive a Buick LaCrosse.
This segment includes upper-middle-class suburban couples, with children, who enjoy focusing on their families. They live in a large home in a subdivision. Their white-collar profession and young age (25–44) provides them the means to have it all.
The segment includes a growing number of Hispanic and Asian Americans. The median household income is \$70,490. They are most likely to shop at The Disney Store, eat at Chuck-E-Cheese, watch Nickelodeon TV, and drive a Nissan Armada SUV.
Young, working singles living active lifestyles in sprawling apartment complexes in fast-growing satellite cities compose this segment. They are under 35, ethnically diverse, and hip, and they want it all. Nightlife, restaurants, and convenience products and services are important to them. Their median household income is \$38,910. Since they don’t have children, they are very active. They are most likely to go snowboarding, watch Fuse network, read The Source magazine, and drive a Nissan Sentra.
Sometimes marketing and advertising firms create psychographic segmentation systems with cute names or acronyms for the segments, such as DINKs (double income, no kids), who are good targets for yuppie products like expensive roadsters and exotic vacations, or even DINKWADs (double income, no kids, with a dog), who are like DINKS but would add in lots of treats for a pampered pooch. msnbc.com, for example, termed its new target audience the News Explorer.
These are some well-known psychographic segmentation tools that advertisers use to divide up their markets:
• VALS2™ (Values and Lifestyle System): According to its parent, SRI International, “VALS reflects a real-world pattern that explains the relationship between personality traits and consumer behavior. VALS uses psychology to analyze the dynamics underlying consumer preferences and choices.”For more information, see www.sric-bi.com/VALS/. VALS2™ divides U.S. adults into eight groups according to what drives them psychologically as well as by their economic resources.
The system arranges groups vertically by their resources (including such factors as income, education, energy levels, and eagerness to buy) and horizontally by self-orientation. Three self-orientations make up the horizontal dimension.
1. Consumers with a principle orientation make purchase decisions guided by a strong internal belief system.
2. People with a status orientation base their decisions on what they think their peers think.
3. Action, or self-oriented individuals, buy products to have an impact on the world around them.
Actualizers, the top VALS2™ group, are successful consumers with many resources. This group is concerned with social issues and is open to change. The next three groups also have sufficient resources but differ in their outlooks on life:Martha Farnsworth Riche, “VALS 2,” American Demographics, July 1989, 25. Additional information provided by William D. Guns, Director, Business Intelligence Center, SRI Consulting Inc., personal communication, May 1997.
1. Fulfilleds are satisfied, reflective, and comfortable. They tend to be practical and value functionality.
2. Achievers are career-oriented and prefer predictability to risk or self-discovery.
3. Experiencers are impulsive and young, and they enjoy offbeat or risky experiences.
The next four groups have fewer resources:
1. Believers have strong principles and favor proven brands.
2. Strivers are similar to achievers but have fewer resources. They are very concerned about the approval of others.
3. Makers are action-oriented and tend to focus their energies on self-sufficiency. They will often be found working on their cars, canning their own vegetables, or building their own houses.
4. Strugglers are at the bottom of the economic ladder. They are most concerned with meeting the needs of the moment and have limited ability to acquire anything beyond the basic goods needed for survival.
VALS2™ helped Isuzu market its Rodeo sport-utility vehicle by targeting Experiencers who believe it’s fun to break rules. The company and its advertising agency promoted the car as a vehicle that lets a driver break the rules by going off road. One ad showed a kid jumping in mud puddles after his mother went to great lengths to keep him clean.For other examples of applications see “Representative VALS™ Projects,” SRI Consulting Business Intelligence, www.sric-bi.com/VALS/projects.shtml#positioning (accessed February 29, 2008).
• Trend analyst Faith Popcorn’s firm BrainReserve refers to segments based on life stages like MOBYs (mommy older, baby younger), DOBYs (the daddies); former yuppies divided into PUPPIEs (poor urban professionals) and WOOFs (well-off older folks); latchkey kids, sandwichers (adults caught between caring for their children and their older parents); and SKIPPIEs (school kids with income and purchasing power). The company also groups consumers based on special interests, like global kids (kids with strong feelings about the environment plus strong influence over family purchase choice); and new health age adults (consumers who consider their health and the health of the planet to be top priorities).
• Mediamark Research (MRI) divides the wealthiest 10 percent of U.S. households (“the upper deck”) by lifestyles: the good life, well-feathered nests, no strings attached, nanny’s in charge, and two careers.
SS+K Spotlight
The additional insights msnbc.com uncovered about the site’s users, as a result of the psychographic information the company obtained in its primary and secondary research, allowed its analysts to start with broad demographic segments and then further slice these groups into smaller but more meaningful psychographic segments. As the company did the research described in Chapter 5 "Know Your Audience: SS+K Learns All About msnbc.com, Inside and Out", it was able to discriminate, for example, between News Explorers and News Junkies.
Behavioral Segmentation
Behavioral segmentation slices the market in terms of participation or nonparticipation in an activity. Sometimes this involves identifying the different ways consumers use products in a category. Mattel introduced a new brand it calls Barbie Girls to attract the increasing number of girls who spend a lot of time online in virtual worlds instead of playing with real dolls in the physical world. It features a free Web site, BarbieGirls.com, that will allow children to create their own virtual characters, design their own room, and try on clothes at a cyber mall. It’s following up with Barbie-inspired handheld MP3 music devices.“Mattel Aims at Preteens with Barbie Web Brand: Toymaker Turns to Tech as Sales Slump for Iconic Fashion Doll,” Associated Press, April 26, 2007, http://www.msnbc.com (accessed April 26, 2007).
Segmenting by behavior often singles out heavy users of a product, because even though these consumers may be relatively small in number, they often are key to sales in a category. Indeed, there is a lot of truth to the so-called 80/20 rule: this is a rough rule of thumb that says 20 percent of customers buy 80 percent of a product. Sure enough, for example, Kraft Foods began a \$30 million campaign to remind its core users not to “skip the zip” after its research showed that indeed 20 percent of U.S. households account for 80 percent of the usage of Miracle Whip—“heavy” users (pun intended) consume seventeen pounds of Miracle Whip per year!Judann Pollack, “Kraft’s Miracle Whip Targets Core Consumers with ’97 Ads,” Advertising Age, February 3, 1997, 12.
Information sources that can pinpoint heavy users in a brand or product category include:
• Industry group reports (for example, the National Golf Foundation tracks the number of golfers in the United States and the extent of their participation in the game).
• Surveys of consumer behavior (for example, the number of people who eat fast food more than three times per week).
• Product sales (install base): Owners of particular products can be an affinity group. For example, a company can choose to target owners of Apple iPods either with accessories or with a brand image that resonates with that population.
Video Spotlight
SS+K
(click to see video)
Michelle Rowley explains how behavioral segmentation of the audience led to understanding the difference between a CNN.com user and an msnbc.com lover.
B2B (Business to Business) Segments
Many clients sell products used by businesses rather than (or in addition to) end users. B2B advertisers also segment their markets, but the dimensions they use are different. In addition to data the government collects about businesses, trade organizations often offer data about their members. In addition, services like Hoovers Online provide detailed breakdowns about many companies. Relevant dimensions include these:For more information, see www.hoovers.com.
• Company size. This comprises such things as revenues or headcount.
• Industry. Marketers often use the North American Industry Classification System (NAICS), a numerical coding of industries the United States, Canada, and Mexico developed. The NAICS reports the number of firms, the total dollar amount of sales, the number of employees, and the growth rate for industries, all broken down by geographic region.
• Geography. This comprises such things as location of headquarters, sites, or geographic focus of distribution.
• Buying cycle. Companies often have a deliberative process for buying with known intentions to buy within a certain number of months.
• Buyer role. Advertising often targets specific people within an organization (e.g., those who influence, specify, and make buying decisions).
Dig Deeper
Encryption-product maker GlobalCerts targets companies that have one hundred to one thousand employees. When GlobalCerts began its direct mail campaign, it collected information on its key prospects, including their needs, buying cycle, and decision makers’ contact information. Knowing the buying cycle of an organization is important because decision makers need different kinds of information, depending on where they are in the buying cycle. Early on, decision makers are looking for more general information about solutions that meet their business needs. In later stages, they want very product-specific performance information. Having a salesperson call a potential customer too early in the buying cycle will likely annoy the customer—they’re not ready to buy—and waste the time of the salesperson.Elias Terman, “Name Dropping,” American Printer, January 1, 2007, v124.
SS+K Spotlight
Defining the audience is a job for both the left brain and the right brain. We use this expression because in general the left side of our brains is more rational and fact-oriented while the right side is more emotional and artistic. Some people tend to be more logical when they approach problems while others are more creative and emotional. For fans of the original Star Trek TV series, just think of Mr. Spock and Dr. McCoy and you’ll get the difference immediately.
So, SS+K needs to combine both rational and emotional factors when they think about their target market. Even the most comprehensive demographic profile seldom communicates a sufficiently nuanced understanding of any group of consumers. At SS+K, the account planners and researchers that make up the AIU are charged with acquiring information beyond current user demographics that will allow the account, media, and creative team to visualize and understand the consumer. An insightful and comprehensive target profile should enable the writers and art directors to imagine the target consumer so well, in fact, that the creatives can develop an empathic understanding of that consumer’s relevant needs and wants. The more complete the creatives’ understanding of the audience, the more likely the team will be able to craft a message that speaks in an authentic, compelling voice to the target consumer.
Video Spotlight
Michelle Rowley: Primary Research Informs User Differences
(click to see video)
Listen as Michelle describes the process of working with Energy Infuser and what the triads uncovered.
If an agency relies on simple demographics to define its target market, the risks of oversimplification and naïve projections are considerable. The job of an account planner like SS+K’s Michelle Rowley is to dig deeper; to see, understand, and report significant differences among potential target markets on the basis of characteristics that aren’t immediately apparent to just anyone with access to a marketing database.
The profile provided Michelle with a basic understanding of the msnbc.com user. In addition to some telling demographics, Michelle had a good sense of how users describe their technological acumen and online news-gathering behavior and preferences.
After analyzing a veritable mountain of proprietary research already collected by the client, Michelle and her colleagues identified a trio of expectations consumers brought to their online news and information experiences. First, the online news audience assumed “the cost of entry” for credible sources was an ability to provide breaking news in a timely fashion; research indicated that consumers considered this a generic attribute and not a point of differentiation for any news provider. The second and third expectations were also considered essential parity characteristics (i.e., elements that any competitor would need): a well-organized site that provides ease of access and a multi-faceted presentation of text, photos, and video. Users said the most important attribute for news and online information providers was to provide trusted coverage.
Beyond that, there were still some significant gaps in the research that Michelle and company had to fill before they were prepared to commit fully to a target audience and position the brand in the marketplace. SS+K wanted to better understand the factors involved in making a choice for news and information:
• What role does news and information play in the lives of online consumers?
• What were the emotional drivers in choosing a source?
• Who was likely to influence others’ choice of a news site, and how was this influence exercised?
Once these more global issues were better understood, SS+K could more effectively address how to position msnbc.com relative to its competition.
Understanding consumers’ behaviors, as well as their motivations and gratifications for using particular sites, was a key focus of the next research phase. The ultimate goal was to find a voice, a tone, a way of presenting the brand that was relevant and clearly differentiated in the minds of the consumers as unique to msnbc.com. Michelle and her colleagues organized focus groups and interviews for further exploration of the opposing goals and perspectives suggested by the initial research. Among these were the following:
• Attraction versus retention
• What is the relationship between what attracts you to a site and what keeps you interested once you’re there?
• Why are users accessing broadcast-related media online?
• How can msnbc.com differentiate itself from MSN? What is the value of the association beyond driving traffic?
• What type of content will motivate your current consumers to spend more time on the site?
• Are light msnbc.com users clicking through on other sites?
• Credibility versus liability
• What value do the NBC news brands bring to an online news site?
• What is credible about the NBC brands?
• How strong are the associations with NBC news personalities?
• Informed versus overwhelmed
• What is the balance between knowledge as power and news as noise?
• Do online news users want “all the news that’s fit to print” or “enough information so I don’t look stupid”?
• Do your users want to know it all or just know enough?
• Entertained versus unfulfilled
• What causes the negative reaction to the site among non-users? Are non-users reacting to the actual product or its reputation?
• What is the appropriate balance between hard news and entertainment content?
• How does the style of storytelling affect a user’s perception of the content on the site?
SS+K needed answers to questions like these before the agency could identify the profile of the person most likely to be attracted to msnbc.com as a news source. That’s where the targeting process comes in, so we’ll turn to that next.
Key Takaway
It’s very rare for an idea, product, or service to appeal to all consumers. Segmentation is the process of dividing the total population into groups that share important characteristics relevant to a client’s product or service. These segments may be based on demographics, psychological/lifestyle characteristics (psychographics), or behavior (e.g., heavy users versus light users of the brand).
1. Segmenting subdivides the population to help you think about who are and are not the potential customers for your product and the potential audience of the advertising.
2. Targeting picks the segment(s) for the campaign that will be the focus of the advertising.
3. Positioning is how to think about the relationship between your product and the customer/audience, with the purpose of distinguishing your product from the competition.
EXERCISES
1. Target marketing requires that we use the STP process, which consists of three steps. List and briefly describe those steps.
2. Demographics are measurable aspects of a population. There are nine widely used demographic measures. List and briefly describe five of those demographic measures.
3. Explain how advertisers might be able to use SRI International’s VALS2™ to construct consumer ad campaigns. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/06%3A_Segment_Target_and_Position_Your_Audience_-_SSK_Identifies_the_Most_Valuable_News_Consumer/6.01%3A_Chapter_Introduction.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Identify who customers are by following the targeting process.
2. Review the properties of a good market target in order to select the optimal target for marketing and advertising efforts.
3. Examine behavioral targeting as a means of determining what consumers want and like.
Targeting increases the cost-effectiveness of advertising. Most advertising channels have a cost that is a strong function of the amount of exposure (e.g., the number of people who see the ad) regardless of whether audience members are potential customers or not. Targeting helps define who the customers are. This section explores how the advertiser can:
1. Profile segments:
1. According to buying power
2. According to likelihood of buying your product or service
3. According to likelihood of being attracted by a potential ad
2. Assess the attractiveness of each potential target.
3. Select segment(s) that are both attractive and likely to have a similar favorable response to a given advertising message.
What Are the Properties of a Good Target?
• Measurable: Key variables easily (and accurately) identify and assess the target.
• Accessible: The target group must be reachable by advertising.
• Profitable: The target group must have sufficient size, willingness to buy, and ability to pay.
• Distinguishable: The target group must provide a clearly differentiated segment in terms of percentage of potential customers and coherence of response to potential advertising messages.
Dig Deeper
In 2007, Japanese auto maker Suzuki began aggressively targeting a new segment: female car buyers in India who now have the income to buy their own vehicles due to India’s economic boom. The carmaker’s Zen Estilo (Estilo means “style” in Spanish) sells for less than \$8,000 and comes in eight colors, including “purple fusion,” “virgin blue,” and “sparkling olive.” For a more modern look, Suzuki gave the car a two-tone dashboard and a front grille design that makes the little car look like it is smiling. Style-conscious drivers can also add rear spoilers, side skirts, and extra colors to the body. Many of Suzuki’s foreign competitors ignored this market because they chose to focus on selling mid- to high-end vehicles.Eric Bellman, “Suzuki’s Stylish Compacts Captivate India’s Women,” Wall Street Journal, May 11, 2007, B1.
SS+K Spotlight
While a lot of readers visit msnbc.com, not all are News Explorers. Remember, the News Explorer is the target that msnbc.com and SS+K determined was the best target for the branding campaign.
Behavioral Targeting: Advertisers Know What You Like (Like It or Not)
The STP process is evolving rapidly as new advances in technology enable advertisers to identify and reach consumers where they live, work, and especially surf (online).
Today, companies define and manage finer and finer segments. In the past, segments had to be broad because it was difficult to reach finer-level segments and because such fine-grain data were not available. Now, companies can process terabytes of data on customers, and new ad channels (such as keyword advertising on the Internet) allow companies to reach smaller segments, down to segments of one (yes, like you).
These three factors fuel the accelerating trend of targeting small, very well-defined segments:
• Growing volume of data on customers
• Rising use of computers and analytic software
• Increasing specificity of advertising channels (e.g., keyword advertising on the Internet)
Behavioral targeting refers to putting ads in front of people customized to their Internet use. It’s become fairly easy for marketers to tailor the ads you see based on prior Web sites you’ve visited. The logic is inescapable: you’re more likely to respond (and probably appreciate) an ad for an idea, product, or service that’s relevant to your needs.
Obviously, privacy concerns arise as advertisers learn more about the sites we visit. But many consumers seem more than happy to trade off some of their personal information in exchange for information they consider more useful to them. More than half of respondents in one recent survey said they’re willing to provide demographic information in exchange for a personalized online experience.“Consumers Willing to Trade Off Privacy for Electronic Personalization,” Marketing Daily, http://www.mediapost.com (accessed January 23, 2007). While the ethics of gathering personal information are still being evaluated, behavioral targeting is the next frontier for many advertisers.
• When you (along with 263 million other users) sign up for Microsoft’s free e-mail service called Hotmail, the service asks you for personal information including your age, occupation, and address (though you’re not required to answer). If you use Microsoft’s Live Search search engine, the company keeps a records of the words you search for and the results you clicked on. Microsoft’s behavioral targeting system will allow its advertising clients to send different ads to each person surfing the Web. For instance, if a twenty-five-year-old financial analyst living in a big city is comparing prices of cars online, BMW could send her an ad for a Mini Cooper. But it could send a forty-five-year-old suburban businessman with children, who is doing the same search, an ad for the X5 SUV.Aaron O. Patrick, “Microsoft Ad Push Is All About You: ‘Behavioral Targeting’ Aims to Use Customer Preferences to Hone Marketing Pitches,” Wall Street Journal, December 26, 2006, B3; Brian Steinberg, “Next Up on Fox: Ads That Can Change Pitch,” Wall Street Journal, April 21, 2005, B1, http://www.aef.com/industry/news/data/2005/3105; Bob Tedeschi, “Every Click You Make, They’ll Be Watching You,” New York Times, April 3, 2006, http://www.nytimes.com/2006/04/03/business/03ecom.html?ei= 5088&en=9e55aeacf695c33a&ex=1301716800&partner=rssnyt&emc= rss&pagewanted=all (accessed November 15, 2008); David Kesmodel, “Marketers Push Online Ads Based on Your Surfing Habits,” Wall Street Journal, April 5, 2005, cob.bloomu.edu/sbatory/CH%2006%20E%20Mktg%20&%20Customer%20Relationships%202 Oct06%20n48.ppt (accessed November 15, 2008).
• The Fox network offers tweakable ads it can digitally alter so they contain elements relevant to particular viewers at the time they watch them. By changing voice-overs, scripts, graphic elements, or other images, advertisers can make an ad appeal to teens in one instance and seniors in another.
• Starwood Hotels & Resorts Worldwide Inc. uses a behavioral targeting campaign to promote spas at its hotels. The hospitality company works with an online media company to deliver ads to Internet users who have browsed travel articles or surfed the Web site of a Starwood-branded hotel like Westin or Sheraton.
• Startup advertising company Pudding Media is testing a service that would let customers make voice-over-Internet protocol (VoIP) calls free, if they agree to let their calls be monitored by speech-recognition software that would then present online ads based on the words it culled from the conversation. The customer would have already supplied Pudding with his or her zip code, age range, and gender, so ads would be targeted by demographics and location, as well as by real-time conversation.“Startup Offers Free Calls in Exchange for Eavesdropping,” InformationWeek, September 24, 2007, http://www.informationweek.com/news/internet/ebusiness/showArticle.jhtml?articleID=202101023 (accessed November 15, 2008).
Dig Deeper
Behavioral targeting allows advertisers to identify our consumption practices so that they can tailor ads to our precise interests. They argue that this technology increases efficiency, saves money, and reduces advertising bloat because we won’t be bombarded with commercial messages for products we don’t want. On the other hand, critics of this practice argue that we’re “making a deal with the devil” because we’re giving companies access to our personal behaviors. This controversy has surfaced on Facebook, which is now sharing data about users’ online behaviors with advertisers. What is the current status of this conflict? How can advertisers do a better job of targeting while respecting the privacy of consumers—especially those who don’t want to be targeted?
SS+K Spotlight
Targeting the msnbc.com User
SS+K was charged with two goals for the new msnbc.com campaign: increase the number of unique viewers who visit the site, and increase the number of clicks per visit among current msnbc.com users.
To refine their understanding of how to develop the msnbc.com proposition, SS+K enlisted the aid of Energy Infuser, a market research company in Chicago that specializes in unearthing consumer insights through qualitative methods such as focus groups, projective techniques, and consumer diaries. A number of “triads” (groups of three consumers) were recruited and agreed to offer their time and consumer experiences of online information seeking. Through analysis of the group’s transcripts, the SS+K team developed a better sense of why a user might choose msnbc.com over other options: relative to competitors like bland news aggregators and “cold” and “serious” CNN.com, msnbc.com virtually sparkled with energy and personality. The site was inviting for users who enjoyed browsing for news and tidbits, including lighthearted information on entertainment, fashion, and sports.
Video Spotlight
Michelle Rowley: The Research Epiphany
(click to see video)
Choosing One from Among Many: Target Defined
Michelle describes consumer insights and how one triad participant helped to clarify just who the client’s key user is and how the brand should speak to its target.
You can see media coverage of consumer focus groups at Energy Infuser here: www.energyinfuser.com/video/InfuseronNBC.wvx).
Ultimately, the target audience—now called the News Explorer—reflected observations about the typical msnbc.com user and what the site had to offer that set it apart from its primary competition. The profile was developed in dialogue with consumers through research approaches and, finally, through negotiation of research findings among client/agency team members.
Key Takaway
Targeting is the process of selecting the customers whose needs you’re likely to satisfy. Targets need to be easily identifiable and measurable. As technology continues to develop, behavioral targeting that allows advertisers to customize messages and products to the needs of each individual will become a more central part of advertisers’ strategies.
EXERCISES
1. Targeting helps define who the customers are. Targeting calls for the advertiser to take three steps. Describe and detail each of those three steps.
2. Good target markets have a series of properties that make them very attractive to advertisers and marketers. Describe and detail the four properties of a good target market.
3. Discuss the logic of using behavioral targeting to reach consumers. Be specific in your discussion. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/06%3A_Segment_Target_and_Position_Your_Audience_-_SSK_Identifies_the_Most_Valuable_News_Consumer/6.03%3A_Target_Your_Customer_-_Who%27s_Going_to_Want_It.txt |
LEARNING OBJECTIVES
After studying this section, students should be able to do the following:
1. Define positioning relative to brand differentiation.
2. Use three positioning dimensions to relate to a brand’s strategic objectives.
Positioning means developing a strategy to influence how a particular market segment perceives a good or service in comparison to the competition. Positioning increases potential ad effectiveness by clarifying the message. This step is all about defining a space in the mind of the customer—something that your customer thinks of and associates with your product.
It’s All Relative
Remember that positioning doesn’t just mean what your target market thinks about your product. Rather, it’s about how she thinks about it relative to competitors’ products—your product is less expensive, performs better, or fits better with the customer’s lifestyle. Positioning often relates to a brand’s strategic objectives. Looking back at our previous discussion of behavioral segmentation, the advertiser might think about potential customers in terms like these:
• Does not use the advertised product category—the company wants to convert nonusers to users (grow the market).
• Uses a competitor’s version of the advertised product category—the company wants to gain market share at the expense of competitors by creating or capturing brand switchers.
• Uses an alternative version of your product in the advertised product category—the company wants to upsell customers (get them to buy a more expensive version of its product) or migrate them to future product variants.
• Uses the advertised product—the company wants to increase the frequency or volume of purchases or reinforce brand loyalty.
Positioning Dimensions
• Value: The product reaches price-sensitive customers by being low cost. An example would be Wal-Mart’s “Every Day Low Prices.” Companies often create subbrands to create distinctive positioning for the brand based on price. The Gap, for example, is a mid-price clothing store, while its sister company Banana Republic is a higher-priced clothing store, and Old Navy is the value-priced offering. Similarly, Volkswagen’s Skoda brand is known as the low-cost car brand.
• Performance: The product is high performing on one or more dimensions that the target audience seeks. For example, if you focus on a lifestyle or design position, you appeal to the customer who values the social or aesthetic statement a brand makes—and often what others will think about him or her after the purchase. For example, Chanel is a designer-led luxury brand. The company has identified a new group of customers it wants to target. Chanel calls the group “new wealth”—women who have acquired a significant amount of money at an earlier age than previous generations. These women, with a net worth of over \$1 million, have more cutting-edge fashion tastes. When Chanel CEO Maureen Chiquet strategizes about launching a new perfume to appeal to this customer segment, her watchword is exclusivity. “Let’s not be thinking about how big we can make this,” she tells her team, “but how exclusive and special you can keep it.”Robert Berner, “Chanel’s American in Paris,” BusinessWeek, January 21, 2007, 70–71.
• Functional: Solves a specific problem or accomplishes a specific goal for the customer. Tide-to-Go®, for example, solves the problem of removing a stain when there’s no time to launder the garment.
Dig Deeper
The average Buick buyer is a man in his midsixties—not the type of consumer inclined to trick out his car with twenty-two-inch wheels, a lowered suspension, and tinted windows. That’s why it’s a bit of a shock to check out a Buick Lucerne with those modifications on display at a party hosted by General Motors that also featured actress Vivica Fox, known for roles in movies like Booty Call and Soul Food and hip-hop star Jay-Z. Buick’s sales are plummeting, and the brand is trying to boost them by expanding its appeal among young, urban consumers.Gina Chon and Jennifer Saranow, “Bling-Bling Buick: Seeking Younger Buyers, General Motors’ Staid Brand Uses Customized Cars, Celebrities to Reach the Hip-Hop Crowd,” Wall Street Journal, January 11, 2007, B1. How far can a promotional campaign go to radically reposition a well-established brand? What do you predict will be the outcome of Buick’s efforts to build some bling into its brand image?
SS+K Spotlight
SS+K’s psychographic research revealed that people have very different motivations for accessing news sites. The account team decided to position msnbc.com’s offering for one primary target—the News Explorer, who “enjoys the thrill of the hunt” when it comes to finding news.
Video Spotlight
Russell Stevens and the Target Audience
(click to see video)
Russell Stevens described how the agency came to this positioning strategy.
Final Words from Michelle on the STP Process
-----Original Message-----
From: Michelle Rowley
Sent: Monday, July 09, 2007 8:23 PM
To: Lisa Duke Cornell
Subject: msnbc.com
Hi Dr. Duke!
So much to say and such little time though - so I thought I would send you a quick e-mail.
Some things I wish I had hit on include the importance of listening not just to what people say, but to what they don’t say. How with planning you need to use the research to build your case, but ultimately there is a small leap of faith you make in the end when you definitively place your stake in the ground about the strategic direction. How it’s so important for planners to be curious about things in life in general, not just in advertising, and how that curiosity comes from getting out there and living life, from talking to people and most importantly by reading, reading, reading.
Michelle
Key Takaway
Positioning your product or service to appeal to the needs of a specific group can set it apart from competitors that are also vying for the same consumers. A client’s product or service can be positioned relative to the competition along such dimensions as lifestyle, reasons for use, or quality/price tradeoffs. SS+K identified a target segment it called the News Explorer as the best prospect for its client. The typical user is a news junkie who enjoys the thrill of hunting for new information and who wants to dive into the information rather than just scan it. The agency will proceed to develop a brand message that emphasizes how msnbc.com delivers what News Explorers want.
EXERCISE
Marketers must consider three positioning dimensions as they formulate their positioning strategy. List and briefly describe the three positioning dimensions discussed in the chapter. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/06%3A_Segment_Target_and_Position_Your_Audience_-_SSK_Identifies_the_Most_Valuable_News_Consumer/6.04%3A_Position_Your_Brand-_Why_Will_They_Want_It.txt |
Tie it All Together
Now that you have read this chapter, you should be able to understand the concept of market segmentation and what you need to do to create a market segmentation plan:
• You can understand the STP (segmenting, targeting, and positioning) process that gives you a framework for understanding information about customers (e.g., who customers are, where they live, what they want).
• You can determine characteristics of market segments based on demographic, geographic, psychological/lifestyle characteristics (psychographics), or behavior (e.g., heavy users versus light users of the brand).
• You can identify the properties of a good market target (e.g., measurable, accessible, profitable, and distinguishable).
• You realize that behavioral targeting can be used to put ads in front of people customized to their Internet use.
• You can explain the necessity for having positioning become part of advertising strategy.
• You are able to decide how to position a product or service so that it is differentiated from products or services of competitors.
USE WHAT YOU’VE LEARNED
1. What is one of the most potent political forces that any political candidate for national office must impress and deal with? If you said AARP, you are correct. If, as an advertiser, you don’t know what AARP is, you will be missing the network organization used by millions of seniors in the United States. (See http://www.aarp.org for more information.) AARP is not just for retired persons anymore. The organization accepts members and offers benefits beginning at age fifty. Given the number of Baby Boomers at this age and beyond, AARP will have a growing market base for a number of years.
Seniors in the United States have become an important market target for many product and service producers. Advertisers are learning new ways to reach and communicate with this market. Seniors today don’t see themselves as old. Baby Boomer seniors see themselves as active, fashion conscious, energetic, adventurous, and knowledgeable about products and services directed toward their market segment. Seniors ride motorcycles, go skydiving, enjoy cruises, listen to concerts from bands popular when they were in their twenties, enjoy entertaining, and like to dress well. Sounds like a great opportunity for the enterprising marketer—right?
Investigate the senior market, Baby Boomers, and the AARP for more information. Once you have completed this task, list the segmentation variables (beyond the age segmentation variable) that advertisers should use to more narrowly focus marketing and advertising efforts toward this market segment. Pick a product or service and demonstrate how your selection of segmentation variables could be used in constructing an ad for this target group. Be creative in your choice of product or service and how you will advertise to the seniors segment.
2. Have you had Vitamin Water today? If you have, you’re part of an increasing number of people that have tried Glacéau’s unique “hydration” product. Vitamin Water (along with other Glacéau products such as Smart Water, Vitamin Energy, and Fruit Water) appears in an increasing number of outlets. Part of the reason for increased attention around Glacéau products is that they were purchased by the Coca-Cola Company in 2007. Coke’s marketing, advertising, and distribution muscle is being used to bring such products as Vitamin Water to the attention of the consuming public.
Another reason for increasing consumer attention is the maverick use of advertising by Vitamin Water. The labels, packaging, and advertising for Vitamin Water are highly entertaining. Using celebrity endorsements, humor, and provocative visuals in advertising is a somewhat unusual strategy for a producer in this product category. To learn more about Vitamin Water advertising, visit the Vitamin Water Web site at http://www.vitaminwater.com.
Assume that a large public university was the target for Glacéau’s Vitamin Water launch introduction in the Midwest. What targeting and positioning strategies would you recommend to Glacéau? Explain the rationale for your recommendation and any assumptions you have made. Be sure to consider competitors that you might encounter during your campus launch.
DIGITAL NATIVES
As indicated in the chapter, one of the ways to conduct psychographic segmentation research is to use SRI International’s VALS2™ to create and group market segments. According to SRI International, “VALS reflects a real-world pattern that explains the relationship between personality traits and consumer behavior. VALS uses psychology to analyze the dynamic underlying consumer behavior preferences and choices.”www.sric-bi.com/VALS/ (accessed February 1, 2009). To learn more about VALS2™ and other SRI International products and services, visit www.sric-bi.com/VALS/.
Your assignment is to take the VALS™ survey mentioned in SRI International’s Web site. Once you have completed the survey, print the detailed summary results that will categorize you into two of the eight VALS2™ categories. Review the summary provided to you and the VALS2™ Segments list described on the Web site. Do you agree with the VALS2™ assessment? Explain. Given the information you have reviewed, write three advertising themes that might be used to reach you (and others like you) based on your VALS2™ categories. If possible, compare your thoughts and ideas to others in the course.
AD-VICE
1. Create a collage that demonstrates the various aspects of behavioral segmentation. Use popular magazines to create your illustration. Indicate any examples within your collage that demonstrate the 80/20 rule.
2. Using information from the chapter, create a comparison between consumer segmentation (e.g., demographic, geographic, psychographic, and behavioral segmentation) and business segmentation (e.g., B2B segments). What key elements do you think clearly separate these two forms of segmentation? Be specific.
3. Use yourself as an example of Web behavior tracking. Track your Web activity for one week and note all the various Web sites that you visit. Comment on any behavior tendencies that you note about your Web visits. Based on these visits, describe how behavioral targeting by an advertiser might be used to reach you during your visits to the various Web sites.
4. Using the “value” and “performance” positioning dimensions described in the chapter, construct a product positioning map for six different automobile brands or models. To construct your product positioning map, put the value dimension on a vertical axis and performance dimension on a horizontal axis. This will create four distinct positioning cells for your illustration. Note that there should be a high-to-low or positive-to-negative dimension for axes on your illustration. As you place the six automobile brands on your illustration, note how many compete in the same positioning space. Comment on how advertisers might differentiate their brand from those of competitors within one of your congested positioning spaces.
ETHICAL DILEMMA
Although targeting selected market segments for advertising and marketing messages would seem to be a sound strategy for any company, there can be difficulties. Some companies have been accused of using segmentation approaches that discriminate against certain groups within society. Complaints have been raised about potential discrimination based on race, culture, age, gender, and sexual lifestyle.
Assume that you have been asked to review segmentation profile practices. Pick one company that you believe avoids discrimination in market targeting and one company that you believe does not. Compare and contrast the two companies with respect to their market target selection process and how the market targets are approached. Comment on any perceived ethical practices that you are aware of. Be sure to check any information on ethics provided by researching the Web sites of your two example companies. Lastly, list the ethical guidelines or best practices you believe organizations should follow when selecting market targets. Be prepared to discuss your thoughts and position. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/06%3A_Segment_Target_and_Position_Your_Audience_-_SSK_Identifies_the_Most_Valuable_News_Consumer/6.05%3A_Exercises.txt |
Before the SS+K team could set off to develop their marketing recommendations, Catherine Captain had to set a budget for their efforts. It was important for Russell and Amit to understand the parameters of the work at hand; creative, media, and promotional recommendations would be vastly different for a \$2 million effort versus a \$20 million effort.
Once they were informed of the blanket budget to cover all SS+K related initiatives, it was up to them to work with Catherine to recommend the best way to make every dollar sing. But before the budget is split up, the client has to determine the total. As the VP of Marketing, Catherine had to request a certain amount of money from the board of msnbc.com—and justify why she wanted it. In the ad biz, there’s no such thing as a free lunch.
7.02: Budgeting Methods
Learning Objectives
After studying this section, students should be able to do the following:
1. Recognize the two primary top-down budgeting methods.
2. Identify the pros and cons of the top-down budgeting methods.
3. Recognize the two primary bottom-up budgeting methods.
4. Discuss budget allocation and the importance of timing in budgeting.
Budget decisions are affected by conditions both internal and external to the client. One key external influence is the overall economic condition of the country and how this affects the client’s industry. Even the most inspired advertising may not motivate consumers to open their wallets in troubled times like now. We see this situation now quite clearly, for example, in the automotive industry, as the stock market and credit crises have made money scarce, and consumers are pressed to pay higher prices for gasoline, home heating, groceries, and other necessities. It’s not surprising, then, that automotive advertising spending in the United States dropped to \$1.99 billion in the first quarter of 2008. That sounds like a lot of money (and it is!)—but it’s down more than 14 percent compared with the same time a year before. As one industry executive observed, ad spending is “sinking as fast as new car sales.” When times are tough, nothing is sacred: Even Tiger Woods’ nine-year relationship as a fixture in General Motors’ advertising got the axe as the industry tries to slash its costs.Quoted in “Auto Ad Spending Down, Except Digital,” eMarketer, July 23, 2008, http://www.emarketer.com/Article.aspx?id=1006426&src=article1_newsltr (accessed July 23, 2008); Rich Thomaselli, “GM Ending Tiger Woods Endorsement Deal,” Advertising Age, November 24, 2008, adage.com/article?article_id=132810 (accessed November 28, 2008); adage.com/article?article_id=46288& search_phrase=shona%20seifert.
Top-Down Budgeting
In top-down budgeting, top management sets the overall amount the company will spend on promotional activities for the year. This total amount is then allocated among all of the advertising, PR, and other promotional programs. How does top management arrive at the annual promotional budget? Typically, they use a percentage-of-sales method, in which the budget is based on the amount the company spent on advertising in the previous year and the sales in that year.
Percentage-of-Sales Method
The percentage-of-sales method is the ratio of the firm’s past annual promotional budget divided by past sales to arrive at the percentage of sales. That percentage of sales is then applied to the expected sales in the coming year to arrive at the budget for that year. For example, if the company spent \$20 million on advertising last year and had \$100 million in sales, the percentage of sales would be 20 percent. If the company expects to achieve \$120 million in sales the following year, then 20 percent of \$120 million is \$24 million, which would be the budget for advertising that year.
Wall Street analysts sometimes look at changes in the ad-to-sales ratio as a sign of the health of a company. For example, Procter & Gamble’s ad-to-sales-ratio slipped from 10.7 percent in 2004 to 9.9 percent in 2006. Those declines came as P&G faced growing margin pressure from rising commodity costs. Some analysts see strong ad spending as an investment in growth or a sign that a company is having no trouble meeting its earnings targets, so they want to see an ad-to-sales ratio that is consistent or increasing.Jack Neff, “P&G Rewrites its Definition of ‘Ad Spend,’” Advertising Age, September 3, 2007, 3.
Industry Averages Method
Some companies use industry averages (published by trade associations) as a guide to set their promotional budget. Ad-to-sales ratios vary widely depending on the industry. For example, health services companies had one of the highest ad-to-sales ratios for 2006, at 18.7 percent. Other industries with high ad-to-sales ratios are transportation services (14.2 percent), motion pictures and videotape productions (13.7 percent), food (11.9 percent), newspapers (11.1 percent), and broadcast television stations (10.7 percent). In contrast, computer and office equipment had an ad-to-sales ratio of 1.2 percent, while computers and software wholesale had only a 0.2 percent ad-to-sales ratio.Kate Maddox, “Ad Spending Up in ’05, ’06,” B to B, August 8, 2005, 17.
Sometimes a dramatic increase in ad spending by one competitor in an industry spurs others to follow suit. For example, in 2007 German insurance giant Allianz more than quadrupled its annual global advertising budget to 225 million euros after competitor Zurich Financial Services launched a large-scale global awareness campaign.“Allianz Plans €225m Global Branding Blitz,” Marketing Week, May 3, 2007, goliath.ecnext.com/coms2/gi_0199-6503373/Allianz-plans-225m-global-branding.html (accessed February 1, 2009). Similarly, the auto insurance industry saw overall ad spending jump more than 32 percent in just two years when GEICO increased its ad spending 75 percent in 2004; this spurred competitors to increase their ad budgets as well. Progressive Insurance spent \$265 million in 2006, up from \$201 million in 2004, and State Farm likewise plans to increase spending, which topped \$270 million in measured media in 2006.Mya Frazier, “Geico’s \$500M Outlay Pays Off,” Advertising Age, July 9, 2007, 8.
Spending on certain segments of the promotional budget, such as on coupons, is very much driven by competitor spending levels. Consumer packaged goods companies like P&G and Unilever claim not to like couponing schemes as a promotional activity. Indeed, P&G looked into eliminating coupons in 1997 due to declining newspaper circulation and usage. But companies are tied to using coupon promotions. If one company alone decides to forgo couponing, they face losing cost-conscious consumers to the competition. If companies try to work together to scale back on couponing, they might be accused of violating antitrust regulations. As a result, spending on the media side of couponing was up 26 percent in 2006, reaching \$1.8 billion, even though consumer use of coupons was down 13 percent during the same time period.Jack Neff, “Package-Goods Players Just Can’t Quit Coupons,” Advertising Age, May 14, 2007, 8.
Pros and Cons of Top-Down Methods
The advantages of top-down approaches are their speed and straightforwardness. The disadvantage is that the methods look to the past as a guide, rather than to future goals. Just because a company spent \$40 million on advertising the previous year doesn’t mean that figure is right for next year. Also, budgets tied to sales figures mean that a company’s promotional budget will decrease if sales decrease—but in fact increasing the promotional budget may be precisely what is needed in order to remedy declining sales.
Bottom-Up Techniques
Alternatively, some companies begin the budgeting process each year with a clean slate. They use bottom-up budgeting techniques, in which they first identify promotional goals (regardless of past performance) and allocate enough money to achieve those goals.
Objective-Task Method
The objective-task method is the most common technique of bottom-up budgeting. Companies that use this method first set the objective or task they want the promotion to achieve. Next, they estimate the budget they will need to accomplish that objective or task. Finally, top management reviews and approves the budget recommendation.
For example, champagne maker Moët & Chandon set its objective “to grow the whole market” in the United States.Jeremy Mullman, “Moët, Rivals Pour More Ad Bucks into Bubbly: Champagne Makers Try to Create Year-Round Demand,” Advertising Age, September 3, 2007, 4. That is, Moët will use advertising to increase consumption of champagne throughout the year, not just over the holidays. Moët based its objective on research that compared champagne consumption in the United States to that in other countries. “The average U.S consumer drinks half a glass of champagne a year, the average British consumer drinks half a bottle and the average French consumer drinks three bottles. There’s clearly room for growth,” said Stuart Foster, director of business development at Moët-Hennessy USA.Jeremy Mullman, “Moët, Rivals Pour More Ad Bucks into Bubbly: Champagne Makers Try to Create Year-Round Demand,” Advertising Age, September 3, 2007, 4. Moët more than tripled its U.S. ad spending in 2006 to \$9.5 million from \$2.8 million. Reflecting the objective, the company ran its advertising in the summer rather than just around the holidays.
Similarly, Danone Waters is increasing its ad spending in the United Kingdom in 2008 in an effort to increase bottled water consumption among British consumers. Danone Waters is increasing its spending by 15 percent, compared to Moët’s tripling of ad expenditures, which shows that there is no hard-and-fast rule about how much budget is needed to reach a given objective.Jeremy Mullman, “Moët, Rivals Pour More Ad Bucks into Bubbly: Champagne Makers Try to Create Year-Round Demand,” Advertising Age, September 3, 2007, 4; “Danone Waters Plans to Increase Spend by 15%,” Marketing, July 25, 2007, 4.
Other objectives advertisers can set include acquiring new customers, retaining existing customers, or building the brand. The objective to acquire new customers often requires a bigger budget than the advertising the firm needs to retain existing customers.
Stage-Based Spending
Some companies use the product life cycle method, in which they allocate more money during the introduction stage of a new product than in later stages when the product is established. For example, Procter & Gamble allocated \$15 million to advertising Dawn Simple Pleasures, a new liquid detergent product that comes with a separate air freshener attached to the base of the bottle. It allocated less money (\$10–12 million) for Dawn Direct Foam, a product it launched two years prior.Vanessa L. Facenda, “Procter Dishes out 3-Tiered Dawn Attack,” Brandweek, September 24, 2007, 4. The need to spend heavily to promote new products is especially strong for pharmaceutical companies when they introduce new drugs. Pharmaceutical companies need to get physicians to talk about their drugs and prescribe them.
In contrast, companies such as baby food manufacturers need to invest in strong promotion on a continual basis, because they get a new set of customers every year. “We provide strong consumer promotion support to drive trial, particularly in our baby segments, where we have a new group of consumers entering the market each year,” said Randy Sloan, executive vice president and general manager at Del Pharmaceuticals, which is the number one advertiser in teething pain relief, children’s toothpaste, and adult oral pain products.Quoted in “A Targeted Approach Creates a Powerhouse,” Chain Drug Review, June 4, 2007, 34.
SS+K Spotlight
Since msnbc.com’s fiscal year runs from July to June, Catherine Captain and all other department heads must start submitting their budget requests in March so that the board can determine their budgets before the next fiscal year starts. They use a bottom-up strategy based on objectives, but sales are also a vital part of determining what the final spend will be.
Video Spotlight
Catherine Captain
(click to see video)
Catherine Captain talks about the relativity of budget sizes.
Budget Allocation and Timing
In addition to deciding how much to spend, companies need to know when they will be spending the money.
For some companies, the timing is smooth. As we saw with the Moët champagne example, the company will spend its budget throughout the year. Many other businesses step up their advertising in the weeks leading up to the Christmas holiday season. Others, such as beach apparel makers or home improvement companies whose work is done in warm weather, may concentrate their spending during a particular time of year.
Keep in mind that the budget needs to pay for more than just creating the ads and buying the media to run them. Consider a beachwear campaign for an apparel maker as an example. Although most of the campaign budget is spent in the second quarter on media buys to hit consumers with swimsuit ads as they gear up for summer, the ad agency has to allocate some of the money to laying the groundwork for this campaign. It will need to spend some money in the earlier part of the year to pay for market research, ad development, and testing. After the ads run, the last of the budget might go to assess the campaign’s effectiveness.
Other factors that contribute to budgeting:
• Media costs: For retailers, the holiday season is a popular time, so like all things supply and demand, media costs tend to go up during that time.
• Production costs: An incredible number of components contribute to making an ad, whether it’s TV, Web banner, or print, and the cost can vary widely, which is important to consider when you build a bottom-up budget.
SS+K Spotlight
While a lump sum budget had been approved for SS+K to spend, Catherine Captain and msnbc.com had to be responsive to their internal revenue situations. In other words, if they weren’t hitting other advertising sales objectives, they were not going to be ready to pull the trigger on the disbursement of millions of dollars.
SS+K outlined each element of the production and when the agency would have to have the client’s money fully committed and available to spend. Part of the account management team’s responsibility is to manage the schedule by which everyone gets paid for her part in a production.
Video Spotlight
Catherine Captain
(click to see video)
Catherine Captain explains the importance of the first marketing budget and what would happen if it didn’t go well.
Key Takaway
Clients use a variety of methods to determine their advertising budgets. One basic distinction is between top-down and bottom-up methods. Top-down approaches are easier; they basically use last year’s expenditures as a starting point. However, they also are more simplistic and may be self-defeating because they wind up allocating more money to promote products that are doing well at the expense of products that are doing poorly—when just the opposite adjustment may make more sense. Bottom-up approaches start by specifying the particular objectives a firm has for a brand and then estimating how much it will cost to meet those objectives. Budget-setting is more complicated than just tallying up what it costs to make and place advertising; the client also has to consider the resources an agency will need to conduct research, develop an advertising strategy, and measure how well the strategy worked so it can tweak the approach in the future if necessary.
EXERCISES
1. Compare and contrast top-down budgeting with bottom-up budgeting.
2. Describe when advertisers should use the percentage of sales and industry averages methods for budgeting.
3. Describe when advertisers should use the objective-and-task and stage-based spending methods for budgeting.
4. Describe and explain the factors that contribute to proper budget allocation and timing. | textbooks/biz/Marketing/Book%3A_Launch__Advertising_and_Promotion_in_Real_Time/07%3A_Decide_What_You_Can_Afford_to_Say_-_msnbc.com_Sets_the_Budget/7.01%3A_Chapter_Introduction.txt |
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