M +Business+-+O.C.+Ferrell

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business 3e
O. C. Ferrell
University of New Mexico
Geoffrey A. Hirt
DePaul University
Linda Ferrell
University of New Mexico
business
VICE PRESIDENT AND EDITOR-IN-CHIEF BRENT GORDON
EDITORIAL DIRECTOR PAUL DUCHAM
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M: BUSINESS
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020.
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This book is printed on acid-free paper.
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ISBN 978-0-07-352458-0
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brief
contents
part one
BUSINESS IN A CHANGING WORLD 2
Chapter 1: The Dynamics of Business and Economics 3
Chapter 2: Business Ethics and Social
Responsibility 23
Appendix: The Legal and Regulatory Environment 46
Chapter 3: Business in a Borderless World 61
part two
STARTING AND GROWING A
BUSINESS 82
Chapter 4: Options for Organizing Business 83
Chapter 5: Small Business, Entrepreneurship,
and Franchising 103
part five
part three MARKETING: DEVELOPING
MANAGING FOR QUALITY RELATIONSHIPS 222
AND COMPETITIVENESS 118 Chapter 11: Customer-Driven Marketing 223
Chapter 6: The Nature of Management 119 Chapter 12: Dimensions of Marketing Strategy 241
Chapter 7: Organization, Teamwork, Chapter 13: Digital Marketing and Social
and Communication 139 Networking 267
Chapter 8: Managing Service and Manufacturing
Options 159
part six
FINANCING THE ENTERPRISE 288
part four Chapter 14: Accounting and Financial Statements 289
CREATING THE HUMAN RESOURCE Chapter 15: Money and the Financial System 315
ADVANTAGE 180 Chapter 16: Financial Management and Securities
Chapter 9: Motivating the Workforce 181 Markets 333
Chapter 10: Managing Human Resources 199 Notes 352
Photo Credits 372
Index 375
v
contents
part one BUSINESS IN A
CHANGING WORLD 2
CHAPTER 1 THE DYNAMICS OF BUSINESS

AND ECONOMICS 3
INTRODUCTION 3
THE NATURE OF BUSINESS 4
Starbucks Managing Global Success 6
THE ECONOMIC FOUNDATIONS OF BUSINESS 7
Patagonia Shines during Recession 12
THE AMERICAN ECONOMY 15
Food Trucks Give Restaurants a Run for Their Money 16
CAN YOU LEARN BUSINESS IN A CLASSROOM? 19
CHAPTER 2 BUSINESS ETHICS AND SOCIAL

RESPONSIBILITY 23
INTRODUCTION 23
BUSINESS ETHICS AND SOCIAL RESPONSIBILITY 24
BP Disaster Leads to Questions about Ethics and Social CHAPTER 3 BUSINESS IN A BORDERLESS
Responsibility 32 WORLD 61
THE NATURE OF SOCIAL RESPONSIBILITY 34 INTRODUCTION 61
Bio-Plastics Are a Growing Business, but Do They Live Up to THE ROLE OF INTERNATIONAL BUSINESS 62
the Hype? 39 China Struggles with Luxury Brands 64
Majora Carter Group LLC Brings Green Living to INTERNATIONAL TRADE BARRIERS 65
Distressed Communities 41 Is There Room for Entrepreneurs in Cuba? 67
APPENDIX THE LEGAL AND REGULATORY TRADE AGREEMENTS, ALLIANCES,
ENVIRONMENT 46 AND ORGANIZATIONS 70
SOURCES OF LAW 46 GETTING INVOLVED IN INTERNATIONAL
COURTS AND THE RESOLUTION OF BUSINESS 75
DISPUTES 46 China’s Money and Hollywood Films Make for a
REGULATORY ADMINISTRATIVE Partnership 78
AGENCIES 48 INTERNATIONAL BUSINESS STRATEGIES 79
IMPORTANT ELEMENTS OF BUSINESS
LAW 49
Patents Provide Competitive Advantage
for Kodak 51
LAWS AFFECTING BUSINESS
PRACTICES 53
THE INTERNET: LEGAL AND
REGULATORY ISSUES 55
LEGAL PRESSURE FOR
RESPONSIBLE BUSINESS
CONDUCT 56
vi
SKILLS NEEDED BY MANAGERS 129
part two STARTING AND GROWING Nick’s Pizza & Pub Succeeds on “Trust and Track” System
A BUSINESS 82 of Management 130
WHERE DO MANAGERS COME FROM? 132
Walmart Goes Smaller 133
CHAPTER 4 OPTIONS FOR ORGANIZING DECISION MAKING 133
BUSINESS 83 THE REALITY OF MANAGEMENT 135
INTRODUCTION 83
SOLE PROPRIETORSHIPS 84
Stella & Dot: A Company for Women by Women 84 CHAPTER 7 ORGANIZATION, TEAMWORK,
PARTNERSHIPS 87 AND COMMUNICATION 139
Microlending Helps Small Entrepreneurs Start INTRODUCTION 139
Businesses 89 ORGANIZATIONAL CULTURE 140
CORPORATIONS 90 Changing the Organizational Culture by Reaching Potential
Bob’s Red Mill Encourages Loyalty through Employee Employees 140
Ownership 96 DEVELOPING ORGANIZATIONAL STRUCTURE 141
OTHER TYPES OF OWNERSHIP 97 ASSIGNING TASKS 142
TRENDS IN BUSINESS OWNERSHIP: MERGERS ASSIGNING RESPONSIBILITY 146
AND ACQUISITIONS 98 Family Team Makes Johnny Cupcakes a Business
Success 147
FORMS OF ORGANIZATIONAL STRUCTURE 149
CHAPTER 5 SMALL BUSINESS,
THE ROLE OF GROUPS AND TEAMS IN
ENTREPRENEURSHIP,
ORGANIZATIONS 151
AND FRANCHISING 103 Ford Develops All-Women Team to Green Its Vehicles 151
INTRODUCTION 103 COMMUNICATING IN ORGANIZATIONS 153
THE NATURE OF ENTREPRENEURSHIP AND SMALL
BUSINESS 104
TerraCycle Converts Trash into Profits 105 CHAPTER 8 MANAGING SERVICE
ADVANTAGES OF SMALL-BUSINESS OWNERSHIP 107 AND MANUFACTURING OPTIONS 159
DISADVANTAGES OF SMALL-BUSINESS OWNERSHIP 108 INTRODUCTION 159
Another Type of Entrepreneurship 110 THE NATURE OF OPERATIONS MANAGEMENT 160
STARTING A SMALL BUSINESS 110 Shell Uses New Refinery to Support Sustainability 161
THE FUTURE FOR SMALL BUSINESS 114 PLANNING AND DESIGNING OPERATIONS SYSTEMS 164
Guitar Syndicate, Inc. Learns to Sell on Facebook 114 MANAGING THE SUPPLY CHAIN 169
MAKING BIG BUSINESSES ACT “SMALL” 117 Trader Joe’s: Secrets of Success 171
MANAGING QUALITY 174
part three MANAGING FOR

Stella & Chewy’s: The Food Dogs Love 176
QUALITY AND COMPETITIVENESS 118
CHAPTER 6 THE NATURE OF MANAGEMENT 119

INTRODUCTION 119
THE IMPORTANCE OF MANAGEMENT 120
MANAGEMENT FUNCTIONS 120
Entrepreneur’s Leadership Guides Company toward
Exceptional Customer Service 120
TYPES OF MANAGEMENT 125
contents vii
part four CREATING THE Part five:
HUMAN RESOURCE ADVANTAGE 180 MARKETING: DEVELOPING
RELATIONSHIPS 222
CHAPTER 9 MOTIVATING THE
WORKFORCE 181 CHAPTER 11 CUSTOMER-
INTRODUCTION 181 DRIVEN
NATURE OF HUMAN RELATIONS 182 MARKETING 223
Full Yield Seeks to Revolutionize Employee INTRODUCTION 223
Health 182
NATURE OF MARKETING 224
HISTORICAL PERSPECTIVES ON EMPLOYEE P&G Makes Inroads in India 228
MOTIVATION 184
DEVELOPING A MARKETING
THEORIES OF EMPLOYEE MOTIVATION 186 STRATEGY 229
Rewarding Performers with Time Off 188 Twitter Treasure Hunt Gets Consumers to
STRATEGIES FOR MOTIVATING EMPLOYEES 191 Hunt While They Play 232
Ursula Burns Motivates Employees 192 MARKETING RESEARCH AND INFORMATION SYSTEMS 233
BUYING BEHAVIOR 235
Yelp: Where Consumers Hold the Power 236
CHAPTER 10 MANAGING HUMAN
THE MARKETING ENVIRONMENT 237
RESOURCES 199
INTRODUCTION 199
THE NATURE OF HUMAN RESOURCES MANAGEMENT 200 CHAPTER 12 DIMENSIONS OF MARKETING
PLANNING FOR HUMAN RESOURCES NEEDS 200 STRATEGY 241
RECRUITING AND SELECTING NEW EMPLOYEES 201 INTRODUCTION 241
Burgerville: Fast Food That Employees Can Love 203 THE MARKETING MIX 242
DEVELOPING THE WORKFORCE 206 PRODUCT STRATEGY 242
King Arthur Flour: An Employee-Centered Corporate Silly Bandz: A Flash in the Pan, or Here to Stay? 246
Culture 210
PRICING STRATEGY 250
COMPENSATING THE WORKFORCE 211
DISTRIBUTION STRATEGY 252
Challenges of Working at Home 212
Will Baby Carrots Become the New Snack Food? 255
MANAGING UNIONIZED EMPLOYEES 214
PROMOTION STRATEGY 257
THE IMPORTANCE OF WORKFORCE DIVERSITY 216 Finding the Real Green Products 257
CHAPTER 13 DIGITAL MARKETING AND SOCIAL

NETWORKING 267
INTRODUCTION 267
WHAT IS DIGITAL MARKETING? 268
GROWTH AND BENEFITS OF DIGITAL
COMMUNICATION 268
USING DIGITAL MEDIA IN BUSINESS 270
DIGITAL MEDIA AND THE MARKETING MIX 271
Nestlé Experiences the Dark Side of Social Media 272
TYPES OF CONSUMER-GENERATED MARKETING
AND DIGITAL MEDIA 274
Facebook and Twitter Offer Businesses Both Opportunities
and Challenges 277
USING DIGITAL MEDIA TO REACH CONSUMERS 280
Viewpoints Network Helps Companies Manage Brands
Online 282
USING DIGITAL MEDIA TO LEARN ABOUT
CONSUMERS 282
LEGAL AND SOCIAL ISSUES IN INTERNET MARKETING 283 CHAPTER 16 FINANCIAL MANAGEMENT AND
DIGITAL MEDIA’S IMPACT ON MARKETING 286 SECURITIES MARKETS 333
INTRODUCTION 333
Part six: FINANCING THE MANAGING CURRENT ASSETS AND LIABILITIES 334
ENTERPRISE 288 Mission Motors Licenses the Fastest E-Bikes to Raise
Funds 334
Y Combinator Gives Boost to Startup Companies 337
CHAPTER 14 ACCOUNTING AND FINANCIAL MANAGING FIXED ASSETS 339
STATEMENTS 289 FINANCING WITH LONG-TERM LIABILITIES 341
INTRODUCTION 288 Shareholders Enjoy Growth at Dick’s Sporting Goods 343
THE NATURE OF ACCOUNTING 290 FINANCING WITH OWNERS’ EQUITY 343
Recession Encouraged United Parcel Service (UPS) to INVESTMENT BANKING 345
Rethink the Budgeting Process 292
THE SECURITIES MARKETS 345
THE ACCOUNTING PROCESS 294
Bloom Energy Servers Cut Costs, Increase NOTES 352
Sustainability 294
PHOTO CREDITS 372
FINANCIAL STATEMENTS 296
INDEX 375
RATIO ANALYSIS: ANALYZING FINANCIAL
STATEMENTS 306
Certified Fraud Examiners Report on Fraudsters 310
ACCOUNTING AND THE IMPACT OF THE FINANCIAL
CRISIS 310
CHAPTER 15 MONEY AND THE FINANCIAL

SYSTEM 315
INTRODUCTION 315
MONEY IN THE FINANCIAL SYSTEM 316
THE AMERICAN FINANCIAL SYSTEM 320
Are Credit Unions a Better Deal Than Banks? 324
Thrust Fund Founders Encourage Investments in
Themselves 326
Consumer Financial Protection Bureau to Undertake
Financial Reform 329
contents ix
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business 3e
2 PART 1 | Business in a Changing World
one
the dynamics
of business +
economics
e begin our study of busi- LEARNING OBJECTIVES
introduction
W ness in this chapter by

examining the fundamen-
tals of business and economics. First,
LO1 Define basic concepts such as
business, product, and profit.
LO2 Identify the main participants and
activities of business and explain
why studying business is important.
we introduce the nature of business,
LO3 Define economics and compare the
including its goals, activities, and four types of economic systems.
participants. Next, we describe the LO4 Describe the role of supply,
demand, and competition in a
basics of economics and apply them
free-enterprise system.
to the United States’ economy. Finally, LO5 Specify why and how the health of
we establish a framework for studying the economy is measured.
business in this text. LO6 Trace the evolution of the American

economy and discuss the role of the
entrepreneur in the economy.
CHAPTER 1 | The Dynamics of Business and Economics 3

business individuals product a good or profit the difference nonprofit stakeholders groups
or organizations who try to service with tangible and between what it costs to organizations that have a stake in the
earn a profit by providing intangible characteristics make and sell a product organizations that may success and outcomes of a
products that satisfy that provide satisfaction and and what a customer pays provide goods or services but business
people’s needs benefits for it do not have the fundamental
purpose of earning profits
THE NATURE OF
BUSINESS
A business tries to earn a profit by providing products that
satisfy people’s needs. The outcome of its efforts are products
that have both tangible and intangible characteristics that pro-
vide satisfaction and benefits. When you purchase a product,
you are buying the benefits and satisfaction you think the prod-
uct will provide. A Subway sandwich, for example, may be
purchased to satisfy hunger, while a Chevrolet Camaro may be
purchased to satisfy the need for transportation and the desire
to present a certain image.
Most people associate the word product with tangible goods—
an automobile, computer, phone, coat, or some other tangible
item. However, a product can also be a service, which occurs
when people or machines provide or process something of
value to customers. Dry cleaning, a checkup by a doctor, a per-
formance by a basketball player—these are examples of services.
Some services, such as Flickr, an online photo management
and sharing application, do not charge a fee for use but obtain
revenue from ads on their sites. A product can also be an idea.
Accountants and attorneys, for example, generate ideas for solv-
ing problems.
The Goal of Business

The primary goal of all businesses is to earn a profit, the dif-
ference between what it costs to make and sell a product and Seventh Generation is a leading brand of environmentally friendly
what a customer pays for it. If a company spends $8.00 to man- household products. Its Natural 4X Laundry Detergent is packed in a
ufacture, finance, promote, and distribute a product that it sells bottle made from 100 percent recycled fiber.
for $10.00, the business earns a profit of $2.00 on each product
sold. Businesses have the right to keep and use their profits as
they choose—within legal limits—because profit is the reward products. Additionally, a business needs financial resources
for the risks they take in providing products. Earning profits and skills to fund, maintain, and expand its operations. Other
contributes to society by providing employment, which in turn challenges for businesspeople include abiding by laws and gov-
provides money that is reinvested in the economy. Not all orga- ernment regulations; acting in an ethical and socially responsi-
nizations are businesses, however. Nonprofit organizations, ble manner; and adapting to economic, technological, political,
such as the Red Cross, Special Olympics, and other charities and social changes. Even nonprofit organizations engage in
and social causes, do not have the fundamental purpose of management, marketing, and finance activities to help reach
earning profits, although they may provide goods or services their goals.
and do engage in fund raising.
To achieve and maintain profitability, businesses have found
To earn a profit, a person or organization needs management that they must produce quality products, operate efficiently,
skills to plan, organize, and control the activities of the busi- and be socially responsible and ethical in dealing with cus-
ness and to find and develop employees so that it can make tomers, employees, investors, government regulators, the
products consumers will buy. A business also needs marketing community, and society. Because these groups have a stake
expertise to learn what products consumers need and want and in the success and outcomes of a business, they are some-
to develop, manufacture, price, promote, and distribute those times called stakeholders. Many businesses, for example,

are concerned about how the produc- FIGURE 1.1
tion and distribution of their prod- Overview of the Business World
ucts affect the environment. Concerns
about landfills becoming high-tech
graveyards plague many electronics Economy
firms. Best Buy offers recycling of elec-
tronics at all of its stores. The stores
Finance
take cell phones, DVD players, and
most other electronic products in their
green program, regardless of where
they were purchased. Other businesses Owners
are concerned about the quality of
life in the communities in which they Information
Competition
Technology
operate. For example, the Kansas City
Chiefs have raised millions for chari-
s
E m pl
m er
M ana
table organizations over the past 10
sto
oy
years. One of the franchise’s philan- es
Cu
ge m
ng
thropic activities is the Chiefs Char-
e ti
en
rk
ity game, which raises over $500,000
t
a
M
annually for local charities.1 Others
are concerned with promoting busi-
ness careers among African Ameri-
Social Legal, Political, and
can, Hispanic, and Native American
Responsibility Regulatory Forces
students. The Diversity Pipeline Alli- and Ethics
ance is a network of national organi-
zations that work toward preparing
students and professionals of color
for leadership and management in the 21st-century work- and forces beyond an organization’s control—such as legal and
force. The Pipeline assists individuals in getting into the regulatory forces, the economy, competition, technology, the
appropriate college, pursuing a career in business, or earn- political environment and ethical and social concerns—all have
ing an advanced degree in business.2 Other companies, such an impact on the daily operations of businesses. You will learn
as Home Depot, have a long history of supporting natural more about these participants in business activities through-
disaster victims, relief efforts, and recovery. Still other com- out this book. Next, we will examine the major activities of
panies have a long history of supporting natural disaster vic- business.
tims from Hurricane Katrina to relief efforts and earthquake
recovery for Haiti.
Management
The People and Activities Notice that in Figure 1.1 management and employees are in
the same segment of the circle. This is because management
of Business involves coordinating employees’ actions to achieve the firm’s
Figure 1.1 shows the people and activities involved in business. goals, organizing people to work efficiently, and motivating
At the center of the figure are owners, employees, and custom- them to achieve the business’s goals. NASCAR has been a fam-
ers; the outer circle includes the primary business activities— ily-run business since its inception. Brian France, current chair
management, marketing, and finance. Owners have to put up and CEO, is following in the footsteps of his father and grand-
resources—money or credit—to start a business. Employees father in providing leadership for the sport. NASCAR is now
are responsible for the work that goes on within a business. the second most popular spectator sport in the country, out-
Owners can manage the business themselves or hire employ- performing fan numbers and viewership for the Indy Racing
ees to accomplish this task. The president, chief executive League. NASCAR is also the second biggest television draw in
officer (CEO), and board chair of Procter & Gamble, Robert sports, behind the NFL.3 Management is also concerned with
A. McDonald, does not own P&G, but is an employee who is acquiring, developing, and using resources (including peo-
responsible for managing all the other employees in a way that ple) effectively and efficiently. The Campbell Soup Company
earns a profit for investors, who are the real owners. Finally, enlists its workers to help squeeze more efficiency out of its
and most importantly, a business’s major role is to satisfy the plants. Operating efficiency comes from saving time, money,
customers who buy its goods or services. Note also that people and effort.5

STARBUCKS coffee per sitting, so serving sizes have Starbucks is ready to grow in a healthier
been reduced. fashion by remodeling its current stores
MANAGING GLOBAL However, not all countries are as accept- and modifying its products to local tastes.
SUCCESS ing as Japan. For example, when Starbucks It continues to be ranked among the world’s
first entered Great Britain, it moved quickly— most ethical companies, which helps boost
perhaps too quickly. British consumers did Starbucks’ reputation. The company hopes
A fter years of large-scale expansion,
Howard Schultz returned as Star-
bucks’ CEO to energize and grow the com-
not take to Starbucks’ signature stores or
its premium high-priced coffee, especially
that its emphasis on individuality and global
expansion will become additional drivers
pany. The plan involved closing nearly since Great Britain was more of a tea-driven for further success.4
1,000 stores and other aggressive cost- market. Starbucks has therefore begun ren-
cutting. Realizing that the United States ovating its stores, creating a unique look for Discussion Questions
has become a saturated market, Starbucks each that fits the local culture. With over 600
1. How has Starbucks been able to be suc-
is now focusing more on international stores in Britain, Starbucks is currently mak-
cessful outside the United States?
growth. ing a profit.
Starbucks is now turning its attention 2. How has Howard Schultz’s (founder
One lucrative market is Japan. Japan
toward expansion in China. Starbucks first and past CEO) return to the company
is the largest coffee consuming country
entered China in 1999 and now operates 700 impacted Starbucks’ success?
globally. Starbucks has been involved in
stores. Finding the right approach in China is 3. What role does maintaining an ethical
Japan since 1995 and now runs close to
difficult, and reaching profitability may take organizational culture play in Starbucks’
900 stores throughout the country. Star-
years of trial and error. The company has success?
bucks has succeeded in part by adapt-
ing its products to Japanese tastes. For recently entered into the Chinese tea mar-
example, the Japanese tend to drink less ket to respond to local consumer demand.
Production and manufacturing is another element of manage- In response to growing concerns over childhood obesity, Kel-
ment. At Campbell Soup, for example, a 20-person work team logg’s has agreed to phase out advertising to children under
was created to determine how best to cut costs in some plants. the age of 12, unless those cereals are healthy (low calorie, low
In essence, managers plan, organize, staff, and control the tasks sugar and salt). In addition, Kellogg’s will stop using cartoon
required to carry out the work of the company or nonprofit and licensed characters such as Shrek to promote its products
organization. We take a closer look at management activities in to children.7 Other food producers have responded to con-
Parts 3 and 4 of this text. sumer health concerns by modifying their products to make
them healthier. Unilever, for example, announced that it was
Consider different management approaches by Samsung
eliminating all hydrogenated oils, which contain trans-fats,
Electronics and Sony. Samsung believes it is important
from its soft-spread brands. I Can’t Believe It’s Not Butter will
to manufacture its own TV sets. The firm believes that not
be one of several Unilever brands to have its hydrogenated
manufacturing is to abandon the quality of your brand.
oils replaced with palm and plant oils. Such a move reduces
Sony is hiring others to build 40 percent of its TVs to reduce
the risk of heart disease for consumers, while simultaneously
costs. In contrast, Samsung is the only TV maker that pro-
allowing Unilever to market its brands as healthier.8 Marketers
duces its own computer chips used in digital TVs. Samsung
use promotion—advertising, personal selling, sales promotion
is managing manufacturing, design, and marketing to gain
(coupons, games, sweepstakes, movie tie-ins), and publicity—
efficiencies.6 Consequently, making decisions to ensure the
to communicate the benefits and advantages of their products
business achieves its short- and long-term goals is a vital part
to consumers and increase sales. Nonprofit organizations also
of management.
use promotion. For example, the National Fluid Milk Proces-
sor Promotion Board’s “milk mustache” advertising campaign
Marketing has featured Brooke Shields, Beyonce Knowles, Sheryl Crow,
Marketing and consumers are in the same segment of Fig- Elizabeth Hurley, Serena Williams, and even animated “celeb-
ure 1.1 because the focus of all marketing activities is satisfy- rities” such as Garfield.9 We will examine marketing activities
ing customers. Marketing includes all the activities designed to in Part 5 of this text.
provide goods and services that satisfy consumers’ needs and
wants. Marketers gather information and conduct research Finance
to determine what customers want. Using information gath- Owners and finance are in the same part of Figure 1.1 because,
ered from marketing research, marketers plan and develop although management and marketing have to deal with finan-
products and make decisions about how much to charge for cial considerations, it is the primary responsibility of the
their products and when and where to make them available. owners to provide financial resources for the operation of

the business. Moreover, the owners have the most to lose if
the business fails to make a profit. Finance refers to all activi-
ties concerned with obtaining money and using it effectively.
People who work as accountants, stockbrokers, investment
advisers, or bankers are all part of the financial world. Owners
sometimes have to borrow money from banks to get started
or attract additional investors who become partners or stock-
holders. Owners of small businesses in particular often rely on
bank loans for funding. Part 6 of this text discusses financial
management.
Why Study Business?

Studying business can help you develop skills and acquire knowl-
edge to prepare for your future career, regardless of whether
you plan to work for a multinational Fortune 500 firm, start
your own business, work for a government agency, or manage
or volunteer at a nonprofit organization. The field of business
offers a variety of interesting and challenging career opportuni-
ties throughout the world, such as marketing, human resources
management, information technology, finance, production and
operations, wholesaling and retailing, and many more.
Studying business can also help you better understand the
many business activities that are necessary to provide satisfy-
ing goods and services—and that these activities carry a price
tag. For example, if you buy a new compact disk, about half of
the price goes toward activities related to distribution and the
retailer’s expenses and profit margins. The production (press-
ing) of the CD represents about $1, or a small percentage of
its price. Most businesses charge a reasonable price for their
products to ensure that they cover their production costs, pay
their employees, provide their owners with a return on their
investment, and perhaps give something back to their local
communities. Bill Daniels founded Cablevision, building his
first cable TV system in Casper, Wyoming, in 1953, and is now
considered “the father of cable television.” Prior to Daniels’
Famous athlete Shaquille O’Neal and his mother sport milk mustaches
passing in 2000, he had established a foundation that currently in the “Got Milk?” campaign.
has funding of $1.1 billion and supports a diversity of causes
from education to business ethics. During his career, Daniels
created the Young American Bank, where children could cre- world economy. Understanding how our free-enterprise eco-
ate bank accounts and learn about financial responsibility, and nomic system allocates resources and provides incentives for
this remains the world’s only charter bank for young people. industry and the workplace is important to everyone.
He created the Daniels College of Business through a donation
of $20 million to the University of Denver. During his life, he
affected many individuals and organizations, and his business
success has allowed his legacy to be one of giving and impacting
THE ECONOMIC
communities throughout the United States.10 Thus, learning
about business can help you become a well-informed consumer
FOUNDATIONS OF
and member of society. BUSINESS
Business activities help generate the profits that are essential To continue our introduction to business, it is useful to explore
not only to individual businesses and local economies but also the economic environment in which business is conducted. In
to the health of the global economy. Without profits, businesses this section, we examine economic systems, the free-enterprise
find it difficult, if not impossible, to buy more raw materials, system, the concepts of supply and demand, and the role of
hire more employees, attract more capital, and create addi- competition. These concepts play important roles in determin-
tional products that in turn make more profits and fuel the ing how businesses operate in a particular society.

economics the natural resources human resources financial resources economic system
study of how resources land, forests, minerals, the physical and mental the funds used to acquire a description of how a
are distributed for the water, and other things that abilities that people use the natural and human particular society distributes
production of goods and are not made by people to produce goods and resources needed to its resources to produce
services within a social services; also called labor provide products; also goods and services
system called capital
Economics is the study of how resources are distributed for issue of economics is how to fulfill an unlimited demand for
the production of goods and services within a social system. goods and services in a world with a limited supply of resources.
You are already familiar with the types of resources available. Different economic systems attempt to resolve this central issue
Land, forests, minerals, water, and other things that are not in numerous ways, as we shall see.
made by people are natural resources. Human resources,
Although economic systems handle the distribution of resources
or labor, refers to the physical and mental abilities that people
in different ways, all economic systems must address three
use to produce goods and services. Financial resources, or
important issues:
capital, are the funds used to acquire the natural and human
resources needed to provide products. Because natural, human, 1. What goods and services, and how much of each, will satisfy
and financial resources are used to produce goods and services, consumers’ needs?
they are sometimes called factors of production. The firm can 2. How will goods and services be produced, who will produce
also have intangible resources such as a good reputation for them, and with what resources will they be produced?
quality products or being socially responsible. The goal is to
3. How are the goods and services to be distributed to consumers?
turn the factors of production and intangible resources into a
competitive advantage. Communism, socialism, and capitalism, the basic economic
systems found in the world today (Table 1.1), have fundamental
Economic Systems differences in the way they address these issues. The factors of
An economic system describes how a particular society dis- production in command economies are controlled by govern-
tributes its resources to produce goods and services. A central ment planning. In many cases, the government owns or con-
trols the production of goods and services.
T A B L E 1 . 1 Comparison of Communism, Socialism, and Capitalism Communism and socialism are, therefore,
considered command economies.
Communism Socialism Capitalism
Business ownership Most businesses are The government Individuals own Communism Karl Marx (1818–1883)
owned and operated owns and operates and operate all first described communism as a society
by the government. major industries; businesses. in which the people, without regard to
individuals own small
businesses. class, own all the nation’s resources. In his
ideal political-economic system, every-
Competition None. The Restricted in major Encouraged by
government owns industries; encouraged market forces
one contributes according to ability and
and operates in small business. and government receives benefits according to need. In a
everything. regulations. communist economy, the people (through
Profits Excess income goes Profits earned by Individuals are free the government) own and operate all busi-
to the government. small businesses to keep profits and nesses and factors of production. Central
may be reinvested in use them as they government planning determines what
the business; profits wish. goods and services satisfy citizens’ needs,
from government-
how the goods and services are produced,
owned industries go
to the government. and how they are distributed. However,
no true communist economy exists today
Product availability Consumers have Consumers have Consumers have
and price a limited choice of some choice a wide choice that satisfies Marx’s ideal.
goods and services; of goods and of goods and On paper, communism appears to be effi-
prices are usually services; prices are services; prices
high. determined by supply are determined by cient and equitable, producing less of a gap
and demand. supply and demand. between rich and poor. In practice, how-
Employment options Little choice in Some choice of Unlimited choice of ever, communist economies have been
choosing a career; careers; many careers. marked by low standards of living, critical
most people work for people work in shortages of consumer goods, high prices,
government-owned government jobs. and little freedom. Russia, Poland, Hun-
industries or farms. gary, and other Eastern European nations
Source: “Gross Domestic Product or Expenditure, 1930–2002,” InfoPlease (n.d.), www.infoplease.com/ipa/ have turned away from communism and
A0104575.html (accessed February 16, 2004). toward economic systems governed by

communism first socialism an economic capitalism, or free free-market system mixed economies
described by Karl Marx system in which the enterprise an economic pure capitalism, in which economies made up of
as a society in which the government owns and system in which individuals all economic decisions are elements from more than
people, without regard to operates basic industries own and operate the made without government one economic system
class, own all the nation’s but individuals own most majority of businesses that intervention
resources businesses provide goods and services
supply and demand rather than by central planning. How- Capitalism Capitalism, or free enterprise, is an eco-
ever, their experiments with alternative economic systems have nomic system in which individuals own and operate the major-
been fraught with difficulty and hardship. Cuba continues to ity of businesses that provide goods and services. Competition,
apply communist principles to its economy, but Cuba is also supply, and demand determine which goods and services are
experiencing economic and political change. Countries such produced, how they are produced, and how they are distrib-
as Venezuela are trying to incorporate communist economic uted. The United States, Canada, Japan, and Australia are
principles. Hugo Chavez, Venezuela’s president, has developed examples of economic systems based on capitalism.
a partnership with Cuba, but 85 percent of his citizens surveyed
do not want their country to be like Cuba.11 Consequently, There are two forms of capitalism: pure capitalism and modi-
communism is declining and its future as an economic system fied capitalism. In pure capitalism, also called a free-market
is uncertain. When Fidel Castro stepped down as president of system, all economic decisions are made without govern-
Cuba, his younger brother Raul formally assumed the role and ment intervention. This economic system was first described
eliminated many of the bans, including allowing the purchase by Adam Smith in The Wealth of Nations (1776). Smith, often
of electric appliances, microwaves, computers, and cell phones. called the father of capitalism, believed that the “invisible
The communist country appears more open to free enterprise hand of competition” best regulates the economy. He argued
now.12 There is a plan to shift hundreds of thousands of work- that competition should determine what goods and services
ers from the public sector to the private sector. Similarly, China people need. Smith’s system is also called laissez-faire (“let it
has become the first communist country to make strong eco- be”) capitalism because the government does not interfere in
nomic gains by adopting capitalist approaches to business. Eco- business.
nomic prosperity has advanced in China with the government
Modified capitalism differs from pure capitalism in that the
claiming to ensure market openness, equality, and fairness.13
government intervenes and regulates business to some extent.
One of the ways in which the United States and Canadian
Socialism Socialism is an economic system in which the governments regulate business is through laws. Laws such as
government owns and operates basic industries—postal ser- the Federal Trade Commission Act, which created the Fed-
vice, telephone, utilities, transportation, health care, banking, eral Trade Commission to enforce antitrust laws, illustrate the
and some manufacturing—but individuals own most busi- importance of the government’s role in the economy. In the
nesses. For example, in France the postal service industry La most recent recession, the government provided loans and
Posta is fully owned by the French government and makes a took ownership positions in banks such as Citigroup, AIG (an
profit. Central planning determines what basic goods and ser- insurance company), and General Motors. These actions were
vices are produced, how they are produced, and how they are thought necessary to keep these firms from going out of busi-
distributed. Individuals and small businesses provide other ness and creating a financial disaster for the economy.
goods and services based on consumer demand and the avail-
ability of resources. Citizens are dependent on the government
Mixed Economies No country practices a pure form
for many goods and services.
of communism, socialism, or capitalism, although most tend
Most socialist nations, such as Sweden, India, and Israel, are to favor one system over the others. Most nations operate as
democratic and recognize basic individual freedoms. Citizens mixed economies, which have elements from more than
can vote for political offices, but central government planners one economic system. In socialist Sweden, most businesses are
usually make decisions about what is best for the nation. People owned and operated by private individuals. In capitalist United
are free to go into the occupation of their choice, but they often States, an independent federal agency operates the postal ser-
work in government-operated organizations. Socialists believe vice and another independent agency operates the Tennes-
their system permits a higher standard of living than other eco- see Valley Authority, an electric utility. In Great Britain and
nomic systems, but the difference often applies to the nation as Mexico, the governments are attempting to sell many state-run
a whole rather than to its individual citizens. Socialist econo- businesses to private individuals and companies. In Germany,
mies profess egalitarianism—equal distribution of income and the Deutsche Post is privatized and trades on the stock market.
social services. They believe their economies are more stable In once-communist Russia, Hungary, Poland, and other East-
than those of other nations. Although this may be true, taxes ern European nations, capitalist ideas have been implemented,
and unemployment are generally higher in socialist countries. including private ownership of businesses. Communist China
Perhaps as a result, many socialist countries have also experi- allows citizens to invest in stocks and permits some private and
enced economic difficulties. foreign ownership of businesses.

demand the number
of goods and services that
consumers are willing to
buy at different prices at a The Free- 3. Individuals and businesses must have the right to make deci-
sions that determine the way the business operates. Although
specific time Enterprise System there is government regulation, the philosophy in countries
supply the number Many economies—including those like the United States and Australia is to permit maximum
of products—goods and of the United States, Canada, and freedom within a set of rules of fairness.
services—that businesses Japan—are based on free enter- 4. Individuals must have the right to choose what career to pur-
are willing to sell at different prise, and many communist sue, where to live, what goods and services to purchase, and
prices at a specific time and socialist countries, such as more. Businesses must have the right to choose where to
China and Russia, are applying locate, what goods and services to produce, what resources to
more principles of free enterprise use in the production process, and so on.
[ “Demand is the number of goods and services that consumers are

willing to buy at different prices at a specific time.”
to their own economic systems. Free enterprise provides an Without these rights, businesses cannot function effectively
]
opportunity for a business to succeed or fail on the basis of because they are not motivated to succeed. Thus, these rights
market demand. In a free-enterprise system, companies that make possible the open exchange of goods and services. In the
can efficiently manufacture and sell products that consumers countries that favor free enterprise, such as the United States,
desire will probably succeed. Inefficient businesses and those citizens have the freedom to make many decisions about the
that sell products that do not offer needed benefits will likely employment they choose and create their own productivity sys-
fail as consumers take their business to firms that have more tems. Many entrepreneurs are more productive in free-enterprise
competitive products. societies because personal and financial incentives are available
that can aid in entrepreneurial success. For many entrepreneurs,
A number of basic individual and business rights must exist
their work becomes a part of their system of goals, values, and
for free enterprise to work. These rights are the goals of many
lifestyle. Consider Barbara Corcoran, who built one of New
countries that have recently embraced free enterprise.
York’s largest real estate companies. She is now a panelist on an
1. Individuals must have the right to own property and to pass ABC program, Shark Tank, which gives entrepreneurs a chance
this property on to their heirs. This right motivates people to to receive funding to realize their dreams.
work hard and save to buy property.
2. Individuals and businesses must have the right to earn profits The Forces of Supply and Demand
and to use the profits as they wish, within the constraints of In the United States and in other free-enterprise systems, the
their society’s laws, principles, and values. distribution of resources and products is determined by sup-
ply and demand. Demand is the num-
ber of goods and services that consumers
FIGURE 1.2 are willing to buy at different prices at a
Equilibrium Price of Handmade Rugs specific time. From your own experience,
you probably recognize that consum-
Prices of ers are usually willing to buy more of an
Rugs item as its price falls because they want
(dollars) to save money. Consider handmade rugs,
$800 for example. Consumers may be willing
Equilibrium to buy six rugs at $350 each, four at $500
650 Price each, but only two at $650 each. The rela-
tionship between the price and the num-
500 ber of rugs consumers are willing to buy
can be shown graphically, with a demand
350 curve (see Figure 1.2).
Supply Demand
Curve Curve Supply is the number of products that
200
businesses are willing to sell at differ-
ent prices at a specific time. In general,
0 because the potential for profits is higher,
1 2 3 4 5 6 7
Handmade Rugs businesses are willing to supply more of
a good or service at higher prices. For

equilibrium price competition the pure competition monopolistic oligopoly the market
the price at which the rivalry among businesses the market structure that competition the structure that exists
number of products that for consumers’ dollars exists when there are many market structure that exists when there are very few
businesses are willing to small businesses selling when there are fewer businesses selling a product
supply equals the amount of one standardized product businesses than in a pure-
products that consumers are competition environment
willing to buy at a specific and the differences among
point in time the goods they sell are small
example, a company that sells rugs may be willing to sell six producers to offer the best products at the most reasonable price;
at $650 each, four at $500 each, but just two at $350 each. The those who fail to do so are not able to stay in business. Thus, com-
relationship between the price of rugs and the quantity the petition should improve the quality of the goods and services
company is willing to supply can be shown graphically with a available or reduce prices. For example, thanks to smart design
supply curve (see Figure 1.2). and excellent timing, Apple dominates the market for download-
In Figure 1.2, the supply and demand curves intersect at the able music with its iTunes online service, iPod MP3 player, and
point where supply and demand are equal. The price at which iPhone. However, many companies have set their sights on cap-
the number of products that businesses are willing to supply turing some of the firm’s market share with new products of their
equals the amount of products that consumers are willing to own. Therefore, Apple must constantly seek to remain competitive
buy at a specific point in time is the equilibrium price. In our by creating new innovations to maintain its market share—and
rug example, the company is willing to supply four rugs at $500 sometimes capture market share from other companies. Its iPad 2
each, and consumers are willing to buy four rugs at $500 each. device, released in 2011, combines the smartphone and the laptop
Therefore, $500 is the equilibrium price for a rug at that point into one product. The iPad also contains an interface that allows
in time, and most rug companies will price their rugs at $500. users to read books as well as take pictures, which will capture
As you might imagine, a business that charges more than $500 some of the e-reader market dominated by Amazon’s Kindle.14
(or whatever the current equilibrium price is) for its rugs will Within a free-enterprise system, there are four types of com-
not sell many and might not earn a profit. On the other hand, petitive environments: pure competition, monopolistic compe-
a business that charges less than $500 accepts a lower profit per tition, oligopoly, and monopoly.
rug than could be made at the equilibrium price. Pure competition exists when there are many small busi-
If the cost of making rugs goes up, businesses will not offer as nesses selling one standardized product, such as agricultural
many at the old price. Changing the price alters the supply curve, commodities like wheat, corn, and cotton. No one business
and a new equilibrium price results. This is an ongoing process, sells enough of the product to influence the product’s price.
with supply and demand constantly changing in response to And, because there is no difference in the products, prices are
changes in economic conditions, availability of resources, and determined solely by the forces of supply and demand.
degree of competition. For example, the
Monopolistic competition exists when
price of oil can change rapidly and has been
there are fewer businesses than in a pure-
between $35 and $145 a barrel over the last
competition environment and the differences
five years. Prices for goods and services Competition, among the goods they sell is small. Aspirin,
vary according to these changes in supply
and demand. This concept is the force that the rivalry among soft drinks, and vacuum cleaners are examples
of such goods. These products differ slightly
drives the distribution of resources (goods
and services, labor, and money) in a free-
businesses for in packaging, warranty, name, and other char-
acteristics, but all satisfy the same consumer
enterprise economy. consumers’ dollars, is need. Businesses have some power over the
Critics of supply and demand say the sys- price they charge in monopolistic competi-
tem does not distribute resources equally. another vital element tion because they can make consumers aware
The forces of supply and demand prevent in free enterprise. of product differences through advertising.
sellers who have to sell at higher prices Dyson, for example, attempts to differentiate
(because their costs are high) and buyers its vacuum cleaners through product design,
who cannot afford to buy goods at the equilibrium price from quality, and advertising. Consumers value some features more
participating in the market. According to critics, the wealthy than others and are often willing to pay higher prices for a prod-
can afford to buy more than they need, but the poor may be uct with the features they want. For example, Advil, a nonpre-
unable to buy enough of what they need to survive. scription pain reliever, contains ibuprofen instead of aspirin.
Consumers who cannot take aspirin or who believe ibuprofen is
The Nature of Competition a more effective pain reliever may not mind paying a little extra
for the ibuprofen in Advil.
Competition, the rivalry among businesses for consumers’ dol-
lars, is another vital element in free enterprise. According to Adam An oligopoly exists when there are very few businesses selling a
Smith, competition fosters efficiency and low prices by forcing product. In an oligopoly, individual businesses have control over

monopoly the market
structure that exists when
there is only one business
their products’ price because each agreement of the original developer. The United States granted its
providing a product in a
given market business supplies a large portion first patent in 1790. Now its patent office receives hundreds of
of the products sold in the mar- thousands of patent applications a year, although it is estimated
economic ketplace. Nonetheless, the prices that China will soon overtake the United States in patent filings.15
expansion the situation charged by different firms stay This monopoly allows the developer to recover research, devel-
that occurs when an fairly close because a price cut or opment, and production expenses and to earn a reasonable profit.
economy is growing and increase by one company will trig- An example of this type of monopoly is the dry-copier process
people are spending more ger a similar response from another developed by Xerox. Xerox’s patents have expired, however, and
money; their purchases
company. In the airline industry, many imitators have forced market prices to decline.
stimulate the production of
for example, when one airline cuts
goods and services, which in
fares to boost sales, other airlines
turn stimulates employment
quickly follow with rate decreases
Economic Cycles and Productivity
inflation a condition to remain competitive. Oligopolies Expansion and Contraction Economies are not stag-
characterized by a exist when it is expensive for new nant; they expand and contract. Economic expansion
continuing rise in prices firms to enter the marketplace. Not occurs when an economy is growing and people are spend-
just anyone can acquire enough ing more money. Their purchases stimulate the production
financial capital to build an auto- of goods and services, which in turn stimulates employment.
mobile production facility or purchase enough airplanes and The standard of living rises because more people are employed
related resources to build an airline. and have money to spend. Rapid expansions of the economy,
however, may result in inflation, a continuing rise in prices.
When there is one business providing a product in a given
Inflation can be harmful if individuals’ incomes do not increase
market, a monopoly exists. Utility companies that supply
at the same pace as rising prices, reducing their buying power.
electricity, natural gas, and water are monopolies. The gov-
Zimbabwe suffered from hyperinflation so severe that its infla-
ernment permits such monopolies because the cost of cre-
tion rate rose into the hundreds of millions. With the elimina-
ating the good or supplying the service is so great that new
tion of the Zimbabwean dollar and certain price controls, the
producers cannot compete for sales. Government-granted
inflation rate began to decrease, but not before the country’s
monopolies are subject to government-regulated prices. Some
economy was virtually decimated.16
monopolies exist because of technological developments that
are protected by patent laws. Patent laws grant the developer Economic contraction occurs when spending declines.
of new technology a period of time (usually 20 years) during Businesses cut back on production and lay off workers, and the
which no other producer can use the same technology without the economy as a whole slows down. Contractions of the economy
PATAGONIA SHINES adoption of organic cotton and its recycling freedom to retain its strong values. Patago-
efforts are a few of the reasons consumers nia treats its employees with respect and
DURING RECESSION are fiercely loyal. Since the inception of its promotes a strong balance between work
“cradle to cradle” Common Threads recy- and personal life. The company provides
P atagonia founder and owner Yvon

Chouinard proves that ethical business
practices and product quality can lead to
cling program, most of its products, when
they do reach the ends of their life spans,
flex time, on-site child care, paid maternity/
paternity leave, and paid leave for volun-
may be returned to Patagonia and made teering. Patagonia’s success epitomizes
profitability, even during periods of eco- into new products. These efforts help drive what can happen when high ethical stan-
nomic contraction. In fact, during the lat- environmentally concerned consumers to dards and sound business strategies are
est recession, Patagonia had its best two pay more for its products. Consumers, who implemented.17
years ever. What was Patagonia’s secret often opt for long-lasting products during
to success? Dedicated employees, loyal periods of economic contraction, began Discussion Questions
customers, and products built to last. Pata- purchasing from Patagonia to get the most 1. Why has Patagonia been successful
gonia’s values are minimalistic and reflect out of their money. during the latest recession?
those of a business founded by climbers Patagonia is also debt free and cre- 2. Describe why consumers tend to be
and surfers. ates quality relationships with stake- more loyal to “green,” environmentally
Based upon these values, Patagonia’s holders. To maintain its debt-free status, friendly companies?
goal is to create durable outdoor gear Chouinard carefully monitors Patagonia’s
and clothing. Since it specializes in envi- 3. How do Patagonia’s employee policies
growth. This allows him to assist suppli-
ronmental gear, the company is dedicated improve its bottom-line success?
ers in tough times and to keep business
to environmentally friendly practices. Its running smoothly. It also gives Patagonia

economic recession a decline in unemployment the
contraction a production, employment, condition in which
slowdown of the economy and income a percentage of the
lead to recession—a decline in produc-
characterized by a decline population wants to work
tion, employment, and income. Recessions
in spending and during but is unable to find jobs
are often characterized by rising levels of which businesses cut back
unemployment, which is measured as the on production and lay off
percentage of the population that wants to workers
work but is unable to find jobs. Figure 1.3
shows the overall unemployment rate in the
civilian labor force over the past 80 years.
Rising unemployment levels tend to stifle demand for goods to stay current on their mortgage and credit card payments.
and services, which can have the effect of forcing prices This caused a crisis in the banking industry, with the gov-
downward, a condition known as deflation. The United States ernment bailing out banks to keep them from failing. This
has experienced numerous recessions, the most recent ones in turn caused a slowdown in spending on consumer goods
occurring in 1990–1991, 2002–2003, and 2008–2011. The and a reduction in employment. Unemployment reached 10
most recent recession (or economic slowdown) was caused percent of the labor force. Don’t forget that personal con-
by the collapse in housing prices and consumers’ inability sumption makes up almost 70 percent of gross domestic
FIGURE 1.3
Annual Average Unemployment Rate, Civilian Labor Force 16 Years and Over
Percent
Unemployed
16
14
12
10
8
6
4
2
0
1940 1950 1960 1970 1980 1990 2000 2003 2004 2005 2006 2007 2008 2009 2010
Year
Sources: “Employment status of the civilian noninstitutional population, 1940 to date,” Bureau of Labor Statistics, www.bls.gov/cps/cpsaat1.pdf
(accessed February 11, 2010); “Where can I find the unemployment rate for previous years?,” Bureau of Labor Statistics,
www.bls.gov/cps/prev_yrs.htm (accessed February 11, 2011).
You can see what the U.S. government currently owes—down to the penny—by going to the website for the Bureau of the Public
Debt, www.publicdebt.treas.gov/.

depression a condition
of the economy in which
unemployment is very high,
product, so consumer behavior is it does include profits earned by foreign companies within
consumer spending is low,
and business output is extremely important for economic the country being measured. However, it does not take into
sharply reduced activity. A severe recession may account the concept of GDP in relation to population (GDP
turn into a depression, in which per capita). Figure 1.4 shows the increase in GDP over several
gross domestic unemployment is very high, con- years, while Table 1.2 compares a number of economic statis-
product (GDP) the sumer spending is low, and business tics for a sampling of countries.
sum of all goods and output is sharply reduced, such as
services produced in a Another important indicator of a nation’s economic health is
what occurred in the United States
country during a year the relationship between its spending and income (from taxes).
in the early 1930s. The most recent
When a nation spends more than it takes in from taxes, it has
budget deficit the recession is often called the Great
a budget deficit. In the 1990s, the U.S. government elimi-
condition in which a nation Recession because it was the longest
nated its long-standing budget deficit by balancing the money
spends more than it takes and most severe economic decline
spent for social, defense, and other programs with the amount
in from taxes since the Great Depression.
of money taken in from taxes.
Economies expand and contract In recent years, however, the budget deficit has reemerged and
in response to changes in consumer, business, and government grown to record levels, partly due to defense spending in the
spending. War also can affect an economy, sometimes stimulat- aftermath of the terrorist attacks of September 11, 2001. Massive
ing it (as in the United States during World Wars I and II) and government stimulus spending during the most recent reces-
sometimes stifling it (as during the Vietnam, Persian Gulf, and sion also increased the national debt. Because Americans do
Iraq wars). Although fluctuations in the economy are inevitable not want their taxes increased, it is difficult for the federal gov-
and to a certain extent predictable, their effects—inflation and ernment to bring in more revenue and reduce the deficit. Like
unemployment—disrupt lives and thus governments try to mini- consumers and businesses, when the government needs money,
mize them. it borrows from the public, banks, and other institutions. The
national debt (the amount of money the nation owes its lend-
Measuring the Economy Countries measure the state ers) exceeded $13.5 trillion in 2010 due largely to increased
of their economies to determine whether they are expanding or spending by the government and an economic stimulus pack-
contracting and whether corrective action is necessary to mini- age to help stave off the worst effects of the Great Recession.18
mize the fluctuations. One commonly used measure is gross This figure is especially worrisome because, to reduce the debt
domestic product (GDP)—the sum of all goods and ser- to a manageable level, the government either has to increase its
vices produced in a country during a year. GDP measures only revenues (raise taxes) or reduce spending on social, defense,
those goods and services made within a country and therefore and legal programs, neither of which is politically popular.
does not include profits from companies’ overseas operations; The national debt figure changes daily and can be seen at the
FIGURE 1.4
Growth in U.S. Gross Domestic Product
Billions
of Dollars
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
1950 1960 1970 1980 1990 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Year
Sources: “Table D1. Population, U.S. Gross Domestic Product, and Implicit Price Deflator, 1949–2008,” EIA, www.eia.doe.gov/aer/txt/
ptb1601.html (accessed February 3, 2010); “Spending As Percent of GDP,” usgovernmentspending.com, www.usgovernmentspending.com/
downchart gs.php?year=1900_2010&units=p&title=Spending%20as%20percent%20of%20GDP (accessed January 4, 2011).

Department of the Treasury, Bureau of the Public Debt, website.
Table 1.3 describes some of the other ways we evaluate our THE AMERICAN ECONOMY
nation’s economy. As we said previously, the United States is a mixed economy
based on capitalism. The answers to the three basic economic
issues are determined primarily by com-
T A B L E 1 . 2 A Comparative Analysis of a Sampling of Countries petition and the forces of supply and
demand, although the federal government
GDP does intervene in economic decisions to
Population (Purchasing Unemployment Inflation a certain extent. To understand the cur-
Country (in millions) Power Parity) Rate (%) (% change)
rent state of the American economy and
Argentina 41.343 596 8.0 11.00 its effect on business practices, it is helpful
Australia 21.515 889.6 5.192 2.90 to examine its history and the roles of the
Brazil 201.1 2,194 7.200 4.90 entrepreneur and the government.
Canada 33.8 1,335 7.991 1.60
A Brief History of the
China 1,330 9,854 4.100 5.00
France 64.768 2,160 1.640 1.50
American Economy
Germany 82.282 2,951 7.053 1.00 The Early Economy Before the
India 1,173 4,046 9.4 11.70 colonization of North America, Native
Americans lived as hunter/gatherers and
Israel 7.353 217.1 7.400 2.60
farmers, with some trade among tribes.
Japan 126.8 4,338 5.145 20.90 The colonists who came later operated
Mexico 112.5 1,560 5.000 4.10 primarily as an agricultural economy.
Russia 139.4 2,229 7.500 6.70 People were self-sufficient and produced
South Africa 49.1 527.5 24.800 4.50
everything they needed at home, includ-
ing food, clothing, and furniture. Abun-
United Kingdom 62.348 2,189 7.876 3.30
dant natural resources and a moderate
United States 310.2 14,720 9.730 1.40 climate nourished industries such as farm-
Sources: International Monetary Fund, www.imf.org/external/pubs/ft/weo/2010/02/weodata/index.aspx ing, fishing, shipping, and fur trading. A
(accessed January 3, 2011); “Unemployment around 10 per cent, very thin social safety net,” AsiaNews. few manufactured goods and money for
it, November 15, 2010, www.asianews.it/news-en/Unemployment-around-10-per-cent,-very-thin-social- the colonies’ burgeoning industries came
safety-net-19993.html (accessed January 3, 2011); The CIA, The World Fact Book, https://www.cia.gov/
from England and other countries.
library/publications/the-world-factbook/rankorder/rankorderguide.html (accessed January 28, 2011).
As the nation expanded slowly toward the
T A B L E 1 . 3 How Do We Evaluate Our Nation’s Economy? West, people found natural resources such
as coal, copper, and iron ore and used them
Unit of Measure Description to produce goods such as horseshoes, farm
Trade balance The difference between our exports and our imports. If the
implements, and kitchen utensils. Farm
balance is negative, as it has been since the mid-1980s, it is families who produced surplus goods sold
called a trade deficit and is generally viewed as unhealthy for or traded them for things they could not
our economy. produce themselves, such as fine furniture
Consumer Price Index Measures changes in prices of goods and services purchased and window glass. Some families also spent
for consumption by typical urban households. time turning raw materials into clothes
Per capita income Indicates the income level of “average” Americans. Useful in and household goods. Because these goods
determing how much “average” consumers spend and how were produced at home, this system was
much money Americans are earning. called the domestic system.
Unemployment rate Indicates how many working age Americans are not working
who otherwise want to work.* The Industrial Revolution The
Inflation Monitors price increases in consumer goods and services 19th century and the Industrial Revolu-
over specified periods of time. Used to determine if costs tion brought the development of new
of goods and services are exceeding worker compensation technology and factories. The factory
over time. brought together all the resources needed
Worker productivity The amount of goods and services produced for each hour to make a product—materials, machines,
worked. and workers. Work in factories became
*Americans who do not work in a traditional sense, such as househusbands/housewives, are not counted specialized as workers focused on one or
as unemployed. two tasks. As work became more efficient,

FOOD TRUCKS GIVE consumer demand by offering gourmet food This is not to say that the life of a food
at affordable prices. These mobile entrepre- truck entrepreneur is easy. Government
RESTAURANTS A RUN neurs are also masters of digital media, using regulations require food truck operators to
FOR THEIR MONEY sites such as Facebook and Twitter to alert obtain a number of permits, and restaurants
their fans of their ever-changing locations sometimes resort to lobbying to keep food
and menu selections. The food truck has trucks away from their areas. Still, by offer-
M obile food trucks are using entrepre-
neurship adapted to our fast-paced
and Internet-based economy to challenge the
become so popular that The Food Network
launched “The Great Food Truck Race,” a
ing consumers new, affordable options for
dining out, mobile food trucks are becom-
dominancy of local cuisine. Long known for reality television show in which mobile food ing a formidable competitor for brick-and-
their prepackaged sandwiches and snacks, operators drive cross-country to see who can mortar restaurants.19
many food truck businesses are adapting to sell the most food.
productivity increased, making more goods available at lower produced. They did this by purchasing the products they liked
prices. Railroads brought major changes, allowing farmers to at prices they were willing to pay. The United States prospered,
send their surplus crops and goods all over the and American citizens had one of the highest
nation for barter or for sale. standards of living in the world.
Factories began to spring up along the railways
to manufacture farm equipment and a variety of
other goods to be shipped by rail. Samuel Slater
The Service and New
set up the first American textile factory after he Digital Economy
memorized the plans for an English factory and After World War II, with the increased standard
emigrated to the United States. Eli Whitney revo- of living, Americans had more money and more
lutionized the cotton industry with his cotton time. They began to pay others to perform ser-
gin. Francis Cabot Lowell’s factory organized all DID YOU KNOW? vices that made their lives easier. Beginning in
the steps in manufacturing cotton cloth for maxi- the 1960s, more and more women entered the
mum efficiency and productivity. John Deere’s Approximately workforce. The United States began experienc-
farm equipment increased farm production and 60 percent of adult ing major shifts in populations. The U.S. popula-
reduced the number of farmers required to feed women work. 21 tion grew 9.7 percent in the past decade to almost
the young nation. Farmers began to move to cit- 309 billion. This is the slowest pace of growth
ies to find jobs in factories and a higher standard since the Great Depression, with the South lead-
of living. Henry Ford developed the assembly-line ing the population gains. While the birth rate in
system to produce automobiles. Workers focused on one part of the United States is declining, new immigrants help with popu-
an automobile and then pushed it to the next stage until it rolled lation gains. The United States is growing at about the same rate
off the assembly line as a finished automobile. Ford’s assembly line as Mexico and Brazil.20 The profile of the family also began to
could manufacture many automobiles efficiently, and the price of change: Today there are more single-parent families and indi-
his cars was $200, making them affordable to many Americans. viduals living alone, and in two-parent families, both parents
often work.
The Manufacturing and Marketing Economies One result of this trend is that time-pressed Americans are increas-
Industrialization brought increased prosperity, and the United
ingly paying others to do tasks they used to do at home, like cooking,
States gradually became a manufacturing economy—one
laundry, landscaping, and child care. These trends have gradually
devoted to manufacturing goods and providing services
changed the United States to a service economy—one devoted to
rather than producing agricultural products. The assembly
the production of services that make life easier for busy consumers.
line was applied to more industries, increasing the variety
Service industries such as restaurants, banking, health care, child
of goods available to the consumer. Businesses became more
care, auto repair, leisure-related industries, and even education
concerned with the needs of the consumer and entered the
are growing rapidly and may account for as much as 80 percent of
marketing economy. Expensive goods such as cars and appli-
the U.S. economy. These trends continue with advanced technol-
ances could be purchased on a time-payment plan. Compa-
ogy contributing to new service products based on Internet-based
nies conducted research to find out what products consumers
e-business and digital media that provide smartphones, social
needed and wanted. Advertising made consumers aware of
networking, and a virtual world. Table 1.4 provides evidence that
differences in products and prices.
the new digital economy is changing how we use information and
Because these developments occurred in a free-enterprise sys- the service industry. More about the Internet, business, and new
tem, consumers determined what goods and services were online social media can be found in Chapter 13.

entrepreneur an
individual who risks his or
her wealth, time, and effort
The Role of the Entrepreneur that mark, with more than $408
to develop for profit an
billion in 2010. Sam Walton’s heirs innovative product or way
An entrepreneur is an individual who risks his or her wealth,
own about 40 percent of the com- of doing something
time, and effort to develop for profit an innovative product or
pany.24 We will examine the impor-
way of doing something. Wolfgang Puck, although an Austrian
tance of entrepreneurship further in
by birth, is a true American entreprenuer. He moved to Los
Chapter 5.
Angeles to be a chef and opened Spago, an Italian-style trattoria
that served good food that attracted movie stars. When people
found his pizza so good that they took home extras to place in The Role of Government
their freezers, he decided to build his frozen pizza into a multi- in the American Economy
million-dollar business. Today, he has over 20 restaurants and
The American economic system is best described as modi-
Wolfgang Express bistros in 80 locations.22
fied capitalism because the government regulates business to
The free-enterprise system provides the conditions neces- preserve competition and protect consumers and employees.
sary for entrepreneurs to succeed. In the past, entrepreneurs Federal, state, and local governments intervene in the economy
were often inventors who brought all the factors of production with laws and regulations designed to promote competition
together to produce a new product. Thomas Edison, whose and to protect consumers, employees, and the environment.
inventions include the record player and lightbulb, was an early Many of these laws are discussed in the Chapter 2 Appendix.
American entrepreneur. Henry Ford was one of the first persons
Additionally, government agencies such as the U.S. Depart-
to develop mass assembly methods in the automobile industry.
ment of Commerce measure the health of the economy (GDP,
Other entrepreneurs, so-called captains of industry, invested
productivity, etc.) and, when necessary, take steps to minimize
in the country’s growth. John D. Rockefeller built Standard Oil
the disruptive effects of economic fluctuations and reduce
out of the fledgling oil industry, and Andrew Carnegie invested
unemployment. When the economy is contracting and unem-
in railroads and founded the United States Steel Corporation.
ployment is rising, the federal government through the Fed-
Andrew Mellon built the Aluminum Company of America
eral Reserve Board (see Chapter 14) tries to spur growth so
and Gulf Oil. J. P. Morgan started financial institutions to fund
that consumers will spend more money and businesses will
the business activities of other entrepreneurs. Although these
hire more employees. To accomplish this, it may reduce inter-
entrepreneurs were born in another century, their legacy to
est rates or increase its own spending for goods and services.
the American economy lives on in the companies they started,
When the economy expands so fast that inflation results, the
many of which still operate today. Milton Hershey began pro-
government may intervene to reduce inflation by slowing
ducing chocolate in 1894 in Lancaster, Pennsylvania. In 1900,
down economic growth. This can be accomplished by raising
the company was mass producing chocolate in many forms,
interest rates to discourage spending by businesses and con-
lowering the cost of chocolate and making it more affordable
sumers. Techniques used to control the economy are discussed
to the masses, where it had once been a high-priced, luxury
in Chapter 14.
good. Early advertising touted chocolate as “a palatable confec-
tion and most nourishing food.” Today, the Hershey Company
employs more than 13,000 employees and sells almost $5 billion The Role of Ethics and Social
in chocolates and candies annually throughout the world.23 Responsibility in Business
Entrepreneurs are constantly changing American business In the past few years, you may have read about a number of
practices with new technology and innovative management scandals at a number of well-known corporations, including
techniques. Bill Gates, for example, built Microsoft, a software Enron, Tyco, Arthur Andersen, BP, Bear Stearns, AIG, and
company whose products include Word
and Windows, into a multibillion-dollar T A B L E 1 . 4 Volume of Traffic on the Internet
enterprise. Frederick Smith had an idea
to deliver packages overnight, and now Application Traffic Share
his FedEx Company plays an important Data 28.1%
role in getting documents and packages
Online Video 26.2%
delivered all over the world for businesses
and individuals. Entrepreneurs have been P2P File Sharing 24.9%
associated with such uniquely American Other File Sharing 18.7%
concepts as Dell Computers, Ben & Jerry’s, Voice and Video Communications 1.7%
Levi’s, Holiday Inns, McDonald’s, Dr Pep- PC Gaming 0.7%
per, Apple, Google, and Walmart. Walmart,
E-mail and Instant Messaging 0.3%
founded by entreprenuer Sam Walton, was
the first retailer to reach $100 billion in Gaming Console 0.2%
sales in one year and now routinely passes Source: Cisco, reproduced in Bloomberg Businessweek Year in Review, 2010, p. 24.

BUSINESS ETHICS GENERALLY REFERS TO
THE STANDARDS AND PRINCIPLES USED BY SOCIETY
TO DEFINE APPROPRIATE AND INAPPROPRIATE
CONDUCT IN THE WORKPLACE.
Lehman Brothers. In many cases, misconduct by individuals Society is increasingly demanding that businesspeople behave
within these firms had an adverse effect on current and retired ethically and responsibly toward not only their customers but
employees, investors, and others associated with these firms. In also their employees, investors, government regulators, com-
some cases, individuals went to jail for their actions. Top execu- munities, and the natural environment. “Intel helped establish
tives like Enron’s Jeffrey Skilling and Tyco’s Dennis Kozlowski a goal for PFCs (perfluorocompounds) that the entire industry
received long prison sentences for their roles in corporate could support,” stated Intel President and CEO Paul Otellini.
misconduct. These scandals undermined public confidence in “It came together before Kyoto and was the first worldwide,
corporate America and sparked a new debate about ethics in industry-wide goal to address climate change. We view our
business. Business ethics generally refers to the standards and environmental strategies as integral to the way we do business.
principles used by society to define appropriate and inappro- We strive to lead by example, and to be trusted stakeholders
priate conduct in the workplace. In many cases, these stan- to governments worldwide.”25 Green business strategies create
dards have been codified as laws prohibiting actions deemed long-run relationships with all stakeholders by maintaining,
unacceptable. supporting, and enhancing the natural environment.
FIGURE 1.5 One of the primary lessons of the scan-

The Organization of This Book dals of the past decade has been that the
reputation of business organizations
depends not just on bottom-line prof-
Economy
(Chapter 1) its but also on ethical conduct and con-
cern for the welfare of others. Consider
Finance that in the aftermath of these scandals,
apters 14, 15, 16 the reputations of every U.S. company
(Ch )
suffered regardless of their association
with the scandals. However, there are
Owners signs that business ethics is improv-
ing. One respected survey reported
Information that well-implemented formal ethics
( C h a pters 7, 8 e m e
Competition
(Chapter 1) Technology and compliance programs dramatically
increase reporting of observed miscon-
s
Emp
m er
M ana
, 13)
duct and also help decrease the rate of

loy
sto
ee misconduct.26 Although these results

ke , 12
s Cu
g
, 9, nt
g
ar s 11
suggest that ethics is improving, the

tin
10
1,
r
fact that employees continue to report

,1
te
12 ap M
) (Ch observing misconduct and experienc-
ing pressure to engage in unethical or
illegal acts remains troubling and sug-
gests that companies need to continue
Legal, Political, and Business Ethics and
Regulatory Forces Social
their efforts to raise ethical standards.
(Chapter 2 Appendix) Responsibility In fact, beginning in 2007 and 2008,
(Chapter 2) ethical questions surfaced about lend-
ing practices in the mortgage industry.
Special Topics: Mortgage lenders had been making
Global Business (Chapter 3)
Forms of Ownership (Chapter 4) adjustable rate mortgage loans in previ-
Small Business, Entrepreneurship, and Franchising (Chapter 5) ous years to people who were not nec-
essarily good credit risks. The brokers

SO YOU WANT A JOB // in the Business World /
W hen most people think of a career in
business, they see themselves enter-
ing the door to large companies and multi-
is changing quickly and large corporations
replace the equivalent of their entire work-
force every four years.
owner. However, there are many who feel
that experience in larger businesses is helpful
to your success later as an entrepreneur.
nationals that they read about in the news The fast pace of technology today means You’re on the road to learning the key
and that are discussed in class. In a national that you have to be prepared to take advan- knowledge, skills, and trends that you can use
survey, students indicated they would like to tage of emerging job opportunities and mar- to be a star in business. Businesses’ impact on
work for Google, Walt Disney, Apple, and Ernst kets. You must also become adaptive and our society, especially in the area of sustain-
& Young. In fact, most jobs are not with large recognize that business is becoming more ability and improvement of the environment, is
corporations, but are in small companies, global, with job opportunities around the a growing challenge and opportunity. Green
nonprofit organizations, the government, and world. If you want to obtain such a job, you businesses and green jobs in the business
even self-employed individuals. There are shouldn’t miss a chance to spend some time world are provided in this book to give you a
20 million individuals who the Small Business overseas. As you get started on the path to glimpse at the possibilities. Along the way, we
Administration says own their businesses thinking about job opportunities, consider all will introduce you to some specific careers
and have no employees. In addition, there of the changes in business today that might and offer advice on developing your own job
are nearly 5 million small businesses that affect your possible long-term track and that opportunities. Research indicates that you
employ 10 or fewer workers. With more than could bring you lots of success. You may won’t be that happy with your job unless you
75 percent of the economy based on services, want to stay completely out of large organi- enjoy your work and feel that it has a purpose.
there are jobs available in industries such zations and corporations and put yourself in Since you spend most of your waking hours
as health care, finance, education, hospitality, a position for an entrepreneurial role as a every day at work, you need to seriously think
entertainment, and transportation. The world self-employed contractor or small-business about what is important to you in a job.27
earned fees for making the loans, and the fees were not contin- to understand the world of business. The boxes and examples
gent on the ability of the borrower to pay. It was later revealed within each chapter describe experiences to help you develop
that some mortgage lenders even knew that the borrowers good business judgment. The Team Exercise at the end of each
were inflating their income to secure loans they could not chapter will help you develop skills that may be useful in your
afford. As interest rates rose and the monthly cost of the mort- future career. However, good judgment is based on knowl-
gage was adjusted upward, many borrowers were unable to edge and experience plus personal insight and understanding.
make their monthly payments and so ended Therefore, you need more courses in busi-
up defaulting on their loans and losing ness, along with some practical experience
their homes. Many faulted the lenders for in the business world, to help you develop
a lack of ethical behavior. The burst of this TEAM EXERCISE the special insight necessary to put your
housing bubble helped contribute signifi- Major economic systems including personal stamp on knowledge as you apply
cantly to what many now refer to as the capitalism, socialism, and commu- it. The challenge in business is in the area of
“Great Recession.” We take a closer look at nism, as well as mixed economies, judgment, and judgment does not develop
ethics and social responsibility in business were discussed in this chapter.
from memorizing an introductory business
in Chapter 2. Assuming that you want an economic
system that is best for the majority, not
textbook. If you are observant in your daily
just a few members of society, defend experiences as an employee, as a student,
CAN YOU LEARN one of the economic systems as the

best system. Form groups and try to
and as a consumer, you will improve your
ability to make good business judgments.
BUSINESS IN A reach agreement on one economic

system. Defend why you support the Figure 1.5 is an overview of how the chap-
system that you advance. ters in this book are linked together and
CLASSROOM? how the chapters relate to the participants,
Obviously, the answer is yes, or there would the activities, and the environmental fac-
be no purpose for this textbook! To be suc- tors found in the business world. The topics
cessful in business, you need knowledge, skills, experience, presented in the chapters that follow are those
and good judgment. The topics covered in this chapter and that will give you the best opportunity to begin the process of
throughout this book provide some of the knowledge you need understanding the world of business. ■

GET ONLINE
mhhe.com/FerrellM3e
for study materials including
quizzes, iPod downloads,
and video

introduction
two
ny organization, including
A nonprofits, has to manage the

ethical behavior of employ-
ees and participants in the over-
business ethics +
all operations of the organization.
Misconduct can take on many forms
social responsibility
within the business environment,
including deceptive business prac-
tices and the withholding of important LEARNING OBJECTIVES
information from investors or consum- LO1 Define business ethics and social
responsibility and examine their
ers. Wrongdoing by some businesses importance.
has focused public attention and gov- LO2 Detect some of the ethical issues
that may arise in business.
ernment involvement on encouraging
LO3 Specify how businesses can
more acceptable business conduct. promote ethical behavior.
Any organizational decision may be LO4 Explain the four dimensions of
social responsibility.
judged as right or wrong, ethical or
LO5 Debate an organization’s social
unethical, legal or illegal. responsibilities to owners,
employees, consumers, the
In this chapter, we take a look at the environment, and the community.
role of ethics and social responsibil-
ity in business decision making. First,
we define business ethics and exam-
ine why it is important to understand
ethics’ role in business. Next, we
explore a number of business ethics
issues to help you learn to recognize
continued on p. 24
CHAPTER 2 | Business Ethics and Social Responsibility 23

business ethics
principles and standards
that determine acceptable
conduct in business
such issues when they arise. Many consumers and social advocates believe that businesses
should not only make a profit but also consider the social impli-
Finally, we consider steps busi-
social cations of their activities. We define social responsibility as a
responsibility a nesses can take to improve business’s obligation to maximize its positive impact and mini-
business’s obligation ethical behavior in their organi- mize its negative impact on society. Although many people use the
to maximize its positive terms social responsibility and ethics interchangeably, they do not
impact and minimize its zations. The second half of the mean the same thing. Business ethics relates to an individual’s or
negative impact on society chapter focuses on social respon- a work group’s decisions that society evaluates as right or wrong,
whereas social responsibility is a broader concept that concerns the
sibility. We survey some impor-
impact of the entire business’s activities on society. From an ethical
tant responsibility issues and detail how companies have perspective, for example, we may be concerned about a health care
responded to them. organization overcharging the government for Medicare services.
For example, Abbot Laboratories Inc., Roxane Laboratories Inc.,
and B. Braun Medical Inc. paid $421 million to settle allegations
BUSINESS ETHICS AND that they committed Medicare and Medicaid fraud. The claim
stated that the companies had reported false prices in order to
SOCIAL RESPONSIBILITY receive larger reimbursements for doctors who chose their drugs.2
From a social responsibility perspective, we might be concerned
In this chapter, we define business ethics as the principles
about the impact that this overcharging will have on the ability of
and standards that determine acceptable conduct in business
the health care system to provide adequate services for all citizens.
organizations. Personal ethics relate to an individual’s val-
ues, principles, and standards of conduct. The acceptability of The most basic ethical and social responsibility concerns have
behavior in business is determined by not only the organiza- been codified by laws and regulations that encourage businesses
tion but also stakeholders such as customers, competitors, gov- to conform to society’s standards, values, and attitudes. For
ernment regulators, interest groups, and the public, as well as example, after accounting scandals at a number of well-known
each individual’s personal principles and values. The publicity firms in the early 2000s shook public confidence in the integrity
and debate surrounding highly visible legal and ethical lapses of corporate America, the reputations of every U.S. company
at a number of well-known firms, including AIG, Country- suffered regardless of their association with the scandals.3 To
wide Financial, and Enron, highlight the need for businesses to help restore confidence in corporations and markets, Congress
integrate ethics and responsibility into all business decisions. passed the Sarbanes-Oxley Act, which criminalized securities
The most recent global financial crisis took a toll on consumer fraud and stiffened penalties for corporate fraud. After the
trust of financial services companies. Words used to describe financial crisis occurred in the most recent recession, the Dodd-
these companies in a survey were “greedy,” “impersonal,” Frank Act was passed to reform the financial industry and offer
“opportunistic,” and “distant.” Most unethical activities within consumers protection against complex and/or deceptive finan-
organizations are supported by an organizational culture that cial products. At a minimum, managers are expected to obey all
encourages employees to bend the rules. laws and regulations. Most legal issues arise as choices that soci-
On the other hand, organizations that exhibit a high ethical cul- ety deems unethical, irresponsible, or otherwise unacceptable.
ture encourage employees to act with integrity and adhere to However, all actions deemed unethical by society are not neces-
organizational values. Many experts agree that ethical leadership, sarily illegal, and both legal and ethical concerns change over
ethical values, and compliance to maintain appropriate conduct time (see Table 2.1). Business law refers to the laws and regula-
are important in creating good business ethics. T-Mobile USA tions that govern the conduct of business. Many problems and
constantly reviews ethics training and all communications. It conflicts in business can be avoided if owners, managers, and
makes sure employees understand company values and regu- employees know more about business law and the legal system.
larly creates new compliance and ethics initiatives to address Business ethics, social responsibility, and laws together act as
[ “Many consumers and social advocates believe that businesses should not only
make a profit but also consider the social implications of their activities.” ]
problems or risk concerns. The senior leadership sets the tone a compliance system, requiring that businesses and employees
by consistently communicating the message that integrity, act responsibly in society. In this chapter, we explore ethics and
compliance, and values are essential ingredients to the firm’s social responsibility; The Appendix addresses business law,
performance.1 including the Sarbanes-Oxley Act and the Dodd-Frank Act.

T A B L E 2 . 1 A Timeline of Ethical and Socially Responsible Concerns
1960s 1970s 1980s 1990s 2000s
• Environmental issues • Employee militancy • Bribes and illegal • Sweatshops and unsafe • Employee benefits
• Civil rights issues • Human rights contracting practices working conditions in third- • Privacy issues
issues • Influence peddling world countries
• Increased employee- • Financial mismanagement
employer tension • Covering up rather • Deceptive advertising • Rising corporate liability
for personal damages (e.g., • Intellectual property theft
• Honesty than correcting • Financial fraud (e.g.,
issues cigarette companies) • Responsible consumption
• Changing work ethic savings and loan
• Discrimination scandal) • Financial mismanagement • The role of business in
• Rising drug use and fraud promoting sustainable
• Harassment • Transparency issues development
• Formalizing business ethics
Source: Adapted from “Business Ethics Timeline,” Copyright © 2003, Ethics Resource Center (n.d.), www.ethics.org, updated 2010. Used with permission.
The Role of Ethics in Business

You have only to pick up The Wall Street Journal or USA Today
to see examples of the growing concern about legal and ethical
issues in business. For example, the Department of Justice filed
a lawsuit against MasterCard, Visa, and American Express for
anticompetitive practices. The three companies forbade mer-
chants from revealing processing fees to customers and offer-
ing discounts to those who had cards with lower fees. With
merchants paying approximately $35 billion annually in credit
card fees, the Justice Department claimed that forcing mer-
chants to keep this information from consumers put retailers at
a financial disadvantage. MasterCard and Visa agreed to settle
the lawsuit.4 Regardless of what an individual believes about a
particular action, if society judges it to be unethical or wrong,
whether correctly or not, that judgment directly affects the
organization’s ability to achieve its business goals.5
Well-publicized incidents of unethical and illegal activity—

ranging from accounting fraud to using the Internet to steal
another person’s credit card number, from deceptive advertis-
ing of food and diet products to unfair competitive practices
in the computer software industry—strengthen the public’s
perceptions that ethical standards and the level of trust in
business need to be raised. Author David Callahan has com-
mented, “Americans who wouldn’t so much as shoplift a pack
of chewing gum are committing felonies at tax time, betraying
the trust of their patients, misleading investors, ripping off their
insurance companies, lying to their clients, and much more.”6
Often, such charges start as ethical conflicts but evolve into
legal disputes when cooperative conflict resolution cannot be
accomplished. Headline-grabbing scandals like those associ-
ated with executive compensation and benefits packages create
ethical concerns. In the United States, Charles O. Prince III, for-
mer CEO of Citigroup; Stanley O’Neal, former CEO of Merrill
Lynch; and Angelo Mozilo, founder and former CEO of Coun-
trywide Financial, rejected suggestions that they reaped lavish
compensation packages while engaging in highly risky sub-
prime lending associated with an international financial crisis. As a young man, Barry Minkow spent seven years in jail for fraudulent
While O’Neal was fired for Merrill Lynch’s poor performance, activities. In March 2011, Minkow pled guilty to securities fraud
he was given a $161 million severance package on top of the and admitted to using his fraud investigation company to make false
$70 million he earned during four years as CEO.7 accusations against Lennar Corporation.

ethical issue an
identifiable problem,
situation, or opportunity
However, it is important to under-
that requires a person
to choose from among stand that business ethics goes
several actions that may beyond legal issues. Ethical con-
be evaluated as right or duct builds trust among individu-
wrong, ethical or unethical als and in business relationships,
which validates and promotes
confidence in business relation-
ships. Establishing trust and confidence is much more difficult
in organizations that have reputations for acting unethically. If
you were to discover, for example, that a manager had misled
you about company benefits when you were hired, your trust
and confidence in that company would probably diminish.
And if you learned that a colleague had lied to you about some-
thing, you probably would not trust or rely on that person in
Nobody likes a cheater, not even in the sports business. Although Mark
the future.
McGwire broke baseball’s home run record in 1998, he later admitted
Ethical issues are not limited to for-profit organizations either. to taking steroids.
Ethical issues include all areas of organizational activities,
including government. In government, several politicians and
some high-ranking officials have faced disciplinary actions
over ethical indiscretions. Former House Majority Leader
Recognizing Ethical
Tom DeLay was sentenced to three years in prison after he was Issues in Business
found guilty of money-laundering and conspiracy. DeLay was Recognizing ethical issues is the most important step in under-
accused of channeling $190,000 of corporate money into the standing business ethics. An ethical issue is an identifiable
Republican National Committee.8 Even sports can be subject to problem, situation, or opportunity that requires a person to
ethical lapses. At many universities, for example, coaches and choose from among several actions that may be evaluated as right
athletic administrators have been put on administrative leave or wrong, ethical or unethical. In business, such a choice often
after allegations of improper recruiting practices came to light. involves weighing monetary profit against what a person con-
After Tiger Woods’s marital infidelity scandal broke, he was siders appropriate conduct. The best way to judge the ethics of
dropped by a number of major sponsors including Gatorade, a decision is to look at a situation from a customer’s or competi-
AT&T, Gillette, and Tag Heuer. Tiger Woods lost an estimated tor’s viewpoint: Should liquid-diet manufacturers make unsub-
$20 million in endorsements within one year because he lost stantiated claims about their products? Should an engineer agree
the high integrity reputation that companies require for an to divulge her former employer’s trade secrets to ensure that she
endorser.9 Across the world, a match-fixing scandal involving gets a better job with a competitor? Should a salesperson omit
Many business issues seem straightforward and easy to

resolve on the surface, but are in reality very complex.
Pakistan cricket shocked the country and caused some to ques- facts about a product’s poor safety record in his presentation to a
tion the integrity of the sport. Three Pakistani cricket players customer? Such questions require the decision maker to evaluate
allegedly accepted payments in exchange for underperforming the ethics of his or her choice.
at a match in England.10 Thus, whether made in science, poli-
Many business issues seem straightforward and easy to resolve
tics, sports, or business, most decisions are judged as right or on the surface, but are in reality very complex. A person often
wrong, ethical or unethical. Negative judgments can affect an needs several years of experience in business to understand what
organization’s ability to build relationships with customers and is acceptable or ethical. For example, if you are a salesperson,
suppliers, attract investors, and retain employees.11 when does offering a gift—such as season basketball tickets—to a
Although we will not tell you in this chapter what you ought customer become a bribe rather than just a sales practice? Clearly,
to do, others—your superiors, co-workers, and family—will there are no easy answers to such a question. But the size of the
make judgments about the ethics of your actions and decisions. transaction, the history of personal relationships within the par-
Learning how to recognize and resolve ethical issues is a key ticular company, and many other factors may determine whether
step in evaluating ethical decisions in business. an action will be judged as right or wrong by others. Companies

ONE OF THE PRINCIPAL CAUSES OF UNETHICAL
BEHAVIOR IN ORGANIZATIONS IS OVERLY AGGRESSIVE
FINANCIAL OR BUSINESS OBJECTIVES.
across the United States are starting to prevent access to Internet- theft is a much larger problem than consumer shoplifting. Time
video services at work. At issue is the theft of time by employees. theft costs can be difficult to measure but are estimated to cost
For example, many employees spend an average of one hour each companies hundreds of billions of dollars annually. It is widely
work day using social networking sites.12 Another issue is the use believed that the average employee “steals” 4.5 hours a week
of company resources to provide personal Internet access. with late arrivals, leaving early, long lunch breaks, inappropriate
sick days, excessive socializing, and engaging in personal activi-
Ethics is also related to the culture in which a business operates.
ties such as online shopping and watching sports while on the
In the United States, for example, it would be inappropriate for
job. All of these activities add up to lost productivity and prof-
a businessperson to bring an elaborately wrapped gift to a pro-
its for the employer—and relate to ethical issues in the area of
spective client on their first meeting—the gift could be viewed
abusing company resources.
as a bribe. In Japan, however, it is considered impolite not to
bring a gift. Experience with the culture in which a business Because misuse of company resources is such a widespread
operates is critical to understanding what is ethical or unethical. problem, many companies, like Boeing, have implemented offi-
To help you understand ethical issues that perplex business- cial policies delineating acceptable use of company resources.
people today, we will take a brief look at some of them in this Boeing’s policy states that use of company resources is accept-
section. Ethical issues can be more complex now than in the able when it does not result in “significant added costs, dis-
past. The vast number of news-format investigative programs ruption of business processes, or any other disadvantage to
has increased consumer and employee awareness of organiza- the company.”13 The policy further states that use of company
tional misconduct. In addition, the multitude of cable channels resources for noncompany purposes is acceptable only when
and Internet resources has improved the awareness of ethical an employee receives explicit permission to do so. This kind of
problems among the general public. The National Business policy is in line with that of many companies, particularly large
Ethics Survey found that workers witness many instances of ones that can easily lose millions of dollars and thousands of
ethical misconduct in their organizations (see Table 2.2). hours of productivity to these activities.
One of the principal causes of unethical behavior in organiza- Abusive and Intimidating Behavior Abusive or intim-
tions is overly aggressive financial or business objectives. Many idating behavior is the second most common ethical problem
of these issues relate to decisions and concerns that managers for employees. These concepts can mean anything from physical
have to deal with daily. It is not possible
to discuss every issue, of course. However, T A B L E 2 . 2 Percentage of U.S. Workforce Observing Specific Forms of
a discussion of a few issues can help you Misconduct, 2007–2009
begin to recognize the ethical problems
with which businesspersons must deal. Behaviors 2009 2007
Many ethical issues in business can be cat-
Company resource abuse 23% n/a
egorized in the context of their relation
with abusive and intimidating behavior, Abusive behavior 22 21%
conflicts of interest, fairness and honesty, Lying to employees 19 20
communications, misuse of company Email or Internet abuse 18 18
resources, and business associations. Conflicts of interest 16 22
Discrimination 14 12
Misuse of Company Resources
Misuse of company resources has been Lying to outside stakeholders 12 14
identified by the Ethics Resource Cen- Employee benefit violations 11 n/a
ter as the leading issue in observed mis- Health or safety violations 11 15
conduct in organizations (see Table 2.2). Employee privacy breach 10 n/a
Misconduct can range from firing work-
Improper hiring practices 10 10
ers for excessive use of e-mail at work to
unauthorized use of equipment and com- Falsifying time or expenses 10 n/a
puter systems to embezzling of company Source: Ethics Resource Center, 2009 National Business Ethics Survey: Business in the Recession, www.
funds. In the retail area, internal employee ethics.org, p. 32.

bribes payments, gifts,
or special favors intended
to influence the outcome of
threats, false accusations, profan- of many organizations has been diminished by the time spent
a decision
ity, insults, yelling, harshness, unraveling abusive relationships.
and unreasonableness to ignoring
Abusive behavior is difficult to assess and manage because of
someone or simply being annoying; and the meaning of these
diversity in culture and lifestyle. What does it mean to speak pro-
words can differ by person—you probably have some ideas of
fanely? Is profanity only related to specific words or other such
your own. Abusive behavior can be placed on a continuum from
terms that are common in today’s business world? If you are using
a minor distraction to a disruption of the workplace. For exam-
words that are normal in your language but that others consider to
ple, what one person may define as yelling might be another’s
be profanity, have you just insulted, abused, or disrespected them?
definition of normal speech. Civility in our society is a con-
cern, and the workplace is no exception. The productivity level Within the concept of abusive behavior, intent should be a con-
sideration. If the employee was trying to convey a compliment
but the comment was considered abusive, then it was probably a
mistake. The way a word is said (voice inflection) can be impor-
tant. Add to this the fact that we now live in a multicultural
environment—doing business and working with many different
cultural groups—and the businessperson soon realizes the depth
of the ethical and legal issues that may arise. There are problems
of word meanings by age and within cultures. For example, an
expression such as “Did you guys hook up last night?” can have
various meanings, including some that could be considered
offensive in a work environment.
Bullying is associated with a hostile workplace when a person
or group is targeted and is threatened, harassed, belittled, ver-
bally abused, or overly criticized. Bullying may create what
some consider a hostile environment, a term generally asso-
ciated with sexual harassment. Although sexual harassment
has legal recourse, bullying has little legal recourse at this
time. Bullying is a widespread problem in the United States,
and can cause psychological damage that can result in health
endangering consequences to the target. Surveys indicate that
approximately one in three adults have experienced bullying
in the workplace, and one in seven workers witness bullying.
Many victims and bystanders do not report bullying for fear
of reprisals.14 As Table 2.3 indicates, bullying can use a mix of
verbal, nonverbal, and manipulative threatening expressions to
damage workplace productivity. One may wonder why work-
ers tolerate such activities. The problem is that 81 percent of
workplace bullies are supervisors. A top officer at Boeing cited
an employee survey indicating 26 percent had observed abusive
or intimidating behavior by management.15
Conflict of Interest A conflict of interest, the most

common ethical issue identified by employees, exists when a
person must choose whether to advance his or her own per-
sonal interests or those of others. For example, a manager in
a corporation is supposed to ensure that the company is prof-
itable so that its stockholder-owners receive a return on their
investment. In other words, the manager has a responsibility
to investors. If she instead makes decisions that give her more
power or money but do not help the company, then she has
The show “Undercover Boss” gives managers the chance to understand
how their subordinates feel as they take on the responsibilities of their
a conflict of interest—she is acting to benefit herself at the
employees. Many develop a stronger appreciation for their employees’ expense of her company and is not fulfilling her responsibilities
challenging jobs, as Todd Rickets, co-owner of the Chicago Cubs, did as an employee. To avoid conflicts of interest, employees must
after spending time working as part of the janitorial staff and grounds be able to separate their personal financial interests from their
crew. business dealings. In the wake of the 2008 meltdown on Wall

T A B L E 2 . 3 Actions Associated with Bullies T A B L E 2 . 4 Least Corrupt Countries
1. Spreading rumors to damage others Rank Country CPI Score*

2. Blocking others’ communication in the workplace 1 Denmark/New 9.3
3. Flaunting status or authority to take advantage of others Zealand/Singapore
4. Discrediting others’ ideas and opinions 4 Finland/Sweden 9.2
5. Use of e-mails to demean others 6 Canada 8.9
6. Failing to communicate or return communication 7 Netherlands 8.8
7. Insults, yelling, and shouting 8 Australia/Switzerland 8.7
8. Using terminology to discriminate by gender, race, or age 10 Norway 8.6
9. Using eye or body language to hurt others or their reputation 11 Iceland/Luxembourg 8.5
10. Taking credit for others’ work or ideas 13 Hong Kong 8.4
Source: © O. C. Ferrell, 2011. 14 Ireland 8.0
15 Austria/Germany 7.9
Street, stakeholders and legislators pushed for reform of the 17 Barbados/Japan 7.8
credit rating industry. Many cited rampant conflicts of interest 19 Qatar 7.7
between financial firms and the companies that rate them as
20 United Kingdom 7.6
part of the reason no one recognized the impending financial
disaster. Conflict of interest has long been a serious problem 21 Chile 7.2
in the financial industry because the financial companies pay 22 Belgium/United States 7.1
the credit raters money in order to be rated. Because different
*CPI score relates to perceptions of the degree of corruption as seen by
rating companies exist, financial firms can also shop around for businesspeople and country analysts and ranges between 10 (highly clean)
the best rating. There is no third-party mediator who oversees and 0 (highly corrupt).
the financial industry and how firms are rated.16 Source: “Corruption Perceptions Index 2010,” Transparency International,
As mentioned earlier, it is considered improper to give or accept www.transparency.org/policy_research/surveys_indices/cpi/2010/results
(accessed January 6, 2011).
bribes—payments, gifts, or special favors intended to influ-
ence the outcome of a decision. A bribe is a conflict of interest
because it benefits an individual at the expense of an organi- workers admit to stealing more expensive equipment such as
zation or society. Companies that do business overseas should laptops, PDAs, and cell phones. Employees should be aware
be aware that bribes are a significant ethical issue and are, in of policies on taking items and recognize how these decisions
fact, illegal in many countries. For example, the Merchant relate to ethical behavior. Figure 2.1 provides an overview of
Bank in New York admitted to making unlawful payments to the most pilfered office supplies.
a government official in the Republic of Kazakhstan in order to
secure business within the country. This payment, or bribe, was One aspect of fairness relates to competition. Although numer-
in clear violation of the U.S. Foreign Corrupt Practices Act.17 ous laws have been passed to foster competition and make
While bribery is an increasing issue in many countries, it is monopolistic practices illegal, companies sometimes gain control
more prevalent in some countries than in others. Transparency over markets by using questionable practices that harm competi-
International has developed a Corruption Perceptions Index tion. Bullying can also occur between companies that are intense
(Table 2.4). Note that there are 21 countries perceived as less competitors. Even respected companies such as Intel have been
corrupt than the United States.18 accused of monopolistic bullying. A competitor, Advanced Micro
Devices (AMD), claimed in a lawsuit that 38 companies, includ-
Fairness and Honesty Fairness and honesty are at the ing Dell and Sony, were strong-arming customers (such as Apple)
heart of business ethics and relate to the general values of deci- into buying Intel chips rather than those marketed by AMD. In
sion makers. At a minimum, businesspersons are expected to many cases, the alleged misconduct not only can have monetary
follow all applicable laws and regulations. But beyond obeying and legal implications but also can threaten reputation, investor
the law, they are expected not to harm customers, employees, confidence, and customer loyalty. A front-cover Forbes head-
clients, or competitors knowingly through deception, misrep- line stated “Intel to ADM: Drop Dead.” The intensely competi-
resentation, coercion, or discrimination. Honesty and fairness tive atmosphere and Intel’s ability to use its large size won it the
can relate to how the employees use the resources of the orga- high-profile Apple account, displacing IBM and Freescale. ADM
nization. A survey by Kelton research revealed that 56 percent claims it had no opportunity to bid because Intel had offered to
of employed Americans pilfer products from their employers deploy 600 Indian engineers to help Apple software run more
for personal use.19 Although the majority of office supply thefts smoothly on Intel chips.20 The U.S. Federal Trade Commission
involve small things such as pencils or Post-it Notes, some joined in on the antitrust accusations against Intel by alleging

FIGURE 2.1 at least once, 36 percent confessed
Office Supplies Reported Missing Most Often to copying documents from the
Internet, and 28 percent admitted
to shoplifting.23 If today’s students
are tomorrow’s leaders, there is
Pens, Pencils, or Highlighters likely to be a correlation between
acceptable behavior today and
Paper Products tomorrow. This adds to the argu-
ment that the leaders of today
Paper Clips or Binders Clips must be prepared for the ethical
risks associated with this down-
Stapler ward trend. According to a poll by
Deloitte and Touche of teenagers
Scissors
aged 13 to 18, when asked if people
who practice good business ethics
Tape Dispenser
are more successful than those
Printer Ink who don’t, 69 percent of teenag-
ers agreed.24 The same poll found
Binders only 12 percent of teens think
business leaders today are ethical.
Other On the other hand, another survey
indicated that many students do
0 10 20 30 40 50 60 70 80 90 not define copying answers from
another students’ paper or down-
Source: “The Truth Behind Disappearing Office Supplies,” OfficeMax, May 2010, multivu.prnewswire.com/mnr/ loading music or content for class-
officemax/44541/docs/44541-Report OfficeMaxWorkplaceUncoveredSurvey.pdf (accessed January 6, 2011).
room work as cheating.25
that Intel used illegal inducements and threats of retaliation to Perhaps even more troubling was the revelation that several
discourage computer makers from buying competitor AMD’s FBI agents had cheated on a test covering FBI procedures for
chips. The FTC also claimed that Intel corrupted software built the surveillance of Americans. An investigation showed that
on Intel compilers to make it run slower on computers using several agents, including some FBI supervisors, took the test
AMD processors. Intel agreed to pay AMD $1.25 billion to set- together or had access to the answer sheets in advance. Such
tle the 2005 lawsuit. Intel also settled with the FTC by agreeing cheating by adult government workers highlights a disturbing
not to engage in payments or other anticompetitive practices to trend within the professional world.26
drive out competitors. The company created a $10 million fund
to assist customers in recompiling the corrupted software. Intel’s Communications Communications is another area in
fines and the damage to its reputation may have a considerable which ethical concerns may arise. False and misleading advertis-
impact on the way it operates in the market.21 ing, as well as deceptive personal-selling tactics, anger consum-
Another aspect of fairness and honesty relates to disclosure ers and can lead to the failure of a business. Truthfulness about
of potential harm caused by product use. For example, many product safety and quality are also important to consumers.
stakeholder groups have become increasingly concerned about Claims about dietary supplements can be particularly problem-
the health effects of additives in food and manufactured prod- atic. VMG Global, a sports nutrition company, pleaded guilty to
ucts. The widespread use of plastic products have caused a illegally putting steroids in two of its body-building supplements.
number of stakeholder groups to raise questions about possi- For four years, the company knowingly spiked Tren Xtreme and
ble health problems associated with additives like Bisphenol A Mass Xtreme, products that generated more than $5.6 million in
(BPA), which is suspected of causing health problems in infants revenue for the company. The company agreed to pay $500,000 in
and children. Many businesses, however, continue to include penalties and destroy all remaining inventory of the products.27
BPA in their products until research proves more conclusive on
Some companies fail to provide enough information for con-
whether it is harmful.22 While it is not mandatory to disclose
sumers about differences or similarities between products. For
whether a product contains BPA, some companies have turned
example, driven by high prices for medicines, many consumers
a potential problem into a competitive advantage by labeling
are turning to Canadian, Mexican, and overseas Internet sources
their BPA-free products to ease the fears of consumers.
for drugs to treat a variety of illnesses and conditions. However,
Dishonesty has become a significant problem in the United research suggests that a significant percentage of these imported
States. A survey of nearly 25,000 high school students revealed pharmaceuticals may not actually contain the labeled drug, and the
that 64 percent of the students admitted to cheating on an exam counterfeit drugs could even be harmful to those who take them.28

plagiarism the act of
taking someone else’s work
and presenting it as your
Another important aspect of communications that may raise manipulation, dishonesty, and con-
own without mentioning the
ethical concerns relates to product labeling. The Food and Drug flicts of interest. source
Administration mandated that by 2012 all cigarette packs must Plagiarism—taking someone
include warnings and graphic images that show the conse- else’s work and presenting it as
quences of smoking. The plans are for these images to cover half your own without mentioning the source—is another ethical
the space on packages and supplement all cigarette advertise- issue. As a student, you may be familiar with plagiarism in school;
ments.29 In Europe, at least 30 percent of the front side of prod- for example, copying someone else’s term paper or quoting from
uct packaging and 40 percent of the back needs to be taken up a published work or Internet source without acknowledging it. In
by the warning. The use of descriptors such as “light” or “mild” business, an ethical issue arises when an employee copies reports
has been banned.30 However, labeling of other products raises or takes the work or ideas of others and presents it as his or her
ethical questions when it threatens basic rights, such as freedom own. A manager attempting to take credit for a subordinate’s
of speech and expression. This is the heart of the controversy ideas is engaging in another type of plagiarism.
surrounding the movement to require warning labels on movies
and videogames, rating their content, language, and appropri- Making Decisions
ate audience age. Although people in the entertainment indus-
try claim that such labeling violates their First Amendment about Ethical Issues
right to freedom of expression, other consumers—particularly Although we’ve presented a variety of ethical issues that may
parents—believe that labeling is needed to protect children arise in business, it can be difficult to recognize specific ethi-
from harmful influences. Similarly, alcoholic beverage and cal issues in practice. Whether a decision maker recognizes an
cigarette manufacturers have argued that a total ban on ciga- issue as an ethical one often depends on the issue itself. Manag-
rette and alcohol advertisements violates the First Amendment. ers, for example, tend to be more concerned about issues that
Internet regulation, particularly that designed to protect chil- affect those close to them, as well as issues that have immedi-
dren and the elderly, is on the forefront in consumer protection ate rather than long-term consequences. Thus, the perceived
legislation. Because of the debate surrounding the acceptability importance of an ethical issue substantially affects choices.
of these business activities, they remain major ethical issues. However, only a few issues receive scrutiny, and most receive
no attention at all.32
Business Relationships The behavior of businessper- Table 2.5 lists some questions you may want to ask yourself
sons toward customers, suppliers, and others in their work- and others when trying to determine whether an action is ethi-
place may also generate ethical concerns. Ethical behavior cal. Open discussion of ethical issues does not eliminate ethi-
within a business involves keeping company secrets, meeting cal problems, but it does promote both trust and learning in
obligations and responsibilities, and avoiding undue pressure an organization.33 When people feel that they cannot discuss
that may force others to act unethically. what they are doing with their co-workers or superiors, there is
Managers in particular, because of the authority of their posi- a good chance that an ethical issue exists. Once a person has rec-
tion, have the opportunity to influence employees’ actions. For ognized an ethical issue and can openly discuss it with others, he
example, a manager might influence employees to use pirated or she has begun the process of resolving that issue.
computer software to save costs. The use of illegal software puts
the employee and the company at legal risk, but employees Improving Ethical Behavior
may feel pressured to do so by their superior’s authority. The in Business
National Business Ethics Survey found that employees who feel
Understanding how people make ethical choices and what
pressure to compromise ethical standards view top and middle
prompts a person to act unethically may reverse the current
managers as the greatest source of such pressure.31
trend toward unethical behavior in business. Ethical decisions
It is the responsibility of managers to create a work environ- in an organization are influenced by three key factors: individ-
ment that helps the organization achieve its objectives and fulfill ual moral standards, the influence of managers and co-workers,
its responsibilities. However, the methods that managers use to and the opportunity to engage in misconduct (Figure 2.2).
enforce these responsibilities should not
compromise employee rights. Organiza-
tional pressures may encourage a person T A B L E 2 . 5 Questions to Consider in Determining Whether an Action Is Ethical
to engage in activities that he or she might
Are there any potential legal restrictions or violations that could result from the action?
otherwise view as unethical, such as invad- Does your company have a specific code of ethics or policy on the action?
ing others’ privacy or stealing a competi-
Is this activity customary in your industry? Are there any industry trade groups that provide
tor’s secrets. The firm may provide only guidelines or codes of conduct that address this issue?
vague or lax supervision on ethical issues,
Would this activity be accepted by your co-workers? Will your decision or action withstand
creating the opportunity for misconduct. open discussion with co-workers and managers and survive untarnished?
Managers who offer no ethical direction to
How does this activity fit with your own beliefs and values?
employees create many opportunities for

BP DISASTER LEADS leaking weeks prior to the explosion. Similar has overshadowed BP’s positive multimil-
accusations of risky or negligent behavior lion dollar investments in renewable energy.
TO QUESTIONS soon followed. Two months into the disaster, BP has implemented a $20 billion Deepwa-
ABOUT ETHICS it was revealed that one-third of BP’s deep ter Horizon Oil Spill Trust to pay out claims
water oil rig designs were deemed risky by and a $500 million Gulf of Mexico Research
AND SOCIAL government inspectors—a higher percent- Initiative to fund the study of the impacts of
RESPONSIBILITY age than those of other oil companies. the disaster, among other initiatives. BP has
Effective business ethics requires firms a long history of environmental disasters
to identify risks and educate employees and safety violations. What will it take to
B ritish Petroleum (BP) has become syn-
onymous with the worst oil leak disaster
in U.S. waters to date. Simply put, BP failed
to deal with issues related to the risks. BP
did not adequately acknowledge the risks
improve the reputation of BP?34
to adequately prepare for a worst case sce- despite warnings from industry experts. It
Discussion Questions
nario. When the Deepwater Horizon oil rig also had no effective crisis management
plan in place. BP did have a spill-response 1. Are BP’s attempts at compensation
exploded, killing eleven workers and pouring
plan; however, its plan proved ineffective to enough to change the company’s reputa-
millions of gallons of oil into the Gulf of Mex-
handle the situation. tion in the eyes of consumers?
ico, BP had no effective contingency plan.
The disaster has undermined BP’s repu- 2. What are the ethical considerations that
The crisis immediately spun out of control.
tation, and its ethics and social responsibil- BP failed to recognize in its management
Not only did BP underestimate the risks,
ity has been questioned by stakeholders. of risks?
but some suggest it willfully cut corners to
save money. A rig technician accused BP of Many consumers responded by boycotting 3. How important is BP’s reputation for
knowing that the rig’s blowout preventer was BP gas stations and products. The disaster business success?
While you have great control over your personal ethics outside and employees often experience some tension between their
the workplace, your co-workers and superiors exert signifi- own ethical beliefs and their obligations to the organizations
cant control over your choices at work through authority and in which they work. Many employees utilize different ethical
example. In fact, the activities and examples set by co-workers, standards at work than they do at home. This conflict increases
along with rules and policies established by when employees feel that their company is
the firm, are critical in gaining consistent encouraging unethical conduct or exerting
ethical compliance in an organization. If pressure on them to engage in it.
the company fails to provide good examples
and direction for appropriate conduct, con- Many It is difficult for employees to determine
what conduct is acceptable within a com-
fusion and conflict will develop and result employees utilize pany if the firm does not have established
in the opportunity for misconduct. If your ethics policies and standards. And with-
boss or co-workers leave work early, you different ethical out such policies and standards, employees
may be tempted to do so as well. If you see may base decisions on how their peers and
co-workers engaged in personal activities standards at work superiors behave. Professional codes of
such as shopping online or watching You-
Tube, then you may be more likely to do than they do at ethics are formalized rules and standards
that describe what the company expects of
so also. In addition, having sound personal home. its employees. Codes of ethics do not have
values contributes to an ethical workplace. to be so detailed that they take into account
Because ethical issues often emerge from conflict, it is useful every situation, but they should provide guidelines and principles
to examine the causes of ethical conflict. Business managers that can help employees achieve organizational objectives and
address risks in an acceptable and ethical
FIGURE 2.2 way. The development of a code of ethics
Three Factors That Influence Business Ethics should include not only a firm’s executives
and board of directors, but also legal staff
and employees from all areas of a firm.35
Individual Managers' Opportunity: Ethical/Unethical Table 2.6 lists some key things to consider
Standards and Codes and Choices when developing a code of ethics.
+ + =
and Co-workers' Compliance in Business
Values Influence Requirements
Codes of ethics, policies on ethics, and
ethics training programs advance ethical
behavior because they prescribe which

codes of ethics
formalized rules and
standards that describe
activities are acceptable and which are not, and they limit misconduct—with reduced fines what a company expects of
the opportunity for misconduct by providing punishments and penalties when violations its employees
for violations of the rules and standards. Codes and policies occur. Congress has also taken
on ethics encourage the creation of an ethical culture in the steps to close a legislative loophole whistleblowing
company. According to the National Business Ethics Survey in whistleblowing legislation that the act of an employee
(NBES), employees in organizations that have written codes has led to the dismissal of many exposing an employer’s
of conduct and ethics training, ethics offices or hotlines, whistleblowers. In 2010 Congress wrongdoing to outsiders,
and systems for reporting are more likely to report miscon- passed the Dodd-Frank Act, which such as the media or
duct when they observe it. The survey found that a com- includes a “whistleblower bounty government regulatory
agencies
pany’s ethical culture is the greatest determinant of future program.” The Securities and
misconduct.36 Exchange Commission can now
award whistleblowers between 10
The enforcement of ethical codes and policies through rewards and 30 percent of monetary sanctions over $1 million. The hope
and punishments increases the acceptance of ethical standards is that incentives will encourage more people to come forward
by employees. For example, employees at Granite Construc- with information regarding corporate misconduct.39
tion are highly encouraged to engage in ethical behavior.
Granite Construction holds six mandatory training sessions The current trend is to move away from legally based ethical
to manage risks, offers computer-based training for employ- initiatives in organizations to cultural- or integrity-based initia-
ees, provides ethics training for board members, and uses tives that make ethics a part of core organizational values. Orga-
Field Compliance Officers to monitor compliance through all nizations recognize that effective business ethics programs are
levels of the company. Granite’s strong ethical culture inspired good for business performance. Firms that develop higher lev-
the creation of the Construction Industry Ethics and Compli- els of trust function more efficiently and effectively and avoid
ance Initiative, consisting of a network of construction firms damaged company reputations and product images. Organiza-
dedicated to supporting ethics and compliance throughout tional ethics initiatives have been supportive of many positive
the industry.37 and diverse organizational objectives, such as profitability, hir-
[ “The current trend is to move away from legally based ethical initiatives
in organizations to cultural- or integrity-based initiatives that
make ethics a part of core organizational values.”
One of the most important components of an ethics program ing, employee satisfaction, and customer loyalty.40 Conversely,
]
is a means through which employees can report observed mis- lack of organizational ethics initiatives and the absence of
conduct anonymously. Although the risk of retaliation is still a workplace values such as honesty, trust, and integrity can have
major factor in whether an employee will
report illegal conduct, the NBES found
that whistleblowing has increased in the T A B L E 2 . 6 Key Things to Consider in Developing a Code of Ethics
past few years. Approximately 63 per-
• Create a team to assist with the process of developing the code (include management
cent of respondents said they reported and nonmanagement employees from across departments and functions).
misconduct when they observed it.38
• Solicit input from employees from different departments, functions, and regions to
Whistleblowing occurs when an compile a list of common questions and answers to include in the code document.
employee exposes an employer’s wrong-
• Make certain that the headings of the code sections can be easily understood by all
doing to outsiders, such as the media or
employees.
government regulatory agencies. However,
more companies are establishing programs • Avoid referencing specific U.S. laws and regulations or those of specific countries,
particularly for codes that will be distributed to employees in multiple regions.
to encourage employees to report illegal
or unethical practices internally so that • Hold employee group meetings on a complete draft version (including graphics and
pictures) of the text using language that everyone can understand.
they can take steps to remedy problems
before they result in legal action or gen- • Inform employees that they will receive a copy of the code during an introduction
session.
erate negative publicity. Unfortunately,
whistleblowers are often treated negatively • Let all employees know that they will receive future ethics training that will, in part, cover
the important information contained in the code document.
in organizations. The government seeks
to discourage this practice by rewarding Source: Adapted from William Miller, “Implementing an Organizational Code of Ethics,” International
firms that encourage employees to report Business Ethics Review 7 (Winter 2004), pp. 1, 6–10.

corporate
citizenship the
extent to which businesses
a negative impact on organiza- Corporate citizenship is the extent to which businesses
meet the legal, ethical,
tional objectives and employee meet the legal, ethical, economic, and voluntary responsibilities
economic, and voluntary
responsibilities placed on retention. According to one report placed on them by their various stakeholders. It involves the
them by their stakeholders on employee loyalty and work activities and organizational processes adopted by businesses
practices, 79 percent of employ- to meet their social responsibilities. A commitment to corpo-
ees who questioned their bosses’ rate citizenship by a firm indicates a strategic focus on fulfill-
integrity indicated that they felt uncommitted or were likely to ing the social responsibilities expected of it by its stakeholders.
quit soon.41 Corporate citizenship involves action and measurement of the
extent to which a firm embraces the corporate citizenship phi-
losophy and then follows through by implementing citizenship
THE NATURE OF SOCIAL and social responsibility initiatives. One of the major corporate
citizenship issues is the focus on preserving the environment.
RESPONSIBILITY Consumers, governments, and special interest groups such
There are four dimensions of social responsibility: eco- as The Nature Conservancy are concerned about greenhouse
nomic, legal, ethical, and voluntary (including philanthropic) gases and carbon emissions that are contributing to global
(Figure 2.3).42 Earning profits is the economic foundation of warming. The majority of people agree that climate change
the pyramid in Figure 2.3, and complying with the law is the is a global emergency, but there is not agreement on how to
next step. However, a business whose sole objective is to maxi- solve the problem.43 Another example of a corporate citizen-
mize profits is not likely to consider its social responsibility, ship issue might be animal rights—an issue that is important to
although its activities will probably be legal. (We looked at ethi- many stakeholders. As the organic and local foods movements
cal responsibilities in the first half of this chapter.) Finally, vol- grow and become more profitable, more and more stakehold-
untary responsibilities are additional activities that may not be ers are calling for more humane practices in factory farms as
required but which promote human welfare or goodwill. Legal well.44 Large factory farms are where most Americans get their
and economic concerns have long been acknowledged in busi- meat, but some businesses are looking at more animal-friendly
ness, but voluntary and ethical issues are more recent concerns. options in response to public outcry.
Part of the answer to the climate change

FIGURE 2.3 crisis is alternative energy such as solar,
The Pyramid of Social Responsibility
wind, biofuels, and hydro applications. The
American Solar Energy Society estimates
that the number of “green” jobs could rise
to 40 million by 2030.45 The drive for
alternative fuels such as ethanol from corn
has added new issues such as food price
Voluntary
increases and food shortages. More than
Responsibilities 2 billion consumers earn less than $2 a
being a "good day in wages. Sharply increased food costs
corporate citizen"; have led to riots and government policies
contributing to the to restrict trade in basic commodities such
community and quality of life
as rice, corn, and soybeans.46
Ethical Responsibilities
being ethical; To respond to these developments, most
doing what is right, just, and fair; companies are introducing eco-friendly
avoiding harm products and marketing efforts. Even
Walmart is taking advantage of the inter-
Legal Responsibilities
est in the environment. The company is
obeying the law (society's codification of
right and wrong); developing a new labeling system that
playing by the rules of the game shows consumers the carbon output of
every product carried in Walmart’s stores.
Economic Responsibilities Americans as consumers are generally
being profitable concerned about the environment, but
only 47 percent trust companies to tell
them the truth in environmental mar-
Source: Reprinted with permission from A. B. Carroll, “The Pyramid of Corporate Social Responsibility:
keting.47 This is because most businesses
Toward the Moral Management of Organizational Stakeholders,” Business Horizons, July/August 1991. are promoting themselves as green-
Copyright © 1991 by the Board of Trustees at Indiana University, Kelley School of Business. conscious and concerned about the

environment without actually making the T A B L E 2 . 7 A Selection of the World’s Most Ethical Companies
necessary commitments to environmental
Hewlett-Packard Co. Xerox
health. Even employees feel their employ-
ers aren’t doing enough to protect the envi- Trader Joe’s Nike
ronment, with nearly 60 percent feeling General Mills, Inc. Salesforce.com
that more needs to be to done to reduce, UPS Barrett Jackson Auction Company
recycle, and support green policies.48 Patagonia Dow Corning Corporation
The Ethisphere Institute selects an annual General Electric Ford Motor Company
list of the world’s most ethical companies Best Buy ARAMARK
based on the following criteria: Corporate
Kao Caterpillar
Citizenship and Responsibility; Corporate
Governance; Innovation that Contributes Gap, Inc. Aflac
to the Public Well Being; Industry Leader- International Paper Whole Foods Market
ship; Executive Leadership and Tone from IKEA Google
the Top; Legal, Regulatory and Reputation AstraZeneca Starbucks Coffee Co.
Track Record; and Internal Systems and
Pepsico Inc. Target
Ethics/Compliance Program.49 Table 2.7
shows the top 20 from that list. Source: “2010 World’s Most Ethical Companies,” Ethisphere, Q4, pp. 30–31.
Although the concept of social responsi-
bility is receiving more and more atten- T A B L E 2 . 8 The Arguments For and Against Social Responsibility
tion, it is still not universally accepted.
For:
Table 2.8 lists some of the arguments for
and against social responsibility. 1. Business helped create many of the social problems that exist today, so it should play
a significant role in solving them, especially in the areas of pollution reduction and
cleanup.
Social Responsibility 2. Businesses should be more responsible because they have the financial and technical
Issues resources to help solve social problems.
As with ethics, managers consider social 3. As members of society, businesses should do their fair share to help others.
responsibility on a daily basis. Among the 4. Socially responsible decision making by businesses can prevent increased government
many social issues that managers must con- regulation.
sider are their firms’ relations with owners 5. Social responsibility is necessary to ensure economic survival: If businesses want
and stockholders, employees, consumers, the educated and healthy employees, customers with money to spend, and suppliers with
quality goods and services in years to come, they must take steps to help solve the
environment, and the community. For exam- social and environmental problems that exist today.
ple, Indra Nooyi, CEO of PepsiCo, believes
Against:
that companies must embrace “purpose,”
not just for financial results, but also for the 1. It sidetracks managers from the primary goal of business—earning profits. Every dollar
donated to social causes or otherwise spent on society’s problems is a dollar less for
imprint they leave on society. She goes on to owners and investors.
say that stakeholders, including employees,
2. Participation in social programs gives businesses greater power, perhaps at the
consumers, and regulators, “will leave no expense of particular segments of society.
doubt that performance without purpose is
3. Some people question whether business has the expertise needed to assess and make
not a long-term sustainable formula.”50 decisions about social problems.
Social responsibility is a dynamic area with 4. Many people believe that social problems are the responsibility of government agencies
issues changing constantly in response to and officials, who can be held accountable by voters.
society’s demands. There is much evidence
that social responsibility is associated with
improved business performance. Consumers are refusing to buy Relations with Owners and Stockholders Busi-
from businesses that receive publicity about misconduct. A num- nesses must first be responsible to their owners, who are pri-
ber of studies have found a direct relationship between social marily concerned with earning a profit or a return on their
responsibility and profitability, as well as a link that exists between investment in a company. In a small business, this respon-
employee commitment and customer loyalty—two major con- sibility is fairly easy to fulfill because the owner or owners
cerns of any firm trying to increase profits.51 This section high- personally manage the business or know the managers well.
lights a few of the many social responsibility issues that managers In larger businesses, particularly corporations owned by
face; as managers become aware of and work toward the solution thousands of stockholders, ensuring responsibility becomes a
of current social problems, new ones will certainly emerge. more difficult task.

Lady Gaga poses at an a M·A·C AIDS Fund event to promote VIVA GLAM lipstick. Money from the lipstick goes toward combating the AIDS virus.

consumerism the
activities that independent
individuals, groups, and
A business’s obligations to its owners and investors, as well as to over the past 5 to 10 years as well. organizations undertake
the financial community at large, include maintaining proper Many Americans today believe to protect their rights as
accounting procedures, providing all relevant information to business has a social obligation to consumers
investors about the current and projected performance of the provide special opportunities for
firm, and protecting the owners’ rights and investments. In women and minorities to improve
short, the business must maximize the owners’ investment in their standing in society.
the firm.
Consumer Relations A critical issue in business today
Employee Relations Another issue of importance to a is business’s responsibility to customers, who look to business
business is its responsibilities to employees. Without employ- to provide them with satisfying, safe products and to respect
ees, a business cannot carry out its goals. Employees expect their rights as consumers. The activities that independent indi-
businesses to provide a safe workplace, pay them adequately viduals, groups, and organizations undertake to protect their
for their work, and keep them informed of what is happen- rights as consumers are known as consumerism. To achieve
ing in their company. They want employers to listen to their their objectives, consumers and their advocates write letters to
grievances and treat them fairly. In an effort to make Ford companies, lobby government agencies, make public service
more competitive with foreign car companies, the United Auto announcements, and boycott companies whose activities they
Workers union agreed to allow the company to hire new work- deem irresponsible.
ers at half the pay and with reduced benefits. This was a major Many of the desires of those involved in the consumer move-
concession on the part of the union, but was deemed a neces- ment have a foundation in John F. Kennedy’s 1962 consumer
sary step in keeping the company afloat. However, hiring new bill of rights, which highlighted four rights. The right to safety
workers to do the same job as established ones for half the pay means that a business must not knowingly sell anything that
can result in dissatisfied employees and low morale.52 could result in personal injury or harm to consumers. Defective
Congress has passed several laws regulating safety in the work- or dangerous products erode public confidence in the ability of
place, many of which are enforced by the Occupational Safety business to serve society. They also result in expensive litigation
and Health Administration (OSHA). Labor unions have also that ultimately increases the cost of products for all consum-
made significant contributions to achieving safety in the workers. The right to safety also means businesses must provide a
place and improving wages and benefits. Most organizations safe place for consumers to shop. In recent years, many large
now recognize that the safety and satisfaction of their employ- retailers have been under increasing pressure to improve safety
ees are critical ingredients in their success, and many strive to in their large stores. Walmart faced serious scrutiny after the
go beyond what is legally expected of them. Healthy, satisfied death of a guard during an early morning Black Friday stam-
employees also supply more than just labor to their employers. pede at a store on Long Island. The company was faced with
Employers are beginning to realize the importance of obtaining lawsuits, bad press, and negative allegations related to the inci-
input from even the lowest-level employees to help the com- dent. In response, it implemented new measures such as stay-
pany reach its objectives. ing open 24 hours on Thanksgiving. The tragic occurrence
led other companies, such as Best Buy, to improve their safety
A major social responsibility for business is providing equal plans as well.54
opportunities for all employees regardless of their sex, age,
The right to be informed gives consumers the freedom to review
race, religion, or nationality. Women and minorities have
complete information about a product before they buy it. This
been slighted in the past in terms of education, employment,
means that detailed information about ingredients, risks, and
and advancement opportunities; additionally, many of their
instructions for use are to be printed on labels and packages. The
needs have not been addressed by business. For example, Out-
right to choose ensures that consumers have access to a variety
back Steakhouse agreed to pay nearly $1.9 million to settle a
of products and services at competitive prices. The assurance
class-action lawsuit that alleged sexual discrimination against
of both satisfactory quality and service at a fair price is also a
thousands of its female employees. The suit accused Outback
part of the consumer’s right to choose. Some consumers are not
of denying women the best job assignments, which prevented
being given this right. Many are being billed for products and
them from gaining the requisite experience to be eligible for
services they never ordered. According to the Federal Trade
upper-level management jobs.53 Women, who continue to bear
Commission, complaints about unordered merchandise and
most child-rearing responsibilities, often experience conflict
services jumped 169 percent over a two-year period. The right
between those responsibilities and their duties as employees.
to be heard assures consumers that their interests will receive
Consequently, day care has become a major employment issue
full and sympathetic consideration when the government for-
for women, and more companies are providing day care facili-
mulates policy. It also ensures the fair treatment of consumers
ties as part of their effort to recruit and advance women in the
who voice complaints about a purchased product.
workforce. In addition, companies are considering alternative
scheduling such as flex-time and job sharing to accommodate The role of the Federal Trade Commission’s Bureau of Con-
employee concerns. Telecommuting has grown significantly sumer Protection exists to protect consumers against unfair,

sustainability
conducting activities in
a way that allows for the
deceptive, or fraudulent practices.
long-term well-being of
the natural environment, The bureau, which enforces a vari-
including all biological ety of consumer protection laws,
entities. Sustainability is divided into five divisions. The
involves the assessment Division of Enforcement monitors
and improvement of legal compliance and investigates
business strategies, violations of laws, including unful-
economic sectors, work filled holiday delivery promises by
practices, technologies, online shopping sites, employment
and lifestyles so that they opportunities fraud, scholarship
maintain the health of the
scams, misleading advertising for
natural environment.
health care products, and more.
Sustainability Issues Most

people probably associate the term environment with nature,
including wildlife, trees, oceans, and mountains. Until the 20th
century, people generally thought of the environment solely in
terms of how these resources could be harnessed to satisfy their
needs for food, shelter, transportation, and recreation. As the
earth’s population swelled throughout the 20th century, how-
ever, humans began to use more and more of these resources
and, with technological advancements, to do so with ever-
greater efficiency. Although these conditions have resulted in
a much-improved standard of living, they come with a cost.
Plant and animal species, along with wildlife habitats, are dis-
appearing at an accelerated rate, while pollution has rendered
the atmosphere of some cities a gloomy haze. How to deal with
these issues has become a major concern for business and soci-
ety in the 21st century.
Although the scope of the word sustainability is broad,
in this book we discuss the term from a strategic business
perspective. Thus, we define sustainability as conducting
activities in such as way as to provide for the long-term well-
being of the natural environment, including all biological
entities. Sustainability involves the interaction among nature
and individuals, organizations, and business strategies and
includes the assessment and improvement of business strat-
egies, economic sectors, work practices, technologies, and
lifestyles, so that they maintain the health of the natural
environment. In recent years, business has played a signifi-
cant role in adapting, using, and maintaining the quality of
sustainability.
Environmental protection emerged as a major issue in the Home Depot has adopted eight core values as the foundation for its
20th century in the face of increasing evidence that pollu- ethical culture, including a strong emphasis on sustainability.
tion, uncontrolled use of natural resources, and population
growth were putting increasing pressure on the long-term
sustainability of these resources. Governments around the
union of businesses, consumer groups, environmentalists, and
globe responded with environmental protection laws during
other stakeholders—has established a set of goals for environ-
the 1970s. In recent years, companies have been increasingly
mental performance.
incorporating these issues into their overall business strategies.
Some nonprofit organizations have stepped forward to pro- In the following section, we examine some of the most signifi-
vide leadership in gaining the cooperation of diverse groups in cant sustainability and environmental health issues facing busi-
responsible environmental activities. For example, the Coali- ness and society today, including animal rights, pollution, and
tion for Environmentally Responsible Economies (CERES)—a alternative energy.

Pollution. Another major issue in the area of environmental other developing countries with large populations. The most
responsibility is pollution. Water pollution results from dump- important way to contain climate change is to control carbon
ing toxic chemicals and raw sewage into rivers and oceans, oil emissions. The move to green buildings, higher-mileage cars,
spills, and the burial of industrial waste in the ground where and other emissions reductions resulting from better efficiency
it may filter into underground water supplies. Fertilizers and have the potential to generate up to 50 percent of the reduc-
insecticides used in farming and grounds maintenance also tions needed to keep warming at no more than 28C above pres-
run off into water supplies with each rainfall. Water pollution ent temperatures—considered the “safe” level.55 The 2007 U.S.
problems are especially notable in heavily industrialized areas. Federal Energy bill raised average fuel economy (CAFE) stan-
Medical waste—such as used syringes, vials of blood, and HIV- dards to 35 mpg for cars by 2020, while Europe has the goal
contaminated materials—has turned up on beaches in New of a 40 mpg standard by the same deadline. Because buildings
York, New Jersey, and Massachusetts, as well as other places. create half of U.S. greenhouse emissions, there is tremendous
Society is demanding that water supplies be clean and healthful opportunity to develop conservation measures. For example,
to reduce the potential danger from these substances. some utilities charge more for electricity in peak demand peri-
ods, which encourages behavioral changes that reduce con-
Air pollution is usually the result of smoke and other pollutants
sumption. On the positive side, there are more than 100 million
emitted by manufacturing facilities, as well as carbon monox-
bicycles produced annually worldwide, more than double the
ide and hydrocarbons emitted by motor vehicles. In addition
passenger vehicles produced.56
to the health risks posed by air pollution, when some chemi-
cal compounds emitted by manufacturing facilities react with Land pollution is tied directly to water pollution because many
air and rain, acid rain results. Acid rain has contributed to the of the chemicals and toxic wastes that are dumped on the land
deaths of many forests and lakes in North America as well as eventually work their way into the water supply. A study con-
in Europe. Air pollution may also contribute to global warm- ducted by the Environmental Protection Agency found resi-
ing; as carbon dioxide collects in the earth’s atmosphere, it dues of prescription drugs, soaps, and other contaminants in
traps the sun’s heat and prevents the earth’s surface from cool- virtually every waterway in the United States. Effects of these
ing. It is indisputable that the global surface temperature has pollutants on humans and wildlife are uncertain, but there is
been increasing over the past 35 years. Worldwide passenger some evidence to suggest that fish and other water-dwellers are
vehicle ownership has been growing due to rapid industrial- starting to suffer serious effects.57 Land pollution results from
ization and consumer purchasing power in China, India, and the dumping of residential and industrial waste, strip mining,
BIO-PLASTICS ARE A These new bio-plastics are excellent commercial composting sites in the United
in theory, but they require commitment on States currently accept plastics.
GROWING BUSINESS, the part of consumers. Paper Mate’s new Consumer convenience is another prob-
BUT DO THEY LIVE UP biodegradable pens, made out of the more lem. Many consumers want to be environ-
expensive PHA, must have their internal mentally friendly, but only if it is convenient.
TO THE HYPE? ink filters removed before the outer case This was clearly revealed after SunChips
can be buried to biodegrade. PLA plastics discontinued its initial biodegradable bags
E nvironmental issues can be addressed

through alternatives such as bio-
plastics. For instance, regular plastic has
require composting, an activity that many
consumers do not currently do. Even con-
sumers that engage in composting might
because consumers were complaining that
the new bags were loud (SunChips has
since released quieter biodegradable bags).
several problems—it stays around forever, encounter difficulties. There are a num- Given all these stumbling blocks, will bio-
and it contains a compound which has ber of differences between commercial plastics really make much of a difference?58
recently been accused of releasing harmful composting and home-based compost-
chemicals into food products. As a result, ing. One lab conducted an experiment in Discussion Questions
companies are working to create plas- which four biodegradable plastic products 1. Do you think consumers will pay more for
tic that biodegrades (degrades naturally). were placed in both types of composting biodegradable packages?
Currently, two different types exist—both situations for 25 weeks. Of the four in the 2. What are the problems of trying to find
composed of fermented corn sugar. One is home-based compost, only one began to and use biodegradable products?
polylactic acid (PLA), which is 20 percent biodegrade, indicating that home compost
3. What are the consumer issues associ-
more expensive than regular plastic. The conditions are not right for many prod-
ated with biodegradable packaging and
other is known as PHA plastic, which is ucts. All but one did begin to break down
products?
twice as expensive as regular plastic. in the commercial setting, but very few

forest fires, and poor forest conservation. In Brazil and other which is between 10 and 20 percent of the total global usage
South American countries, rain forests are being destroyed— (estimated at 500 billion to 1 trillion bags).59 It takes 1,000 years
to make way for farms and ranches, at a cost of the extinction for the bags to decompose. San Francisco has banned plastic
of the many animals and plants (some endangered species) bags; Ireland is now charging a nationwide tax of 15 cents on all
that call the rain forest home. Large-scale deforestation also supermarket shopping bags; and Australia and China are plan-
depletes the oxygen supply available to humans and other ning a similar program.60 Whole Foods, the nation’s leading
animals. natural and organic supermarket, ended its use of plastic bags
on Earth Day 2008.61 Whole Foods estimates that this move
Related to the problem of land pollution is the larger issue of
will keep 150 million new plastic grocery bags out of the envi-
how to dispose of waste in an environmentally responsible
ronment each year.
manner. Americans use 100 billion plastic bags each year,
Alternative Energy. With ongoing plans to reduce global
carbon emissions, countries and companies alike are looking
toward alternative energy sources. Traditional fossil fuels are
problematic because of their emissions, but also because stores
have been greatly depleted. Foreign fossil fuels are often imported
from politically and economically unstable regions, often mak-
ing it unsafe to conduct business there. The United States
spends over $1 billion a day on foreign oil.62 With global warm-
ing concerns and rising gas prices, the U.S. government has
begun to recognize the need to look toward alternative forms
of energy as a source of fuel and electricity. There have been
many different ideas as to which form of alternative energy
would best suit the United States’ energy needs. These sources
include wind power, solar power, nuclear power, biofuels, elec-
tric cars, and hydro and geothermal power. As of yet, no “best”
form of alternative fuel has been selected to replace gasoline.
However, the U.S. government has begun to recognize the need
to reduce the nation’s dependence on fossil fuels. It allocated
billions of dollars toward renewable energy as part of Presi-
dent Obama’s stimulus package.63 Table 2.9 provides some facts
regarding energy consumption.
Response to Environmental Issues. Partly in response

to federal legislation such as the National Environmental Pol-
icy Act of 1969 and partly due to consumer concerns, busi-
nesses are responding to environmental issues. Many small
and large companies, including
Walt Disney Company, Chev-
ron, and Scott Paper, have cre-
ated a new executive position—a
vice president of environmental
affairs—to help them achieve
their business goals in an envi-
ronmentally responsible man-
ner. A survey indicated that 83.5
percent of Fortune 500 compa-
DID YOU KNOW? nies have a written environmen-
tal policy, 74.7 percent engage in
In one year, recycling efforts, and 69.7 per-
Americans generated cent have made investments in
230 million tons of waste-reduction efforts.64 Some
trash and recycled companies are finding that envi-
Wind power is growing in popularity as an alternative to traditional fuel 23.5 percent of it.65 ronmental consciousness can
sources. save them money. DuPont saved

more than $3 billion through energy con- T A B L E 2 . 9 Facts Related to Reducing Energy Consumption
servation by replacing natural gas with
• Keep your tires inflated at the recommended pressure. Not only is it safer, it can improve
methane in its industrial boilers in many your gas mileage by more than 3 percent.
of its plants.66
• The next time you buy a refrigerator, choose an ENERGY STAR model. If everyone buying
Many firms are trying to eliminate wasteful a new refrigerator chose an ENERGY STAR model, it could save 914 million kilowatt-hours
practices, the emission of pollutants, and/ of electricity and more than $101 million in energy bills each year.
or the use of harmful chemicals from their • Turn off your electronics when not in use. Stand-by power can account for up to
manufacturing processes. Other companies 20 percent of energy use in the home.
are seeking ways to improve their products. • Use ENERGY STAR CFL light bulbs. If every home in America replaced just one light
Utility providers, for example, are increas- bulb with a CFL bulb, it could save as much as 6 billion kilowatts a year. This would save
ingly supplementing their services with consumers more than $600 million in energy costs per year and reduce greenhouse gases
by the equivalent of almost 750,000 cars.
alternative energy sources, including solar,
wind, and geothermal power. Environmen- • More than 50 percent of energy used in American homes is used for space heating and
talists are concerned that some companies cooling. By properly sealing and insulating your attic, you can save up to 10 percent per
year on your energy bills.
are merely greenwashing, or “creating a
positive association with environmental Source: “Make Every Day Earth Day,” U.S. Department of Energy, www.energy.gov/energytips.htm
issues for an unsuitable product, service, or (accessed January 25, 2010).
practice.”
In many places, local utility customers can even elect to pur- products, packaging, and processes more environmentally
chase electricity from green sources—primarily wind power— friendly have been labeled “green” business or marketing by
for a few extra dollars a month. Austin Energy of Austin, Texas, the public and media. New Belgium, for instance, started sell-
has an award-winning GreenChoice program that includes ing aluminum cans of its beers because aluminum is easily
many small and large businesses among its customers.67 Indeed, recyclable and creates less waste. Lumber products at Home
a growing number of businesses and consumers are choosing Depot may carry a seal from the Forest Stewardship Council to
[ “Environmentalists are concerned that some companies are merely greenwashing, or ‘creating
a positive association with environmental issues for an unsuitable product, service, or practice.” ]
green power sources where available. New Belgium Brewing, indicate that they were harvested from sustainable forests using
the third-largest craft brewer in the United States, is the first all- environmentally friendly methods.68 Likewise, most Chiquita
wind-powered brewery in the country. Many businesses have bananas are certified through the Better Banana Project as hav-
turned to recycling, the reprocessing of materials—aluminum, ing been grown with more environmentally and labor-friendly
paper, glass, and some plastic—for reuse. Such efforts to make practices.69
MAJORA CARTER Founded by environmental advocate Majora her consulting firm, Carter now wants to
Carter, the organization serves as a consul- go even further. Currently, Majora Carter is
GROUP LLC BRINGS tancy for clients interested in creating sus- working to launch a national brand of locally
GREEN LIVING tainability and green job growth within their grown, fresh produce under a coopera-
communities. Majora Carter was inspired tive structure. She is testing the concept in
TO DISTRESSED several years ago to take action to bring Detroit, a city hit hard by the recent reces-
COMMUNITIES environmentally healthy practices to all sion and job loss. If Majora Carter has her
communities, not just those in upper-class way, distressed communities will be trans-
neighborhoods. The nonprofit organization formed into healthy areas offering opportu-
S adly, many polluting factories and waste
management facilities are located
in lower-income communities. Majora
she subsequently founded created a suc-
cessful urban green-collar job training and
nities for sustainability.70
Carter Group LLC wants to change all that. placement system in the South Bronx. With

It is important to recognize that, with current technology, envi- manner, to recycle as much of their own waste as possible, or
ronmental responsibility requires trade-offs. Society must weigh to permit the building of additional waste-disposal facilities
the huge costs of limiting or eliminating pollution against the (the “not in my backyard,” or NIMBY, syndrome). Managers
health threat posed by the pollution. Environmental responsi- must coordinate environmental goals with other social and
bility imposes costs on both business and the public. Although economic ones.
people certainly do not want oil fouling beautiful waterways and
killing wildlife, they insist on low-cost, readily available gasoline Community Relations A final, yet very significant, issue
and heating oil. People do not want to contribute to the grow- for businesses concerns their responsibilities to the general
ing garbage-disposal problem, but they often refuse to pay more welfare of the communities and societies in which they oper-
for “green” products packaged in an environmentally friendly ate. Many businesses simply want to make their communities
better places for everyone to live and work. The most common
way that businesses exercise their community responsibility is
through donations to local and national charitable organiza-
tions. Corporations contribute more than $14 billion each year
to charitable causes.71 For example, Safeway, the nation’s fourth-
largest grocer, has donated millions of dollars to organizations
involved in medical research, such as Easter Seals and the Juve-
nile Diabetes Research Foundation International. The compa-
ny’s employees have also raised funds to support social causes of
interest.72 Avon’s Breast Cancer Awareness Crusade has helped
raise $700 million for breast cancer programs worldwide. Avon,
a marketer of women’s cosmetics, is also known for employing
a large number of women and promoting them to top man-
agement; the firm has more female top managers (86 percent)
than any other Fortune 500 company.73 Even small companies
participate in philanthropy through donations and volunteer
support of local causes and national charities, such as the Red
Cross and the United Way.
After realizing that the current pool of prospective employ-
ees lacks many basic skills necessary to work, many compa-
nies have become concerned about the quality of education
in the United States. Recognizing that today’s students are
tomorrow’s employees and customers, firms such as Kroger,
Campbell Soup, Kodak, American Express, Apple, Xerox, and
Coca-Cola are donating money, equipment, and employee
time to help improve schools in their communities and
around the nation. They provide scholarship money, sup-
port for teachers, and computers for students, and they send
employees out to tutor and motivate young students to stay
in school and succeed. Target, for example, contributes sig-
nificant resources to education, including direct donations of
$100 million to schools as well as fund-raising and scholar-
ship programs that assist teachers and students. Through the
retailer’s Take Charge of Education program, customers using
a Target Guest Card can designate a specific school to which
Target donates 1 percent of their total purchase price. This
program is designed to make customers feel that their pur-
chases are benefiting their community while increasing the
use of Target Guest Cards.74
Another tactic taken by some companies is to let consumers
decide whether they want to contribute to socially responsible
activities. What if Dell sold one notebook computer for $1,000
and the same computer for $1,150, with the understanding
Many companies encourage their employees to volunteer for charitable that the purchase of this computer would support the fight
organizations such as Habitat for Humanity. against AIDS around the world? Dell and Microsoft created

products for the Product(Red) campaign, In addition to fostering self-support, such
joining other large corporations such as opportunities enhance self-esteem and help
The Gap, Apple, and Motorola in sup- TEAM EXERCISE people become productive members of
port of The Global Fund, an international Sam Walton, founder of Walmart, had society.
organization fighting AIDS, tuberculosis, an early strategy for growing his busi-
and malaria. The Product(Red) computer ness related to pricing. The “Opening Finally, another way that many businesses
sold by Dell is significant to consum- Price Point” strategy used by Walton are supporting philanthropy is through
involved offering the introductory prod- employee volunteerism programs. Sales-
ers and communicates their support to
uct in a product line at the lowest point force.com, for example, strongly emphasizes
others. in the market. For example, a minimally community service within its corporate cul-
equipped microwave oven would sell for
Business is also beginning to take more ture. Salesforce.com believes that the most
less than anyone else in town could sell
responsibility for the hard-core unem- the same unit. The strategy was that if
effective community service is through the
ployed. These are people who have never consumers saw a product, such as the donation of money, time, and product. To
had a job or who have been unemployed microwave, and saw it as a good value, encourage company employees to give of
for a long period of time. Some are men- they would assume that all of the micro- their time, Salesforce.com allows employees
tally or physically disabled; some are home- waves were good values. Walton also 1 percent time to volunteer in their commu-
less. Organizations such as the National noted that most people don’t buy the nities. Studies have indicated that company
Alliance of Businessmen fund programs entry-level product; they want more fea- support for employee volunteerism not only
to train the hard-core unemployed so that tures and capabilities and often trade up. benefits communities but tends to increase
they can find jobs and support themselves. Form teams and assign the role of employee morale as well.75 ■
defending this strategy or casting this
strategy as an unethical act. Present
your thoughts on either side of the issue.
SO YOU WANT A JOB // in Business Ethics and Social

Responsibility /
I n the words of Kermit the Frog, “It’s not
easy being green.” It may not be easy, but
green business opportunities abound. A popu-
to lead them. Carbon emissions’ trading is gain-
ing popularity as large corporations and indi-
viduals alike seek to lower their footprints. A job
about ethical issues; taking actions on possible
ethics code violations; and reviewing and modi-
fying the code of ethics of the organization.
lar catch phrase, “Green is the new black,” in this growing field could be similar to that of There are also opportunities to support initia-
indicates how fashionable green business is a stock trader, or you could lead the search for tives that help companies relate social responsi-
becoming. Consumers are more in tune with carbon-efficient companies in which to invest. bility to stakeholder interests and needs. These
and concerned about green products, policies, In the ethics arena, current trends in busi- jobs could involve coordinating and implement-
and behaviors by companies than ever before. ness governance strongly support the developing philanthropic programs that give back to oth-
Companies are looking for new hires to help ment of ethics and compliance departments to ers important to the organization or developing
them see their business creatively and bring help guide organizational integrity. This alone a community volunteering program for employ-
insights to all aspects of business operations. is a billion-dollar business, and there are jobs ees. In addition to the human relations function,
The American Solar Energy Society estimates in developing organizational ethics programs, most companies develop programs to assist
that the number of green jobs could rise to developing company policies, and training employees and their families to improve their
40 million in the United States by 2030. Green employees and management. An entry-level quality of life. Companies have found that the
business strategies not only give a firm a composition might be as a communication special- healthier and happier employees are, the more
mercial advantage in the marketplace, but help ist or trainer for programs in a business ethics productive they will be in the workforce.
lead the way toward a greener world. The fight department. Eventually there’s an opportunity to Social responsibility, ethics, and sustain-
to reduce our carbon footprint in an attempt become an ethics officer that would have typical able business practices are not a trend, they
against climate change has opened up opportu- responsibilities of meeting with employees, the are good for business and the bottom line. New
nities for renewable energy, recycling, conser- board of directors, and top management to dis- industries are being created and old ones are
vation, and increasing overall efficiency in the cuss and provide advice about ethics issues in adapting to the new market demands, opening
way resources are used. New businesses that the industry; developing and distributing a code up many varied job opportunities that will lead
focus on hydro, wind, and solar power are on of ethics; creating and maintaining an anony- to not only a paycheck, but to the satisfaction
the rise and will need talented businesspeople mous, confidential service to answer questions of making the world a better place.76

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chapter two
appendix
the legal and regulatory Business law refers to the rules and regulations that govern
the conduct of business. Problems in this area come from
the failure to keep promises, misunderstandings, disagree-
environment ments about expectations, or, in some cases, attempts to
take advantage of others. The regulatory environment
offers a framework and enforcement system in order to
provide a fair playing field for all businesses. The regulatory
environment is created based on inputs from competitors, customers, employees, special
interest groups, and the public’s elected representatives. Lobbying by pressure groups that
try to influence legislation often shapes the legal and regulatory environment.
SOURCES OF LAW
Laws are classified as either criminal or civil. Criminal law not only prohibits a specific
kind of action, such as unfair competition or mail fraud, but also imposes a fine or impris-
onment as punishment for violating the law. A violation of a criminal law is thus called
[ “The primary method of resolving conflicts and business disputes is through lawsuits,
where one individual or organization takes another to court using civil laws.” ]
a crime. Civil law defines all the laws not classified as criminal, and it
specifies the rights and duties of individuals and organizations (includ-
ing businesses). Violations of civil law may result in fines but not impris-
onment. The primary difference between criminal and civil law is that
criminal laws are enforced by the state or nation, whereas civil laws are
enforced through the court system by individuals or organizations.
Criminal and civil laws are derived from four sources: the Constitution
(constitutional law), precedents established by judges (common law),
federal and state statutes (statutory law), and federal and state admin-
istrative agencies (administrative law). Federal administrative agencies
established by Congress control and influence business by enforcing laws
and regulations to encourage competition and protect consumers, work-
ers, and the environment. The Supreme Court is the ultimate authority
on legal and regulatory decisions for appropriate conduct in business.
COURTS AND THE

Marcia and Bill Baker found Heinz was underfilling their 20-oz.
RESOLUTION OF DISPUTES
ketchup bottles by 1.5 oz. Heinz paid civil penalties and The primary method of resolving conflicts and business disputes is
costs of $180,000 and had to overfill all ketchup bottles in through lawsuits, where one individual or organization takes another
California by 1/8 oz. for a year. to court using civil laws. The legal system, therefore, provides a forum

for businesspeople to resolve disputes based on our legal foun- a case being appealed, it is not retried, but rather reevaluated.
dations. The courts may decide when harm or damage results Appellate judges do not hear witnesses but instead base their
from the actions of others. decisions on a written transcript of the original trial. Moreover,
appellate courts do not draw factual conclusions; the appel-
Because lawsuits are so frequent in the world of business, it is
late judge is limited to deciding whether the trial judge made
important to understand more about the court system where
a mistake in interpreting the law that probably affected the
such disputes are resolved. Both financial restitution and spe-
outcome of the trial. If the trial judge made no mistake (or if
cific actions to undo wrongdoing can result from going before
mistakes would not have changed the result of the trial), the
a court to resolve a conflict. All decisions made in the courts
appellate court will let the trial court’s decision stand. If the
are based on criminal and civil laws derived from the legal and
appellate court finds a mistake, it usually sends the case back to
regulatory system.
the trial court so that the mistake can be corrected. Correction
A businessperson may win a lawsuit in court and receive a judg- may involve the granting of a new trial. On occasion, appellate
ment, or court order, requiring the loser of the suit to pay mon- courts modify the verdict of the trial court without sending the
etary damages. However, this does not guarantee the victor will case back to the trial court.
be able to collect those damages. If the loser of the suit lacks the
financial resources to pay the judgment—for example, if the loser Alternative Dispute
is a bankrupt business—the winner of the suit may not be able to Resolution Methods
collect the award. Most business lawsuits involve a request for a
sum of money, but some lawsuits request that a court specifically Although the main remedy for business disputes is a lawsuit,
order a person or organization to do or to refrain from doing a other dispute resolution methods are becoming popular. The
certain act, such as slamming telephone customers. schedules of state and federal trial courts are often crowded;
long delays between the filing of a case and the trial date are
common. Further, complex cases can become quite expensive
The Court System to pursue. As a result, many businesspeople are turning to
Jurisdiction is the legal power of a court, through a judge, alternative methods of resolving business arguments: media-
to interpret and apply the law and make a binding decision tion and arbitration, the mini-trial, and litigation in a private
in a particular case. In some instances, other courts will not court.
enforce the decision of a prior court because it lacked juris-
Mediation is a form of negotiation to resolve a dispute by
diction. Federal courts are granted jurisdiction by the Con-
bringing in one or more third-party mediators, usually chosen
stitution or by Congress. State legislatures and constitutions
by the disputing parties, to help reach a settlement. The media-
determine which state courts hear certain types of cases.
tor suggests different ways to resolve a dispute between the
Courts of general jurisdiction hear all types of cases; those of
parties. The mediator’s resolution is nonbinding—that is, the
limited jurisdiction hear only specific types of cases. The Fed-
parties do not have to accept the mediator’s suggestions; they
eral Bankruptcy Court, for example, hears only cases involving
are strictly voluntary.
bankruptcy. There is some combination of limited and general
jurisdiction courts in every state. Arbitration involves submission of a dispute to one or more
third-party arbitrators, usually chosen by the disputing parties,
In a trial court (whether in a court of general or limited juris-
whose decision usually is final. Arbitration differs from media-
diction and whether in the state or the federal system), two
tion in that an arbitrator’s decision must be followed, whereas a
tasks must be completed. First, the court (acting through the
mediator merely offers suggestions and facilitates negotiations.
judge or a jury) must determine the facts of the case. In other
Cases may be submitted to arbitration because a contract—such
words, if there is conflicting evidence, the judge or jury must
as a labor contract—requires it or because the parties agree to
decide who to believe. Second, the judge must decide which law
do so. Some consumers are barred from taking claims to court
or set of laws is pertinent to the case and must then apply those
by agreements drafted by banks, brokers, health plans, and oth-
laws to resolve the dispute.
ers. Instead, they are required to take complaints to mandatory
An appellate court, on the other hand, deals solely with appeals arbitration. Arbitration can be an attractive alternative to a
relating to the interpretation of law. Thus, when you hear about lawsuit because it is often cheaper and quicker, and the parties

frequently can choose arbitrators who are knowledgeable about
the particular area of business at issue. REGULATORY
A method of dispute resolution that may become increas- ADMINISTRATIVE
ingly important in settling complex disputes is the mini-trial,
in which both parties agree to present a summarized version AGENCIES
of their case to an independent third party. That person then
advises them of his or her impression of the probable outcome Federal and state administrative agencies (listed in Table A.1)
if the case were to be tried. Representatives of both sides then also have some judicial powers. Many administrative agen-
attempt to negotiate a settlement based on the advisor’s rec- cies, such as the Federal Trade Commission, decide disputes
ommendations. For example, employees in a large corpora- that involve their regulations. In such disputes, the resolution
tion who believe they have muscular or skeletal stress injuries process is usually called a “hearing” rather than a trial. In these
caused by the strain of repetitive motion in using a computer cases, an administrative law judge decides all issues.
could agree to a mini-trial to address a dispute related to dam- Federal regulatory agencies influence many business activities
ages. Although the mini-trial itself does not resolve the dispute, and cover product liability, safety, and the regulation or dereg-
it can help the parties resolve the case before going to court. ulation of public utilities. Usually, these bodies have the power
Because the mini-trial is not subject to formal court rules, it can to enforce specific laws, such as the Federal Trade Commission
save companies a great deal of money, allowing them to recog- Act, and have some discretion in establishing operating rules
nize the weaknesses in a particular case. and regulations to guide certain types of industry practices.
Because of this discretion and overlapping areas of responsibil-
In some areas of the country, disputes can be submitted to a pri-
ity, confusion or conflict regarding which agencies have juris-
vate nongovernmental court for resolution. In a sense, a private
diction over which activities is common.
court system is similar to arbitration in that an independent third
party resolves the case after hearing both sides of the story. Trials Of all the federal regulatory units, the Federal Trade Com-
in private courts may be either informal or highly formal, depend- mission (FTC) most influences business activities related to
ing on the people involved. Businesses typically agree to have questionable practices that create disputes between businesses
their disputes decided in private courts to save time and money. and their customers. Although the FTC regulates a variety of
T A B L E A . 1 The Major Regulatory Agencies
Agency Major Areas of Responsibility

Federal Trade Commission (FTC) Enforces laws and guidelines regarding business practices; takes action to stop
false and deceptive advertising and labeling.
Food and Drug Administration (FDA) Enforces laws and regulations to prevent distribution of adulterated or misbranded
foods, drugs, medical devices, cosmetics, veterinary products, and particularly
hazardous consumer products.
Consumer Product Safety Commission (CPSC) Ensures compliance with the Consumer Product Safety Act; protects the public
from unreasonable risk of injury from any consumer product not covered by other
regulatory agencies.
Interstate Commerce Commission (ICC) Regulates franchises, rates, and finances of interstate rail, bus, truck, and water
carriers.
Federal Communications Commission (FCC) Regulates communication by wire, radio, and television in interstate and foreign
commerce.
Environmental Protection Agency (EPA) Develops and enforces environmental protection standards and conducts research
into the adverse effects of pollution.
Federal Energy Regulatory Commission (FERC) Regulates rates and sales of natural gas products, thereby affecting the supply and
price of gas available to consumers; also regulates wholesale rates for electricity and
gas, pipeline construction, and U.S. imports and exports of natural gas and electricity.
Equal Employment Opportunity Commission (EEOC) Investigates and resolves discrimination in employment practices.
Federal Aviation Administration (FAA) Oversees the policies and regulations of the airline industry.
Federal Highway Administration (FHA) Regulates vehicle safety requirements.
Occupational Safety and Health Administration (OSHA) Develops policy to promote worker safety and health and investigates infractions.
Securities and Exchange Commission (SEC) Regulates corporate securities trading and develops protection from fraud and
other abuses; provides an accounting oversight board.

OF ALL THE FEDERAL REGULATORY UNITS, THE
FEDERAL TRADE COMMISSION (FTC) MOST INFLUENCES
BUSINESS ACTIVITIES RELATED TO QUESTIONABLE
PRACTICES THAT CREATE DISPUTES BETWEEN BUSINESSES
AND THEIR CUSTOMERS.
business practices, it allocates a large portion of resources to The most notable of these issues was lead paint discovered in
curbing false advertising, misleading pricing, and deceptive toys produced in China. Other problems have included the
packaging and labeling. When it receives a complaint or other- manufacture of toys that include small magnets that pose a
wise has reason to believe that a firm is violating a law, the FTC choking hazard, and lead-tainted costume jewelry.77
issues a complaint stating that the business is in violation.
If a company continues the questionable practice, the FTC can

issue a cease-and-desist order, which is an order for the busi-
IMPORTANT ELEMENTS
ness to stop doing whatever has caused the complaint. In such
cases, the charged firm can appeal to the federal courts to have
OF BUSINESS LAW
the order rescinded. However, the FTC can seek civil penalties To avoid violating criminal and civil laws, as well as discourag-
in court—up to a maximum penalty of $10,000 a day for each ing lawsuits from consumers, employees, suppliers, and others,
infraction—if a cease-and-desist order is violated. In its battle businesspeople need to be familiar with laws that address busi-
against unfair pricing, the FTC has issued consent decrees ness practices.
alleging that corporate attempts to engage in price fixing or
invitations to competitors to collude are violations even when The Uniform Commercial Code
the competitors in question refuse the invitations. The com-
At one time, states had their own specific laws governing vari-
mission can also require companies to run corrective advertis-
ous business practices, and transacting business across state
ing in response to previous ads considered misleading.
lines was difficult because of the variation in the laws from state
The FTC also assists businesses in complying with laws. New mar- to state. To simplify commerce, every state—except Louisiana—
keting methods are evaluated every year. When general sets of has enacted the Uniform Commercial Code (Louisiana has
guidelines are needed to improve business practices in a particular enacted portions of the code). The Uniform Commercial Code
industry, the FTC sometimes encourages firms within that industry (UCC) is a set of statutory laws covering several business law
to establish a set of trade practices voluntarily. The FTC may even topics. Article II of the Uniform Commercial Code, which is
sponsor a conference bringing together industry leaders and con- discussed in the following paragraphs, has a significant impact
sumers for the purpose of establishing acceptable trade practices. on business.
Unlike the FTC, other regulatory units are limited to dealing
with specific products, services, or business activities. The Food
Sales Agreements Article II of the Uniform Commer-
cial Code covers sales agreements for goods and services such as
and Drug Administration (FDA) enforces regulations prohib-
installation but does not cover the sale of stocks and bonds, per-
iting the sale and distribution of adulterated, misbranded, or
sonal services, or real estate. Among its many provisions, Article II
hazardous food and drug products. For example, the FDA out-
stipulates that a sales agreement can be enforced even though it
lawed the sale and distribution of most over-the-counter hair-
does not specify the selling price or the time or place of delivery.
loss remedies after research indicated that few of the products
It also requires that a buyer pay a reasonable price for goods at
were effective in restoring hair growth.
the time of delivery if the buyer and seller have not reached an
The Environmental Protection Agency (EPA) develops and agreement on price. Specifically, Article II addresses the rights of
enforces environmental protection standards and conducts buyers and sellers, transfers of ownership, warranties, and the legal
research into the adverse effects of pollution. The Consumer placement of risk during manufacture and delivery.
Product Safety Commission (CPSC) recalls about 300 products
Article II also deals with express and implied warranties. An
a year, ranging from small, inexpensive toys to major appli-
express warranty stipulates the specific terms the seller will
ances. The commission’s website provides details regarding
honor. Many automobile manufacturers, for example, provide
current recalls.
three-year or 36,000-mile warranties on their vehicles, during
The CPSC has fallen under increasing scrutiny in the wake of which period they will fix any and all defects specified in the
a number of product safety scandals involving children’s toys. warranty. An implied warranty is imposed on the producer

or seller by law, although it may not be a written document T A B L E A . 2 State Court Systems’ Reputations for
provided at the time of sale. Under Article II, a consumer may Supporting Business
assume that the product for sale has a clear title (in other words, Most Friendly to Business Least Friendly to Business
that it is not stolen) and that the product will both serve the
purpose for which it was made and sold as well as function as Delaware Mississippi
advertised. Nebraska West Virginia
Virginia Alabama
The Law of Torts and Fraud Iowa Louisiana
A tort is a private or civil wrong other than breach of contract.
Idaho California
For example, a tort can result if the driver of a Domino’s Pizza
delivery car loses control of the vehicle and damages property Utah Texas
or injures a person. In the case of the delivery car accident, New Hampshire Illinois
the injured persons might sue the driver and the owner of the Minnesota Montana
company—Domino’s in this case—for damages resulting from Kansas Arkansas
the accident.
Wisconsin Missouri
Fraud is a purposeful unlawful act to deceive or manipulate in
order to damage others. Thus, in some cases, a tort may also Source: U.S. Chamber of Commerce Institute for Legal Reform, in Martin
represent a violation of criminal law. Health care fraud has Kasindorf, “Robin Hood Is Alive in Court, Say Those Seeking Lawsuit Limits,”
USA Today, March 8, 2004, p. 4A.
become a major issue in the courts.
An important aspect of tort law involves product liability— to comply with the terms of the contract. If you rent an apart-
businesses’ legal responsibility for any negligence in the design, ment or house, for example, your lease is a contract. If you have
production, sale, and consumption of products. Product liabil- borrowed money under a student loan program, you have a
ity laws have evolved from both common and statutory law. contractual agreement to repay the money. Many aspects of
Some states have expanded the concept of product liability contract law are covered under the Uniform Commercial Code.
to include injuries by products whether or not the producer
is proven negligent. Under this strict product liability, a con- A “handshake deal” is in most cases as fully and completely
sumer who files suit because of an injury has to prove only that binding as a written, signed contract agreement. Indeed, many
the product was defective, that the defect caused the injury, and oil-drilling and construction contractors have for years agreed
that the defect made the product unreasonably dangerous. For to take on projects on the basis of such handshake deals. How-
example, a carving knife is expected to be sharp and is not con- ever, individual states require that some contracts be in writing
sidered defective if you cut your finger using it. But an electric to be enforceable. Most states require that at least some of the
knife could be considered defective and unreasonably danger- following contracts be in writing:
ous if it continued to operate after being switched off. • Contracts involving the sale of land or an interest in land.
Reforming tort law, particularly in regard to product liability, • Contracts to pay somebody else’s debt.
has become a hot political issue as businesses look for relief
from huge judgments in lawsuits. Although many lawsuits • Contracts that cannot be fulfilled within one year.
are warranted—few would disagree that a wrong has occurred • Contracts for the sale of goods that cost more than $500
when a patient dies because of negligence during a medical pro- (required by the Uniform Commercial Code).
cedure or when a child is seriously injured by a defective toy,
Only those contracts that meet certain requirements—called
and that the families deserve some compensation—many suits
elements—are enforceable by the courts. A person or busi-
are not. Because of multimillion-dollar judgments, companies
ness seeking to enforce a contract must show that it contains
are trying to minimize their liability, and sometimes they pass
the following elements: voluntary agreement, consideration,
on the costs of the damage awards to their customers in the
contractual capacity of the parties, and legality.
form of higher prices. Some states have passed laws limiting
damage awards and some tort reform is occurring at the federal For any agreement to be considered a legal contract, all persons
level. Table A.2 lists the state court systems the U.S. Chamber of involved must agree to be bound by the terms of the contract.
Commerce’s Institute for Legal Reform has identified as being Voluntary agreement typically comes about when one party
“friendliest” and “least friendly” to business in terms of juries’ makes an offer and the other accepts. If both the offer and the
fairness, judges’ competence and impartiality, and other factors. acceptance are freely, voluntarily, and knowingly made, the
acceptance forms the basis for the contract. If, however, either
The Law of Contracts the offer or the acceptance are the result of fraud or force, the
Virtually every business transaction is carried out by means individual or organization subject to the fraud or force can
of a contract, a mutual agreement between two or more par- void, or invalidate, the resulting agreement or receive compen-
ties that can be enforced in a court if one party chooses not sation for damages.

The second requirement for enforcement of a contract is that it contract. The breaching party—the one who fails to comply—
must be supported by consideration—that is, money or some- may be liable for monetary damages that he or she causes the
thing of value must be given in return for fulfilling a contract. other person.
As a general rule, a person cannot be forced to abide by the
terms of a promise unless that person receives a consideration.
The something-of-value could be money, goods, services, or
The Law of Agency
even a promise to do or not to do something. An agency is a common business relationship created when
one person acts on behalf of another and under that person’s
Contractual capacity is the legal ability to enter into a contract. control. Two parties are involved in an agency relationship:
As a general rule, a court cannot enforce a contract if either The principal is the one who wishes to have a specific task
party to the agreement lacks contractual accomplished; the agent is the one who acts
capacity. A person’s contractual capacity on behalf of the principal to accomplish
may be limited or nonexistent if he or she An agency is the task. Authors, movie stars, and athletes
is a minor (under the age of 18), mentally often employ agents to help them obtain
unstable, retarded, insane, or intoxicated. a common business the best contract terms.
Legality is the state or condition of being relationship created An agency relationship is created by the
lawful. For an otherwise binding contract to mutual agreement of the principal and the
be enforceable, both the purpose of and the when one person agent. It is usually not necessary that such
consideration for the contract must be legal.
an agreement be in writing, although put-
A contract in which a bank loans money at acts on behalf of ting it in writing is certainly advisable. An
a rate of interest prohibited by law, a prac-
tice known as usury, would be an illegal another and under agency relationship continues as long as
both the principal and the agent so desire. It
contract, for example. The fact that one of that person’s can be terminated by mutual agreement, by
the parties may commit an illegal act while
fulfillment of the purpose of the agency, by
performing a contract does not render the control. the refusal of either party to continue in the
contract itself illegal, however.
relationship, or by the death of either the
Breach of contract is the failure or refusal of a party to a con- principal or the agent. In most cases, a principal grants author-
tract to live up to his or her promises. In the case of an apart- ity to the agent through a formal power of attorney, which is a
ment lease, failure to pay rent would be considered breach of legal document authorizing a person to act as someone else’s
PATENTS PROVIDE struggles to survive a late entrance into have raised the money it needs to survive
digital technology (the company has had as it restructures.
COMPETITIVE only one profitable year since 2004), it relies Although the company’s catalog of pat-
ADVANTAGE on patents—its source of intellectual prop- ents is expansive, some analysts worry that
erty income—to keep it afloat. Kodak is running out of opportunities to raise
FOR KODAK Over the past few years, Kodak has this type of money. Revenue without intellec-
sued a number of companies for patent tual property income continues to plummet,
I n the fierce world of business competi-

tion, patents offer companies a com-
petitive advantage over rivals. It is small
infringement in order to receive settle-
ment money. For example, the company
and shares keep falling. Can Kodak stretch
out its safety net long enough to create profit
sued Samsung Electronics Co., claiming in other areas of its business?78
wonder then that companies will defend that Samsung’s camera phone technol-
their patents so aggressively. A patent ogy infringed on two Kodak patents. Kodak Discussion Questions
secures an inventor’s exclusive rights to an received $550 million. The company also 1. Why are companies such as Kodak
invention for 20 years in the United States. sued LG Electronics for the same reason, awarded patents to protect their exclu-
Essentially, the company gets a temporary netting $400 million. Kodak is currently sive use of technology?
monopoly on the product, allowing it to reap locked in battle with Apple, each company 2. Why does Kodak have to sue companies
the profits. Once the patent expires, how- accusing the other of patent infringement. that infringe on its patents?
ever, anyone is free to copy the invention. In addition to lawsuits, the company has
Patenting an invention does not guarantee 3. What can Kodak do to make a profit if
negotiated licensing deals regarding its
success, but when one does succeed it can most of its patents expire?
patents. All in all, Kodak’s many patents
be highly profitable. As Eastman Kodak Co.

agent. The power of attorney can be used for any agency rela- their trademarks both to avoid confusion in consumers’ minds
tionship, and its use is not limited to lawyers. For instance, and because a term that becomes part of everyday language can
in real estate transactions, often a lawyer or real estate agent no longer be trademarked. The names aspirin and nylon, for
is given power of attorney with the authority to purchase real example, were once the exclusive property of their creators but
estate for the buyer. Accounting firms often give employees became so widely used as product names (rather than brand
agency relationships in making financial transactions. names) that now anyone can use them.
Both officers and directors of corporations are fiduciaries, or As the trend toward globalization of trade continues, and more
people of trust, who use due care and loyalty as an agent in and more businesses trade across national boundaries, protect-
making decisions on behalf of the organization. This relation- ing property rights, particularly intellectual property such as
ship creates a duty of care, also called duty of diligence, to make computer software, has become an increasing challenge. While
informed decisions. These agents of the corporation are not a company may be able to register as a trademark a brand name
held responsible for negative outcomes if they are informed or symbol in its home country, it may not be able to secure that
and diligent in their decisions. The duty of loyalty means that protection abroad. Some countries have copyright and patent
all decisions should be in the interests of the corporation and its laws that are less strict than those of the United States; some
stakeholders. Many people believe that executives at financial countries will not enforce U.S. laws. China, for example, has
firms such as Countrywide Financial, Lehman Brothers, and often been criticized for permitting U.S. goods to be counter-
Merrill Lynch failed to carry out their fiduciary duties. Lawsuits feited there. Such counterfeiting harms not only the sales of
from shareholders called for the officers and directors to pay U.S. companies but also their reputations if the knockoffs are
large sums of money from their own pockets. of poor quality. Thus, businesses engaging in foreign trade may
have to take extra steps to protect their property because local
The Law of Property laws may be insufficient to protect them.
Property law is extremely broad in scope because it covers the
ownership and transfer of all kinds of real, personal, and intel- The Law of Bankruptcy
lectual property. Real property consists of real estate and every- Although few businesses and individuals intentionally fail to
thing permanently attached to it; personal property basically repay (or default on) their debts, sometimes they cannot ful-
is everything else. Personal property can be further subdivided fill their financial obligations. Individuals may charge goods
into tangible and intangible property. Tangible property refers and services beyond their ability to pay for them. Businesses
to items that have a physical existence, such as automobiles, may take on too much debt in order to finance growth or busi-
business inventory, and clothing. Intangible property consists ness events such as an increase in the cost of commodities.
of rights and duties; its existence may be represented by a docu- An option of last resort in these cases is bankruptcy, or legal
ment or by some other tangible item. For example, accounts insolvency. The recent financial crisis caused a number of well-
receivable, stock in a corporation, goodwill, and trademarks known companies to declare bankruptcy, including Six Flags,
are all examples of intangible personal property. Intellectual
Chrysler, Eddie Bauer, and Circuit City. While some of these
property refers to property, such as musical works, artwork,
companies managed to negotiate deals with their creditors or
books, and computer software, that is generated by a person’s received a government bailout, the electronics retailer Circuit
creative activities. City had no such luck. The company was forced to liquidate all
Copyrights, patents, and trademarks provide protection to the its U.S. stores.79
owners of property by giving them the exclusive right to use
Individuals or companies may ask a bankruptcy court to
it. Copyrights protect the ownership rights on material (often
declare them unable to pay their debts and thus release them
intellectual property) such as books, music, videos, photos, and
from the obligation of repaying those debts. The debtor’s
computer software. The creators of such works, or their heirs,
assets may then be sold to pay off as much of the debt as pos-
generally have exclusive rights to the published or unpublished
sible. In the case of a personal bankruptcy, although the indi-
works for the creator’s lifetime, plus 50 years. Patents give
vidual is released from repaying debts and can start over with
inventors exclusive rights to their invention for 20 years. The
a clean slate, obtaining credit after bankruptcy proceedings
most intense competition for patents is in the pharmaceutical
is very difficult. About 2 million households in the United
industry. Most patents take a minimum of 18 months to secure.
States filed for bankruptcy in 2005, the most ever. However, a
A trademark is a brand (name, mark, or symbol) that is regis- new, more restrictive law went into effect in late 2005, allow-
tered with the U.S. Patent and Trademark Office and is thus ing fewer consumers to use bankruptcy to eliminate their
legally protected from use by any other firm. Among the sym- debts. The law makes it harder for consumers to prove that
bols that have been so protected are McDonald’s golden arches they should be allowed to clear their debts for what is called a
and Coca-Cola’s distinctive bottle shape. It is estimated that “fresh start” or Chapter 7 bankruptcy. The number of Ameri-
large multinational firms may have as many as 15,000 conflicts cans filing personal bankruptcy reached 1.53 million in 2010,
related to trademarks. Companies are diligent about protecting up 9 percent from 2009. This is the highest level since the 2005

T A B L E A . 3 Types of Bankruptcy
Chapter 7 Requires that the business be dissolved and its assets liquidated, or sold, to pay off the debts. Individuals declaring
Chapter 7 retain a limited amount of exempt assets, the amount of which may be determined by state or federal law, at the
debtor’s option. Although the type and value of exempt assets varies from state to state, most states’ laws allow a bankrupt
individual to keep an automobile, some household goods, clothing, furnishings, and at least some of the value of the debtor’s
residence. All nonexempt assets must be sold to pay debts.
Chapter 11 Temporarily frees a business from its financial obligations while it reorganizes and works out a payment plan with its
creditors. The indebted company continues to operate its business during bankruptcy proceedings. Often, the business sells
off assets and less-profitable subsidiaries to raise cash to pay off its immediate obligations.
Chapter 13 Similar to Chapter 11 but limited to individuals. This proceeding allows an individual to establish a three- to five-year plan for
repaying his or her debt. Under this plan, an individual ultimately may repay as little as 10 percent of his or her debt.
law was implemented.80 Although the person or company in it was forming with Yahoo!. The deal allowed Google to sell
debt usually initiates bankruptcy proceedings, creditors may and place advertisements on Yahoo!’s Web pages for a share
also initiate them. The subprime mortgage crisis of early 2008 in the revenue. Authorities felt this would give Google too
caused a string of bankruptcies among individuals, Chapter much power that could enable it to gain monopolistic control
7 and 11 bankruptcies among banks, and other businesses over online advertising. Increased pressure caused Google
as well. Tougher bankruptcy laws and a slowing economy and Yahoo! to delay the alliance.81 The Sherman Antitrust
converged on the subprime crisis to create a situation where Act, still highly relevant 100 years after its passage, is being
bankruptcy filings skyrocketed. Table A.3 describes the vari- copied throughout the world as the basis for regulating fair
ous levels of bankruptcy protection a business or individual competition.
may seek.
Because the provisions of the Sherman Antitrust Act are
rather vague, courts have not always interpreted it as its cre-
LAWS AFFECTING ators intended. The Clayton Act was passed in 1914 to limit
specific activities that can reduce competition. The Clayton
BUSINESS PRACTICES Act prohibits price discrimination, tying and exclusive agree-
ments, and the acquisition of stock in another corporation
One of the government’s many roles is to act as a watchdog to where the effect may be to substantially lessen competition
ensure that businesses behave in accordance with the wishes of or tend to create a monopoly. In addition, the Clayton Act
society. Congress has enacted a number of laws that affect busi- prohibits members of one company’s board of directors from
ness practices; some of the most important of these are summa- holding seats on the boards of competing corporations. The
rized in Table A.4. Many state legislatures have enacted similar act also exempts farm cooperatives and labor organizations
laws governing business within specific states. from antitrust laws.
The Sherman Antitrust Act, passed in 1890 to prevent busi- In spite of these laws regulating business practices, there
nesses from restraining trade and monopolizing markets, are still many questions about the regulation of business.
condemns “every contract, combination, or conspiracy in For instance, it is difficult to determine what constitutes an
restraint of trade.” For example, a request that a competi- acceptable degree of competition and whether a monopoly is
tor agree to fix prices or divide markets would, if accepted, harmful to a particular market. Many mergers were permit-
result in a violation of the Sherman Act. The search engine ted that resulted in less competition in the banking, publish-
Google has faced increased attention from antitrust authori- ing, and automobile industries. In some industries, such as
ties. In 2009, antitrust authorities were investigating a settle- utilities, it is not cost-effective to have too many competitors.
ment Google had reached with the Author’s Guild and the For this reason, the government permits utility monopolies,
Association of American Publishers. The $125 million settle- although recently, the telephone, electricity, and communi-
ment would give Google the ability to scan millions of books cations industries have been deregulated. Furthermore, the
into what will be known as the Google Book Search service. antitrust laws are often rather vague and require interpreta-
The Department of Justice thought this settlement might give tion, which may vary from judge to judge and court to court.
Google too much control, particularly over the distribution Thus, what one judge defines as a monopoly or trust today
and pricing of certain books. It began investigating whether may be permitted by another judge a few years from now.
Google was breaking any antitrust laws. This was not the Businesspeople need to understand what the law says on these
first time Google was investigated for antitrust violations. A issues and try to conduct their affairs within the bounds of
year earlier, Google had been investigated for a partnership these laws.

T A B L E A . 4 Major Federal Laws Affecting Business Practices
Act (Date Enacted) Purpose

Sherman Antitrust Act (1890) Prohibits contracts, combinations, or conspiracies to restrain trade; establishes as a
misdemeanor monopolizing or attempting to monopolize.
Clayton Act (1914) Prohibits specific practices such as price discrimination, exclusive dealer
arrangements, and stock acquisitions in which the effect may notably lessen
competition or tend to create a monopoly.
Federal Trade Commission Act (1914) Created the Federal Trade Commission; also gives the FTC investigatory powers to be
used in preventing unfair methods of competition.
Robinson-Patman Act (1936) Prohibits price discrimination that lessens competition among wholesalers or
retailers; prohibits producers from giving disproportionate services of facilities to
large buyers.
Wheeler-Lea Act (1938) Prohibits unfair and deceptive acts and practices regardless of whether competition
is injured; places advertising of foods and drugs under the jurisdiction of the FTC.
Lanham Act (1946) Provides protections and regulation of brand names, brand marks, trade names, and
trademarks.
Celler–Kefauver Act (1950) Prohibits any corporation engaged in commerce from acquiring the whole or any
part of the stock or other share of the capital assets of another corporation when the
effect substantially lessens competition or tends to create a monopoly.
Fair Packaging and Labeling Act (1966) Makes illegal the unfair or deceptive packaging or labeling of consumer products.
Magnuson-Moss Warranty (FTC) Act (1975) Provides for minimum disclosure standards for written consumer product warranties;
defines minimum consent standards for written warranties; allows the FTC to
prescribe interpretive rules in policy statements regarding unfair or deceptive
practices.
Consumer Goods Pricing Act (1975) Prohibits the use of price maintenance agreements among manufacturers and
resellers in interstate commerce.
Antitrust Improvements Act (1976) Requires large corporations to inform federal regulators of prospective mergers or
acquisitions so that they can be studied for any possible violations of the law.
Trademark Counterfeiting Act (1980) Provides civil and criminal penalties against those who deal in counterfeit consumer
goods or any counterfeit goods that can threaten health or safety.
Trademark Law Revision Act (1988) Amends the Lanham Act to allow brands not yet introduced to be protected through
registration with the Patent and Trademark Office.
Nutrition Labeling and Education Act (1990) Prohibits exaggerated health claims and requires all processed foods to contain
labels with nutritional information.
Telephone Consumer Protection Act (1991) Establishes procedures to avoid unwanted telephone solicitations; prohibits marketers
from using automated telephone dialing system or an artificial or prerecorded voice to
certain telephone lines.
Federal Trademark Dilution Act (1995) Provides trademark owners the right to protect trademarks and requires
relinquishment of names that match or parallel existing trademarks.
Digital Millennium Copyright Act (1998) Refined copyright laws to protect digital versions of copyrighted materials, including
music and movies.
Children’s Online Privacy Protection Act (2000) Regulates the collection of personally identifiable information (name, address, e-mail
address, hobbies, interests, or information collected through cookies) online from
children under age 13.
Sarbanes–Oxley Act (2002) Made securities fraud a criminal offense; stiffened penalties for corporate fraud;
created an accounting oversight board; and instituted numerous other provisions
designed to increase corporate transparency and compliance.
Do Not Call Implementation Act (2003) Directs FCC and FTC to coordinate so their rules are consistent regarding
telemarketing call practices, including the Do Not Call Registry.
Dodd–Frank Wall Street Reform and Consumer Increases accountability and transparency in the financial industry, protects
Protection Act (2010) consumers from deceptive financial practices, and establishes the Bureau of
Consumer Financial Protection.

OUR USE AND DEPENDENCE ON THE INTERNET
IS INCREASINGLY CREATING A POTENTIAL LEGAL
PROBLEM FOR BUSINESSES.
THE INTERNET: LEGAL
AND REGULATORY ISSUES
Our use and dependence on the Internet is increasingly creat-
ing a potential legal problem for businesses. With this grow-
ing use come questions of maintaining an acceptable level
of privacy for consumers and proper competitive use of the
medium. Some might consider that tracking individuals who
visit or “hit” their website by attaching a “cookie” (identifying
you as a website visitor for potential recontact and tracking
your movement throughout the site) is an improper use of the
Internet for business purposes. Others may find such practices
acceptable and similar to the practices of non-Internet retail-
Whether you like it or not, Google, like Yahoo! and AOL, tracks people’s
ers who copy information from checks or ask customers for
Web browsing patterns. By tracking the sites you visit, the companies’
their name, address, or phone number before they will process
advertisers can aim ads targeted closer to your interests.
a transaction. There are few specific laws that regulate busi-
ness on the Internet, but the standards for acceptable behavior
that are reflected in the basic laws and regulations designed
personal data as property will ensure privacy rights by recog-
for traditional businesses can be applied to business on the
nizing that customers have a right to control the use of their
Internet as well. One law aimed specifically at advertising on
personal data.
the Internet is the CAN-SPAM Act of 2004. The law restricts
unsolicited e-mail advertisements by requiring the consent of Internet use is different from traditional interaction with busi-
the recipient. Furthermore, the CAN-SPAM Act follows the nesses in that it is readily accessible, and most online businesses
“opt-out” model wherein recipients can elect to not receive are able to develop databases of information on customers.
further e-mails from a sender simply by clicking on a link.82 Congress has restricted the development of databases on chil-
dren using the Internet. The Children’s Online Privacy Protec-
The central focus for future legislation of business conducted
tion Act of 2000 prohibits websites and Internet providers from
on the Internet is the protection of personal privacy. The pres-
seeking personal information from children under age 13 with-
ent basis of personal privacy protection is the U.S. Constitu-
out parental consent.
tion, various Supreme Court rulings, and laws such as the
1971 Fair Credit Reporting Act, the 1978 Right to Financial The Internet has also created a copyright dilemma for some
Privacy Act, and the 1974 Privacy Act, which deals with the organizations that have found that the Web addresses of other
release of government records. With few regulations on the online firms either match or are very similar to their company
use of information by businesses, companies legally buy and trademark. “Cybersquatters” attempt to sell back the registra-
sell information on customers to gain competitive advantage. tion of these matching sites to the trademark owner. Compa-
Sometimes existing laws are not enough to protect people, nies such as Taco Bell, MTC, and KFC have paid thousands of
and the ease with which information on customers can be dollars to gain control of domain names that match or parallel
obtained becomes a problem. For example, identity theft has company trademarks. The Federal Trademark Dilution Act of
increased due to the proliferation of the use of the Internet. 1995 helps companies address this conflict. The act provides
In 2009, it was estimated that data and security breaches cost trademark owners the right to protect trademarks, prevents
organizations more than $6 million on average each time they the use of trademark-protected entities, and requires the relin-
occurred. Some of the more common security breaches (and quishment of names that match or closely parallel company
most disturbing) occur at universities, banks, and insurance trademarks. The reduction of geographic barriers, speed of
companies. Another concern is companies that use informa- response, and memory capability of the Internet will continue
tion from online consumers without the person’s knowledge to create new challenges for the legal and regulatory environ-
or permission.83 It has been suggested that the treatment of ment in the future.

LEGAL PRESSURE If an organization’s culture and policies reward or provide
opportunities to engage in misconduct through lack of mana-
FOR RESPONSIBLE gerial concern or failure to comply with the seven minimum
requirements of the FSGO (provided in Table A.5), then the
BUSINESS CONDUCT organization may incur not only penalties but also the loss of
customer trust, public confidence, and other intangible assets.
To ensure greater compliance with society’s desires, both federal For this reason, organizations cannot succeed solely through a
and state governments are moving toward increased organiza- legalistic approach to compliance with the sentencing guide-
tional accountability for misconduct. Before 1991, laws mainly lines; top management must cultivate high ethical standards
punished those employees directly responsible for an offense. that will serve as barriers to illegal conduct. The organiza-
Under new guidelines established by the Federal Sentencing tion must want to be a good citizen and recognize the impor-
Guidelines for Organizations (FSGO), however, both the respon- tance of compliance to successful workplace activities and
sible employees and the firms that employ them are held account- relationships.
able for violations of federal law. Thus, the government now
places responsibility for controlling and preventing misconduct The federal guidelines also require businesses to develop pro-
squarely on the shoulders of top management. The main objec- grams that can detect—and that will deter employees from
tives of the federal guidelines are to train employees, self-monitor engaging in—misconduct. To be considered effective, such
and supervise employee conduct, deter unethical acts, and pun- compliance programs must include disclosure of any wrong-
ish those organizational members who engage in illegal acts. doing, cooperation with the government, and acceptance of
[ “To ensure greater compliance with society’s desires, both federal and
state governments are moving toward increased organizational
accountability for misconduct.”
A 2004 amendment to the FSGO requires that a business’s

]
responsibility for the misconduct. Codes of ethics, employee
governing authority be well informed about its ethics program ethics training, hotlines (direct 800 phone numbers), compli-
with respect to content, implementation, and effectiveness. ance directors, newsletters, brochures, and other communica-
This places the responsibility squarely on the shoulders of the tion methods are typical components of a compliance program.
firm’s leadership, usually the board of directors. The board The ethics component, discussed in Chapter 2, acts as a buffer,
must ensure that there is a high-ranking manager accountable keeping firms away from the thin line that separates unethical
for the day-to-day operational oversight of the ethics program. and illegal conduct.
The board must provide for adequate authority, resources,
and access to the board or an appropriate subcommittee of Despite the existing legislation, a number of ethics scandals in
the board. The board must ensure that there are confidential the early 2000s led Congress to pass—almost unanimously—
mechanisms available so that the organization’s employees and the Sarbanes–Oxley Act, which criminalized securities fraud
agents may report or seek guidance about potential or actual and strengthened penalties for corporate fraud. It also created
misconduct without fear of retaliation. Finally, the board is an accounting oversight board that requires corporations to
required to oversee the discovery of risks and to design, imple- establish codes of ethics for financial reporting and to develop
ment, and modify approaches to deal with those risks. greater transparency in financial reports to investors and other
T A B L E A . 5 Seven Steps to Compliance
1. Develop standards and procedures to reduce the propensity for criminal conduct.
2. Designate a high-level compliance manager or ethics officer to oversee the compliance program.
3. Avoid delegating authority to people known to have a propensity to engage in misconduct.
4. Communicate standards and procedures to employees, other agents, and independent contractors through training programs
and publications.
5. Establish systems to monitor and audit misconduct and to allow employees and agents to report criminal activity.
6. Enforce standards and punishments consistently across all employees in the organization.
7. Respond immediately to misconduct and take reasonable steps to prevent further criminal conduct.
Source: United States Sentencing Commission, Federal Sentencing Guidelines for Organizations, 1991.

interested parties. Additionally, the law requires top corporate Some companies such as Cisco and Pitney Bowes report
executives to sign off on their firms’ financial reports, and they improved efficiency and cost savings from better financial
risk fines and jail sentences if they misrep- information.
resent their companies’ financial position.
In spite of the benefits Sarbanes–Oxley offers,
Table A.6 summarizes the major provisions
it did not prevent widespread corporate
of the Sarbanes–Oxley Act. In spite corruption from leading to the most recent
The Sarbanes–Oxley Act has created a recession. The resulting financial crisis
number of concerns and is considered
of the benefits prompted the Obama administration to cre-
burdensome and expensive to corpora- Sarbanes–Oxley ate new regulation to reform Wall Street and
tions. Large corporations report spending the financial industry. In 2010, the Dodd–
more than $4 million each year to comply offers, it did not Frank Wall Street Reform and Consumer
with the Act according to Financial Execu- Protection Act was passed. In addition to
tives International. The Act has caused prevent widespread new regulations for financial institutions,
more than 500 public companies a year to the legislation created a Consumer Finan-
report problems in their accounting sys-
corporate corruption cial Protection Bureau to protect consumers
tems. Additionally, Sarbanes-Oxley failed from leading to from complex or deceptive financial prod-
to prevent and detect the widespread mis- ucts. Table A.7 highlights some of the major
conduct of financial institutions that led the most recent provisions of the Dodd–Frank Act.
to the financial crisis. This means that the
overwhelming majority of businesses are recession. The Dodd–Frank Act contains 16 titles
meant to increase consumer protection,
in compliance with the law.
enhance transparency and accountability in
On the other hand, there are many benefits, including greater the financial sector, and create new financial agencies. In some
accountability of top managers and boards of directors, that ways, Dodd–Frank is attempting to improve upon provisions
improve investor confidence and protect employees, especially laid out in the Sarbanes–Oxley Act. For instance, Dodd–Frank
their retirement plans. It is believed that the law has more takes whistleblower protection a step further by offering addi-
benefits than drawbacks—with the greatest benefit being that tional incentives to whistleblowers for reporting misconduct.
boards of directors and top managers are better informed. If whistleblowers report misconduct that results in penalties of
T A B L E A . 6 Major Provisions of the Sarbanes-Oxley Act
1. Requires the establishment of a Public Company Accounting Oversight Board in charge of regulations administered by the Securities
and Exchange Commission.
2. Requires CEOs and CFOs to certify that their companies’ financial statements are true and without misleading statements.
3. Requires that corporate boards of directors’ audit committees consist of independent members who have no material interests in the
company.
4. Prohibits corporations from making or offering loans to officers and board members.
5. Requires codes of ethics for senior financial officers; code must be registered with the SEC.
6. Prohibits accounting firms from providing both auditing and consulting services to the same client without the approval of the client firm’s
audit committee.
7. Requires company attorneys to report wrongdoing to top managers and, if necessary, to the board of directors; if managers and directors
fail to respond to reports of wrongdoing, the attorney should stop representing the company.
8. Mandates “whistleblower protection” for persons who disclose wrongdoing to authorities.
9. Requires financial securities analysts to certify that their recommendations are based on objective reports.
10. Requires mutual fund managers to disclose how they vote shareholder proxies, giving investors information about how their shares
influence decisions.
11. Establishes a 10-year penalty for mail/wire fraud.
12. Prohibits the two senior auditors from working on a corporation’s account for more than five years; other auditors are prohibited from
working on an account for more than seven years. In other words, accounting firms must rotate individual auditors from one account to
another from time to time.
Source: O. C. Ferrell, John Fraedrich, and Linda Ferrell, Business Ethics: Ethical Decision Making and Cases, 8th ed. (Mason, OH: South-Western Cengage Learning,
2011), pp. 108–109.

T A B L E A . 7 Major Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act
1. Enhances stability of the finance industry through the creation of two new financial agencies, the Financial Oversight Stability Council
and the Office of Financial Research.
2. Institutes an orderly liquidation procedure for the Federal Deposit Insurance Corporation to liquidate failing companies.
3. Eliminates the Office of Thrift Supervision and transfers its powers to the Comptroller of the Currency.
4. Creates stronger regulation and greater oversight of hedge funds.
5. Establishes the Federal Insurance Agency to gather information and oversee the insurance industry for risks.
6. Requires regulators to have regulations in place for banks. Also prohibits and/or limits proprietary trading, hedge fund sponsorship and
private equity funds, and relationships with hedge funds and private equity funds.
7. Regulates derivatives and complex financial instruments by limiting where they can be traded and ensuring that traders have the financial
resources to meet their responsibilities.
8. Provides a framework for creating risk-management standards for financial market utilities and the payment, clearing, and settlement
activities performed by institutions.
9. Improves investor protection through acts such as creating a whistle-blower bounty program and increasing consumer access to their
credit scores.
10. Institutes the Bureau of Consumer Financial Protection to educate consumers and protect them from deceptive financial products.
11. Attempts to reform the Federal Reserve in ways that include limiting the Federal Reserve’s lending authority, re-evaluating methods for
Federal Reserve regulations and the appointment of Federal Reserve Bank directors, and instituting additional disclosure requirements.
12. Reforms mortgage activities with new provisions that include increasing the lender’s responsibility to ensure the borrower can pay back
the loan, prohibiting unfair lending practices, requiring additional disclosure in the mortgage loan process, and imposing penalties against
those found guilty of noncompliance with the new standards.
Source: Brief Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act, http://banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_
Street_Reform_comprehensive_summary_Final.pdf
over $1 million, the whistleblower will be entitled to a percentage Research, and the Financial Stability Oversight Council. While
of the settlement.84 Another provision, the Durbin Amendment, the CFPB was passed to protect consumers, the other two
limits the swipe fees that debit card issuers are allowed to charge agencies work to maintain stability in the financial industry
merchants.85 Additionally, complex financial instruments must so such a crisis will not reoccur in the future.86 Although it
now be made more transparent so that consumers will have a is too early to tell whether these regulations will serve to cre-
better understanding of what these instruments involve. ate wide-scale positive financial reform, the Dodd-Frank Act
is certainly leading to major changes on Wall Street and in the
The Act also created three new agencies: the Consumer financial sector. ■
Financial Protection Bureau (CFPB), the Office of Financial

three

business in a
borderless world
onsumers around the world products. Today, the nearly 7 billion
C
introduction
can drink Coca-Cola and people who inhabit the earth comprise
Pepsi; eat at McDonald’s and one tremendous marketplace.
Pizza Hut; see movies from Mexico, In this chapter, we explore busi-
England, France, Australia, and China; ness in this exciting global market-
and watch CNN and MTV on Samsung place. First, we look at the nature of
and Panasonic televisions. It may international business, including bar-
surprise you that the Japanese firm riers and promoters of trade across
Komatsu sells earth-moving equip- international boundaries. Next, we
ment to China that is manufactured consider the levels of organizational
in Peoria, Illinois.1 The products you involvement in international business.
consume today are just as likely to Finally, we briefly discuss strategies
have been made in China, Korea, for trading across national borders.
or Germany as in the United States.
LEARNING OBJECTIVES
Likewise, consumers in other coun-
LO1 Explore some of the factors within
tries buy Western electrical equip- the international trade environment
ment, clothing, rock music, cosmetics, that influence business.
LO2 Investigate some of the economic,
and toiletries, as well as computers,
legal-political, social, cultural,
robots, and earth-moving equipment. and technological barriers to
international business.
Many U.S. firms are finding that LO3 Specify some of the agreements,
international markets provide tre- alliances, and organizations
that may encourage trade across
mendous opportunities for growth. international boundaries.
Accessing these markets can pro- LO4 Summarize the different levels
mote innovation, while intensifying of organizational involvement in
international trade.
global competition spurs companies
LO5 Contrast two basic strategies used
to market better and less expensive in international business.
CHAPTER 3 | Business in a Borderless World 61

international absolute advantage comparative outsourcing exporting the sale
business the buying, a monopoly that exists advantage the basis the transferring of of goods and services to
selling, and trading of when a country is the only of most international trade, manufacturing or other foreign markets
goods and services across source of an item, the only when a country specializes tasks—such as data
national boundaries producer of an item, or the in products that it can processing—to countries
most efficient producer of supply more efficiently or where labor and supplies
an item at a lower cost than it can are less expensive
produce other items
brand with the needs of local consumers.6 To

THE ROLE OF begin our study of international business, we
INTERNATIONAL must first consider some economic issues: why

nations trade, exporting and importing, and the
BUSINESS balance of trade.
International business refers to the buy-

ing, selling, and trading of goods and services Why Nations Trade
across national boundaries. Falling political Nations and businesses engage in interna-
barriers and new technology are making it pos- DID YOU KNOW?
tional trade to obtain raw materials and goods
sible for more and more companies to sell their Subway has that are otherwise unavailable to them or are
products overseas as well as at home. And, as available elsewhere at a lower price than that
surpassed McDonald’s
differences among nations continue to narrow, at which they themselves can produce. A
the trend toward the globalization of business as the largest global
nation, or individuals and organizations from
is becoming increasingly important. Starbucks, restaurant chain with a nation, sell surplus materials and goods to
for example, serves 60 million customers a week over 33,000 units.2 acquire funds to buy the goods, services, and
at 17,000 locations in 55 countries.3 The Inter- ideas its people need. Poland and Hungary, for
net provides many companies easier entry to example, want to trade with Western nations
access global markets than opening brick-and-mortar stores.4 so that they can acquire new technology and techniques to
Amazon.com, an online retailer, has distribution centers from revitalize their formerly communist economies. Which goods
Falling political barriers and new technology are

making it possible for more and more companies to
sell their products overseas as well as at home.
Nevada to Germany that fill millions of orders a day and ship and services a nation sells depends on what resources it has
them to customers in every corner of the world. Procter & available.
Gamble’s Febreze brand passed the $1 billion mark partially
Some nations have a monopoly on the production of a par-
due to its strong growth overseas. While U.S. sales of air-
ticular resource or product. Such a monopoly, or absolute
fresheners have fallen in recent years, global sales have seen
advantage, exists when a country is the only source of
an increase.5 Indeed, most of the world’s population and two-
an item, the only producer of an item, or the most efficient
thirds of its total purchasing power are outside the United
producer of an item. Because South Africa has the largest
States.
deposits of diamonds in the world, one company, De Beers
When McDonald’s sells a Big Mac in Moscow, Sony sells a Consolidated Mines Ltd., controls a major portion of the
stereo in Detroit, or a small Swiss medical supply company world’s diamond trade and uses its control to maintain high
sells a shipment of orthopedic devices to a hospital in Mon- prices for gem-quality diamonds. The United States, until
terrey, Mexico, the sale affects the economies of the coun- recently, held an absolute advantage in oil-drilling equipment.
tries involved. The U.S. market, with 311 million consumers, But an absolute advantage not based on the availability of
makes up only a small part of the nearly 7 billion people else- natural resources rarely lasts, and Japan and Russia are now
where in the world to whom global companies must consider challenging the United States in the production of oil-drilling
marketing. Global marketing requires balancing your global equipment.

American companies such as KFC have become widely popular in China. Some are making more sales in China than they are in the United States.
Most international trade is based on comparative advantage, become a controversial practice in the United States because
which occurs when a country specializes in products that it can many jobs have moved overseas where those tasks can be
supply more efficiently or at a lower cost than it can produce accomplished for lower costs. For example, the Philippines
other items. The United States has a comparative advantage in has surpassed India as the popular choice for call-center jobs.
producing agricultural commodities such as corn and wheat. Call-center jobs are appealing to many Filipinos because the
The United States at one time had a comparative advantage in pay is almost as much as the average family income within the
[ “Outsourcing has become a controversial practice in the

United States because many jobs have moved overseas
where those tasks can be accomplished for lower costs.” ]
manufacturing automobiles, heavy machinery, airplanes, and country. English is also one of the country’s official languages,
weapons; other countries now hold the comparative advantage which makes it easier to communicate with English-speaking
for many of these products. Other countries, particularly India customers.7
and Ireland, are also gaining a comparative advantage over the
United States in the provision of some services, such as call- Trade between Countries
center operations, engineering, and software programming. To obtain needed goods and services and the funds to pay for
As a result, U.S. companies are increasingly outsourcing, them, nations trade by exporting and importing. Exporting
or transferring manufacturing and other tasks to countries is the sale of goods and services to foreign markets. The
where labor and supplies are less expensive. Outsourcing has United States exported more than $1.8 trillion in goods and

T A B L E 3 . 1 U.S. Trade Deficit (in billions of dollars)
1980 1990 2000 2005 2006 2007 2008 2009 2010*

Exports $333 $576 $1,133 $1,300 $1,455.7 $1,621.8 $1,826.6 $1,553.1 $1,831.8
Imports 326 632 1,532 2,026 2,204.2 2,333.4 2,522.5 1,933.7 $2,329.7
Trade Surplus/Deficit 7 57 399 726 758.5 711.6 695.9 380.7 497.8
Sources: Department of Commerce and Robert E. Scott and David Ratner, “Trade Picture,” The Economic Policy Institute, February 10, 2006, www.epinet.org/
content.cfm/webfeatures_econindicators_tradepich20060210 (accessed June 5, 2006); U.S. Census Bureau, Foreign Trade Statistics, www.census.gov/foreign-trade/
statistics/highlights/annual.html (accessed April 4, 2008); “Goods and Services Deficit Increases in 2010,” U.S. Census Bureau, February 11, 2011, www.census.gov/
indicator/www/ustrade.html (accessed March 2, 2011).
services in 2010.8 In China, General Motors is targeting Balance of Trade

wealthier customers with the Cadillac, middle management
You have probably read or heard about the fact that the United
with the Buick Excelle, office workers with the Chevrolet
States has a trade deficit, but what is a trade deficit? A nation’s
Spark, and rural consumers with the Wuling minivan.9 U.S.
balance of trade is the difference in value between its exports
companies that view China as both a growth market for
and imports. Because the United States (and some other nations
exports and a market for lower cost labor for imports and can
as well) imports more products than it exports, it has a negative
strategically integrate these into their operations enjoy sig-
balance of trade, or trade deficit. In 2010 the United States had
nificantly higher profits than companies that focus on only
a trade deficit of $497.8 billion.12 Table 3.1 shows the U.S. trade
one of these opportunities.10 U.S. businesses export many
deficit. The trade deficit fluctuates according to such factors as
goods and services, particularly agricultural, entertainment
the health of the United States and other economies, productiv-
(movies, television shows, etc.), and technological products.
ity, perceived quality, and exchange rates. In 2010 the United
Importing is the purchase of goods and services from for-
States had a trade deficit with China of over $273 billion.13 As
eign sources. Many of the goods you buy in the United States
Figure 3.1 indicates, U.S. exports to China have been rapidly
are likely to be imports or to have some imported compo-
increasing but not fast enough to offset the imports from China.
nents. Sometimes, you may not even realize they are imports.
Trade deficits are harmful because they can mean the failure of
The United States imported more than $2.3 trillion in goods
businesses, the loss of jobs, and a lowered standard of living.
and services in 2010.11
CHINA STRUGGLES country’s quality standards. Luxury brands to consumer preferences. For example,
can also suffer when they manufacture prod- Chinese consumers enjoy seeing new inven-
WITH LUXURY ucts in China itself. Giorgio Armani found this tory on a regular basis. Therefore, Zegna
BRANDS out when it manufactured its Emporio Armani boasts six collections annually compared to
line in China. Chinese consumers patron- four collections common to other companies.
izing Armani wanted to purchase European These adaptations, in addition to its commit-
T hanks to its rapid economic growth,
Chinese demand for luxury items is
growing. Some Chinese consumers like
fashions. After realizing that the items were
made in China, they felt deceived. On the
ment to quality, have helped Zegna succeed
in China. For many luxury brand owners, the
luxury products so much that they will make other hand, while Chinese consumers enjoy success of Zegna and similar brands makes
significant sacrifices (such as skipping foreign brands, the Chinese government is doing business in China well worth the risk.14
meals) in order to purchase them. China working to promote brands created within
currently ranks number two among luxury China. These opposing forces (consumer
goods markets and is growing faster in this versus government preferences) make it dif-
ficult for foreign luxury goods. 1. Why do you believe that luxury brands
area than any other nation.
In spite of these challenges, companies are so popular in China?
Despite a love for high-class products,
that can adapt to the Chinese market have 2. Why is the Chinese government working
luxury brands face many difficulties in China.
done well. Take Italian menswear company to discourage consumers from buying
The Administration for Industry and Com-
Zegna. Zegna owes its success in China, foreign luxury brands?
merce of Zhejiang province recently took
actions against brands such as Tommy Hil- which makes up one-quarter of the compa- 3. Why are Chinese brands not as desired
figer for selling goods that did not meet the ny’s annual sales, to its willingness to adapt by consumers as foreign luxury brands?

importing the purchase balance of trade the trade deficit a balance of
of goods and services from difference in value between nation’s negative balance payments
foreign sources a nation’s exports and its of trade, which exists when the difference between the
imports that country imports more flow of money into and out
products than it exports of a country
Of course, when a nation exports

FIGURE 3.1
U.S. Exports to China ($ millions of U.S. dollars)
more goods than it imports, it has a
favorable balance of trade, or trade
surplus. Until about 1970, the United
100,000.00 States had a trade surplus due to an
abundance of natural resources and
90,000.00 the relative efficiency of its manu-
91,878.30
facturing systems. Table 3.2 shows
80,000.00
the top 10 countries with which the
70,000.00 United States has a trade deficit and
a trade surplus.
60,000.00 69,732.80
The difference between the flow of
50,000.00 money into and out of a country is
called its balance of payments.
53,673.00
40,000.00 A country’s balance of trade, foreign
investments, foreign aid, loans, mili-
30,000.00 tary expenditures, and money spent
34,427.80
by tourists comprise its balance of
20,000.00
22,127.70 payments. As you might expect, a
16,185.20 country with a trade surplus gener-
10,000.00
ally has a favorable balance of pay-
0.00 ments because it is receiving more
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 money from trade with foreign
countries than it is paying out. When
a country has a trade deficit, more
Sources: “Trade in Goods (Imports, Exports and Trade Balance) with China,” U.S. Census Bureau: Foreign Trade money flows out of the country than
Statistics, www.census.gov/foreign-trade/balance/c5700.html (accessed March 2, 2011).
into it. If more money flows out of
the country than into it from tour-
ism and other sources, the country
T A B L E 3 . 2 Top Ten Countries with Which United States may experience declining production and higher unemployment,
Has Trade Deficits/Surpluses
because there is less money available for spending.
Trade Deficit Trade Surplus
1. China
2. Mexico
Hong Kong
Netherlands
INTERNATIONAL
3. Japan Singapore TRADE BARRIERS
4. Federal Republic of Germany Australia Completely free trade seldom exists. When a company decides
5. Canada Belgium to do business outside its own country, it will encounter a
6. Nigeria United Arab Emirates
number of barriers to international trade. Any firm consider-
ing international business must research the other country’s
7. Saudi Arabia Turkey economic, legal, political, social, cultural, and technological
8. Venezuela Spain background. Such research will help the company choose an
9. Russia Brazil appropriate level of involvement and operating strategies, as we
10. Angola Egypt will see later in this chapter.
Sources: “Top Ten Countries with Which the U.S. Has a Trade Deficit,” April Economic Barriers
2010, www.census.gov/foreign-trade/top/dst/2010/04/deficit.html (accessed
March 2, 2011); “Top Ten Countries with Which the U.S. Has a Trade Surplus,”
When looking at doing business in another country, manag-
December 2010, www.census.gov/foreign-trade/top/dst/current/surplus.html ers must consider a number of basic economic factors, such as
(accessed March 2, 2011). economic development, infrastructure, and exchange rates.

infrastructure the
physical facilities that
support a country’s
economic activities, such Economic Development profit on these drugs, they build their reputation as good corpo-
as railroads, highways, When considering doing busi- rate citizens and help many people have better lives. As emerg-
ports, airfields, utilities ness abroad, U.S. businesspeople ing economies such as China and India have begun to prosper,
and power plants, schools, need to recognize that they cannot more citizens are demanding health care. With China now the
hospitals, communication take for granted that other coun- third-largest vaccine market in the world, pharmaceutical man-
systems, and commercial tries offer the same things as are ufacturers like Novartis are partnering with Chinese companies
distribution systems found in industrialized nations— to offer medicines at affordable prices and increase their share in
economically advanced countries this lucrative industry.15
exchange rate the
ratio at which one nation’s such as the United States, Japan, A country’s level of development is determined in part by its
currency can be exchanged Great Britain, and Canada. Many infrastructure, the physical facilities that support its eco-
for another nation’s countries in Africa, Asia, and nomic activities, such as railroads, highways, ports, airfields,
currency South America, for example, are in utilities and power plants, schools, hospitals, communication
general poorer and less economi- systems, and commercial distribution systems. When doing
cally advanced than those in North business in LDCs, for example, a business may need to com-
America and Europe; they are often called less-developed coun- pensate for rudimentary distribution and communication sys-
tries (LDCs). LDCs are characterized by low per-capita income tems, or even a lack of technology.
(income generated by the nation’s production of goods and
services divided by the population), which means that consum- Exchange Rates The ratio at which one nation’s cur-
ers are less likely to purchase nonessential products. Nonethe- rency can be exchanged for another nation’s currency is the
less, LDCs represent a potentially huge and profitable market exchange rate. Exchange rates vary daily and can be found
for many businesses because they may be buying technology to in newspapers and through many sites on the Internet. Famil-
improve their infrastructures, and much of the population may iarity with exchange rates is important because they affect the
desire consumer products. For example, pharmaceutical com- cost of imports and exports. When the value of the U.S. dollar
panies offer infant vaccines in LDCs at a fraction of what they declines relative to other currencies, such as the euro, the price
cost in developed countries. While the companies make less in of imports becomes relatively expensive for U.S. consumers.
[ “Devaluation decreases the value of currency in

relation to other currencies.” ]
On the other hand, U.S. exports become relatively cheap for
international markets—in this example, the European Union.
Occasionally, a government may intentionally alter the value of its
currency through fiscal policy. Devaluation decreases the value of
currency in relation to other currencies. If the U.S. government
were to devalue the dollar, it would lower the cost of American
goods abroad and make trips to the United States less expensive
for foreign tourists. Thus, devaluation encourages the sale of
domestic goods and tourism. Mexico has repeatedly devalued the
peso for this reason. Revaluation, which increases the value of a
currency in relation to other currencies, occurs rarely.
Ethical, Legal,
and Political Barriers
A company that decides to enter the international market-
place must contend with potentially complex relationships
The infrastructure of countries—their transportation, communication, among the different laws of its own nation, international laws,
and other systems—differ around the world. AT&T has used the and the laws of the nation with which it will be trading; vari-
opportunity to make inroads with consumers who don’t want their cell ous trade restrictions imposed on international trade; chang-
phones to stop working when they go abroad. ing political climates; and different ethical values. Legal and

import tariff a tax
levied by a nation on goods
imported into the country
ethical requirements for successful business are increasing can be brought in; others forbid
globally. Research in Motion (RIM) ran into legal barriers in foreigners from owning real prop-
Saudi Arabia and the United Arab Emirates. The two coun- erty outright. In Mexico, for example, foreigners cannot directly
tries announced a countrywide ban of the company’s Black- own property in what is known as the “Restricted Zone.” The
Berry devices out of a concern that data on the devices were Restricted Zone includes land within 100 kilometers of Mexico’s
encrypted and could not be monitored. Additionally, because international borders along with land within 50 kilometers of
information on BlackBerrys was routed through RIM’s over- Mexico’s oceans and beaches. Foreigners who wish to use prop-
sea suppliers, the countries felt this could allow outside parties erty in these areas must obtain a title through a bank title trans-
access to personal data. The bans were lifted after RIM agreed fer or through a corporation.18
to make some changes. As part of the agreement with Saudi
Arabia, RIM agreed to use local data servers.16 Some countries have copyright and patent laws that are less
strict than those of the United States, and some countries fail
Laws and Regulations The United States has a num- to honor U.S. laws. Because copying is a tradition in China
ber of laws and regulations that govern the activities of U.S. and Vietnam and laws protecting copyrights and intellectual
firms engaged in international trade. For example, the Webb- property are weak and minimally enforced, those countries are
Pomerene Export Trade Act of 1918 exempts American firms flooded with counterfeit videos, movies, CDs, computer soft-
from antitrust laws if those firms are acting together to enter ware, furniture, and clothing. Companies are angry because the
international trade. This law allows selected U.S. firms to form counterfeits harm not only their sales, but also their reputations
monopolies to compete with foreign monopolistic organiza- if the knockoffs are of poor quality. Such counterfeiting is not
tions, although they are not allowed to limit free trade and limited to China or Vietnam. It is estimated that nearly half of
competition within the United States or to use unfair methods all software installed on personal computers worldwide is ille-
of competition in international trade. The United States also gally pirated or copied, amounting to more than $50 billion in
has a variety of friendship, commerce, and navigation treaties global revenue losses annually.19 In countries where these activ-
with other nations. These treaties allow business to be trans- ities occur, laws against them may not be sufficiently enforced,
acted between citizens of the specified countries. For example, if counterfeiting is deemed illegal. Thus, businesses engaging in
Belgium is a gateway to European markets and has lowered foreign trade may have to take extra steps to protect their prod-
its taxes to give U.S. companies greater reason to locate their ucts because local laws may be insufficient to do so.
European operations there. Belgium has the lowest patent
income tax and has 0 percent withholding tax on corporate Tariffs and Trade Restrictions Tariffs and other trade
restrictions are part of a country’s legal structure but may be
dividends and interest from a U.S. company. This prevents a
established or removed for political reasons. An import tariff
company from paying both U.S. and Belgian tax, or double
is a tax levied by a nation on goods imported into the country.
taxation.17
A fixed tariff is a specific amount of money levied on each unit
Once outside U.S. borders, businesspeople are likely to find that of a product brought into the country, while an ad valorem tariff
the laws of other nations differ from those of the United States. is based on the value of the item. Most countries allow citizens
Many of the legal rights that Americans take for granted do not traveling abroad to bring home a certain amount of merchan-
exist in other countries, and a firm doing business abroad must dise without paying an import tariff. A U.S. citizen may bring
understand and obey the laws of the host country. Some coun- $200 worth of merchandise into the United States duty free.
tries have strict laws limiting the amount of local currency that After that, U.S. citizens must pay an ad valorem tariff based on
can be taken out of the country and the amount of currency that the cost of the item and the country of origin. Thus, identical
IS THERE ROOM This marks a major shift in a country to find work on their own, and lease more
traditionally viewed as the enemy of entre- land.
FOR ENTREPRENEURS preneurship. Cuban entrepreneurs are sub- These changes seem promising to other
IN CUBA? jected to high taxes, advertising bans, no countries. A more privatized Cuban econ-
access to bank or foreign credit exchange, omy might enable more foreign investment.
hiring restrictions, and more. Creating There is already talk of extending micro-
F or the first time in its communist history,
the entrepreneur may become part of
Cuba’s business landscape. However, it
private-sector job growth will require major
economic reforms. According to the Cuban
loans to Cuba to support small-business
growth. However, the willingness of the
will come at a cost. Cuba will lay off over a union, the government has announced government to lift restrictions on private
half million state workers to make way for it will increase the job options available, enterprise will largely determine whether
private-sector jobs. distribute more licenses to allow citizens entrepreneurship in Cuba will take off.20

exchange controls quota a restriction on embargo a prohibition dumping the act of a cartel a group of firms or
regulations that restrict the the number of units of a on trade in a particular country or business selling nations that agree to act as a
amount of currency that can particular product that can product products at less than what monopoly and not compete
be bought or sold be imported into a country it costs to produce them with each other, in order
to generate a competitive
advantage in world markets
which is significantly less expensive, in order to protect remain-

ing U.S. steel production. The United States has also imposed
tariffs on imported sugar for almost two centuries. The Euro-
pean Union levies tariffs on many products, including some
seafood imports.
Critics of protective tariffs argue that their use inhibits free trade
and competition. Supporters of protective tariffs say they insu-
late domestic industries, particularly new ones, against well-
established foreign competitors. Once an industry matures,
however, its advocates may be reluctant to let go of the tariff
that protected it. Tariffs also help when, because of low labor
costs and other advantages, foreign competitors can afford to
sell their products at prices lower than those charged by domes-
tic companies. Some Americans argue that tariffs should be
used to keep domestic wages high and unemployment low.
Exchange controls restrict the amount of currency that
can be bought or sold. Some countries control their for-
eign trade by forcing businesspeople to buy and sell foreign
products through a central bank. If John Deere, for example,
receives payments for its tractors in a foreign currency, it may
be required to sell the currency to that nation’s central bank.
When foreign currency is in short supply, as it is in many less-
developed countries, the government uses foreign currency
to purchase necessities and capital goods and produces other
products locally, thus limiting its need for foreign imports.
A quota limits the number of units of a particular product
The vegetable cutter in the bottom photo was distributed by the NingHai
that can be imported into a country. A quota may be estab-
Well International Trade Co. in China. The dubious honor is given to
the “best” product knockoffs by the organization Action Plagiarius in
lished by voluntary agreement or by government decree. The
an effort to shame their makers. (The Veggi Cut Revolution, top photo, United States imposes quotas on certain goods, such as gar-
manufactured by swizzzProzzz AG in Switzerland, is the original item.) ments produced in Vietnam and China. Quotas are designed
to protect the industries and jobs of the country imposing the
quota.
items purchased in different countries might have different
An embargo prohibits trade in a particular product. Embar-
tariffs.
goes are generally directed at specific goods or countries and
Countries sometimes levy tariffs for political reasons, as when may be established for political, economic, health, or religious
they impose sanctions against other countries to protest their reasons. While the United States maintains a trade embargo
actions. However, import tariffs are more commonly imposed with Cuba, European hotel chains are engaged in a building
to protect domestic products by raising the price of imported boom on the Caribbean island, where tourism is the number-
ones. Such protective tariffs have become controversial, as one industry. U.S. hotel chains are eager to build in Cuba but
Americans become increasingly concerned over the U.S. trade have no opportunity until the embargo is lifted. Even U.S. tour-
deficit. Protective tariffs allow more expensive domestic goods ists are forbidden by the U.S. government to vacation in Cuba,
to compete with foreign ones. For example, the United States although the push to lift the government embargo is growing
has lost a significant number of steelworks over the past few stronger all the time. If permitted, cruise ships would likely be
decades to foreign competition in places such as China. Other the first type of U.S. tourism to reach the island since the early
markets can produce steel more cheaply than the United States. 1960s. It may be surprising to know that U.S. farmers export
Many people and special interest groups in the United States, hundreds of millions of dollars worth of commodities to Cuba
such as unions, would like to see tariffs placed on Chinese steel, each year, based on a 2000 law that provided permission for

some trade to the embargoed country.21 Health embargoes pre- Social and Cultural Barriers
vent the importing of various pharmaceuticals, animals, plants,
Most businesspeople engaged in international trade under-
and agricultural products. Muslim nations forbid the importa-
estimate the importance of social and cultural differences;
tion of alcoholic beverages on religious grounds.
but these differences can derail an important transaction. For
One common reason for setting quotas or tariffs is to prohibit example, when Big Boy opened a restaurant in Bangkok, it
dumping, which occurs when a country or business sells quickly became popular with European and American tour-
products at less than what it costs to produce them. President ists, but the local Thais refused to eat there. Instead, they placed
Obama, for example, restricted tire imports from China after gifts of rice and incense at the feet of the Big Boy statue (a
union workers accused the country of dumping its products chubby boy holding a hamburger) because it reminded them
into the U.S. markets, which in turn affected domestic tire mak- of Buddha. In Japan, customers tiptoed around a logo painted
ers. China retaliated by threatening its own investigations into on the floor at the entrance to an Athlete’s Foot store because
whether the United States is dumping auto and chicken parts in Japan it is considered taboo to step on a crest.23 And in Rus-
on the Chinese market.22 A company may dump its products sia, consumers found the American-style energetic happiness
for several reasons. Dumping permits quick entry into a mar- of McDonald’s employees insincere and offensive when the
ket. Sometimes dumping occurs when the domestic market for company opened its first stores there.24 Unfortunately, cultural
a firm’s product is too small to support an efficient level of pro- norms are rarely written down, and what is written down may
duction. In other cases, technologically obsolete products that well be inaccurate.
are no longer salable in the country of origin are dumped over-
seas. Dumping is relatively difficult to prove, but even the suspi- Cultural differences include differences in spoken and written
cion of dumping can lead to the imposition of quotas or tariffs. language. Although it is certainly possible to translate words
from one language to another, the true meaning is sometimes
Political Barriers Unlike legal issues, political consid- misinterpreted or lost. Consider some translations that went
erations are seldom written down and often change rapidly. awry in foreign markets:
Nations that have been subject to economic sanctions for • Scandinavian vacuum manufacturer Electrolux used the fol-
political reasons in recent years include Cuba, Iran, Syria, and lowing in an American campaign: “Nothing sucks like an
North Korea. While these were dramatic events, political con- Electrolux.”
siderations affect international business daily as governments
enact tariffs, embargoes, or other types of trade restrictions in • The Coca-Cola name in China was first read as “Ke-kou-ke-la,”
meaning “bite the wax tadpole.”
response to political events.
Businesses engaged in international trade must consider the • In Italy, a campaign for Schweppes Tonic Water translated
relative instability of countries such as Iraq, Haiti, and Ven- the name into Schweppes Toilet Water.25
ezuela. Political unrest in countries such as Pakistan, Somalia, Translators cannot just translate slogans, advertising cam-
and the Democratic Republic of the Congo may create a hos- paigns, and website language; they must know the cultural dif-
tile or even dangerous environment for foreign businesses. ferences that could affect a company’s success.
Natural disasters, like the Haitian or Chilean earthquakes in
2010, can cripple a country’s government, making the region Differences in body language and personal space also affect inter-
even more unstable. Even a developed country such as Japan national trade. Body language is nonverbal, usually unconscious
had its social, economic, and political institutions stressed by communication through gestures, posture, and facial expressions.
the 2011 earthquake and tsunamis. Finally, a sudden change in Personal space is the distance at which one person feels comfort-
power can result in a regime that is hostile to foreign invest- able talking to another. Americans tend to stand a moderate dis-
ment. Some businesses have been forced out of a country alto- tance away from the person with whom they are speaking. Arab
gether, as when Hugo Chávez conducted a socialist revolution businessmen tend to stand face-to-face with the object of their con-
in Venezuela to force out or take over American oil compa- versation. Additionally, gestures vary from culture to culture, and
nies. Whether they like it or not, companies are often involved gestures considered acceptable in American society—pointing,
directly or indirectly in international politics. for example—may be considered rude in others. Table 3.3 shows
some of the behaviors considered rude or unacceptable in other
Political concerns may lead a group of nations to form a cartel,
countries. Such cultural differences may generate uncomfortable
a group of firms or nations that agree to act as a monopoly
feelings or misunderstandings when businesspeople of different
and not compete with each other, to generate a competitive
countries negotiate with each other.
advantage in world markets. Probably the most famous car-
tel is OPEC, the Organization of Petroleum Exporting Coun- Family roles also influence marketing activities. Many countries
tries, founded in the 1960s to increase the price of petroleum do not allow children to be used in advertising, for example.
throughout the world and to maintain high prices. By working Advertising that features people in nontraditional social roles may
to ensure stable oil prices, OPEC hopes to enhance the econo- or may not be successful either. One airline featured advertise-
mies of its member nations. ments with beautiful flight attendants serving champagne on a

General Agreement
on Tariffs and
Trade (GATT) a
trade agreement, originally
flight. The ad does not seem unusual foreign markets in liters or meters, and Japanese sellers must
signed by 23 nations in in Western markets, but there was convert to the English system if they plan to sell a product in the
1947, that provided a forum a major backlash in the Middle United States. Tools also must be calibrated in the correct sys-
for tariff negotiations and a East. Saudi Arabia even considered tem if they are to function correctly. Hyundai and Honda ser-
place where international restricting the airline from flights vice technicians need metric tools to make repairs on those cars.
trade problems could be in that country. Not only is alcohol
discussed and resolved
The literature dealing with international business is filled with
usage forbidden among Muslims,
accounts of sometimes humorous but often costly mistakes that
unveiled women are not allowed to
World Trade occurred because of a lack of understanding of the social and cul-
interact with men—especially with-
Organization (WTO) tural differences between buyers and sellers. Such problems cannot
international organization
out their husbands around. Some
always be avoided, but they can be minimized through research on
dealing with the rules of in Saudi Arabia saw the airline as
the cultural and social differences of the host country.
trade between nations being insensitive to their religious
beliefs and customs.26 Technological Barriers
North American
Free Trade The people of other nations quite Many countries lack the technological infrastructure found in the
Agreement often have a different perception United States, and some marketers are viewing such barriers as
(NAFTA) agreement of time as well. Americans value opportunities. For instance, marketers are targeting many coun-
that eliminates most tariffs promptness; a business meeting tries such as India and China and some African countries where
and trade restrictions scheduled for a specific time sel- there are few private phone lines. Citizens of these countries are
on agricultural and dom starts more than a few minutes turning instead to wireless communication through cell phones.
manufactured products to late. In Mexico and Spain, however, Technological advances are creating additional global marketing
encourage trade among it is not unusual for a meeting to be opportunities. Along with opportunities, changing technologies
Canada, the United States,
delayed half an hour or more. Such also create new challenges and competition. The U.S. market
and Mexico
a late start might produce resent- share of the personal computer market is dropping as new com-
ment in an American negotiating petitors emerge that are challenging U.S. PC makers. Although
in Spain for the first time. Apple is making strides in the tablet industry, its market share
in the PC market remains low compared to competitors. In fact,
Companies engaged in foreign trade must observe the national out of the top five global PC companies—Hewlett-Packard, Dell,
and religious holidays and local customs of the host country. In
Acer, Lenovo, and Toshiba—three are from Asian countries.28
many Islamic countries, for example, workers expect to take a
break at certain times of the day to observe religious rites. Com-
panies also must monitor their advertising to guard against
offending customers. In Thailand and many other countries,
TRADE AGREEMENTS,
public displays of affection between the sexes are unacceptable
in advertising messages; in many Middle Eastern nations, it is
ALLIANCES,
unacceptable to show the soles of one’s feet.27 In Russia, smiling
is considered appropriate only in private settings, not in business.
AND ORGANIZATIONS
Although these economic, political, legal, and sociocultural issues
With the exception of the United States, most nations use may seem like daunting barriers to international trade, there are
the metric system. This lack of uniformity creates problems also organizations and agreements—such as the General Agree-
for both buyers and sellers in the international marketplace. ment on Tariffs and Trade, the World Bank, and the Interna-
American sellers, for instance, must package goods destined for tional Monetary Fund—that foster international trade and can
help companies get involved in and succeed
T A B L E 3 . 3 Cultural Behavioral Differences in global markets. Various regional trade
agreements, such as the North American
Region Gestures Viewed as Rude or Unacceptable Free Trade Agreement and the European
Japan, Hong Kong, Middle East Summoning with the index finger Union, also promote trade among mem-
Middle and Far East Pointing with index finger ber nations by eliminating tariffs and trade
restrictions. In this section, we’ll look briefly
Thailand, Japan, France Sitting with soles of shoes showing
at these agreements and organizations.
Brazil, Germany Forming a circle with fingers (e.g., the “OK”
sign in the United States) General Agreement
Japan Winking means “I love you”
on Tariffs and Trade
Buddhist countries Patting someone on the head During the Great Depression of the 1930s,
Source: Adapted from Judie Haynes, “Communicating with Gestures,” EverythingESL (n.d.), www. nations established so many protective
everythingesl.net/inservices/body_language.php (accessed March 8, 2010). tariffs covering so many products that

international trade became virtually impossible. By the end of WTO trade agreements, the WTO presents a forum for trade
World War II, there was considerable international momen- negotiations, monitors national trade policies, provides techni-
tum to liberalize trade and minimize the effects of tariffs. The cal assistance and training for developing countries, and coop-
General Agreement on Tariffs and Trade (GATT), origi- erates with other international organizations. Based in Geneva,
nally signed by 23 nations in 1947, provided a forum for tariff Switzerland, the WTO has also adopted a leadership role in
negotiations and a place where international trade problems negotiating trade disputes among nations.29 For example, the
could be discussed and resolved. More than 100 nations abided WTO investigated Chinese accusations of unfair treatment
by its rules. GATT sponsored rounds of negotiations aimed at against the European Union after the EU levied tariffs against
reducing trade restrictions. The most recent round, the Uru- Chinese-manufactured steel fasteners. The EU claimed that
guay Round (1988–1994), further reduced trade barriers for China was dumping its steel fasteners and imposed a tariff of
most products and provided new rules to prevent dumping. 63 to 87 percent. The WTO ruled in favor of China, claiming
that the tariff was discriminating against Chinese exporters.30
The World Trade Organization (WTO), an international
organization dealing with the rules of trade between nations,
was created in 1995 by the Uruguay Round. Key to the World
The North American
Trade Organization are the WTO agreements, which are the Free Trade Agreement
legal ground rules for international commerce. The agreements The North American Free Trade Agreement (NAFTA),
were negotiated and signed by most of the world’s trading which went into effect on January 1, 1994, effectively merged
nations and ratified by their parliaments. The goal is to help Canada, the United States, and Mexico into one market of
producers of goods and services and exporters and import- nearly 440 million consumers. NAFTA virtually eliminated all
ers conduct their business. In addition to administering the tariffs on goods produced and traded among Canada, Mexico,
The WTO facilitates trade between nations through the development of trade policies.

[ “NAFTA makes it easier for U.S. businesses to invest
in Mexico and Canada.”
and the United States to create a free-trade area. The estimated
]
the north. The disparities are growing, as can be seen compar-
annual output for this trade alliance is more than $14 trillion. ing the south to the northern industrial capital of Monterrey,
NAFTA makes it easier for U.S. businesses to invest in Mexico which is beginning to seem like south Texas.39 However, drug
and Canada; provides protection for intellectual property (of gang wars threaten the economic stability of Mexico, especially
special interest to high-technology and entertainment indus- in the northern states close to the U.S. border.
tries); expands trade by requiring equal treatment of U.S. firms
Mexico’s membership in NAFTA links the United States and
in both countries; and simplifies country-of-origin rules, hin-
Canada with other Latin American countries, providing addi-
dering Japan’s use of Mexico as a staging ground for further
tional opportunities to integrate trade among all the nations in
penetration into U.S. markets.
the Western Hemisphere. Indeed, efforts to create a free-trade
Canada’s 34 million consumers are relatively affluent, with an agreement among the 34 nations of North and South America
estimated GDP per capita of $39,033.693.31 Trade between the was expected to be completed by 2005. Like NAFTA, the Free
United States and Canada totals approximately $430 billion. Trade Area of the Americas (FTAA) will progressively eliminate
About 80 percent of Canada’s exports go to the United States, trade barriers and create the world’s largest free-trade zone with
including gold, oil, and uranium.32 In fact, Canada is the single 800 million people.40 However, opposition and demonstrations
largest trading partner of the United States.33 have hampered efforts to move forward with the proposed plan.
Although the deadline was missed and it is not in place yet,
With an estimated per capita GDP of $14,266, Mexico’s
there is still a chance for the FTAA to become a reality.
111 million consumers are less affluent than Canadian con-
sumers.34 However, trade with the United States and Mexico Despite its benefits, NAFTA has been controversial, and dis-
has tripled since NAFTA was initiated.35 More than 31 million putes continue to arise over the implementation of the trade
Americans cite their heritage as Mexican, making them the agreement. For example, a trucking dispute between the United
most populous Hispanic group in the country.36 These indi- States and Mexico resulted in a ban on Mexican trucks oper-
viduals often have close ties to relatives in Mexico and assist in ating within the U.S. border. In retaliation Mexico instituted a
Mexican–U.S. economic development and trade. Mexico is on punitive tariff on U.S. imports, claiming that the ban violated
a course of a market economy, rule of law, respect for human NAFTA. Americans in support of the ban felt it was necessary
rights, and responsible public policies. There is also a com- to protect the jobs of U.S. truck and warehouse workers. The
mitment to the environment and sustainable human develop- dispute was eventually resolved, with President Obama agree-
ment. Many U.S. companies have taken advantage of Mexico’s ing to lift the ban in exchange for tougher standards for Mexi-
low labor costs and proximity to the United States to set up can trucks crossing the border.41 While many Americans feared
production facilities, sometimes called maquiladoras. Mexico the agreement would erase jobs in the United States, Mexicans
is also attracting major technological industries, including have been disappointed that the agreement failed to create more
electronics, software, and aerospace. Mexicali, for example, jobs. Moreover, Mexico’s rising standard of living has increased
has attracted such companies as Skyworks Solutions, a maker the cost of doing business there; many hundreds of maquila-
of cell phone and PDA semiconductors; Gulfstream, a maker doras have closed their doors and transferred work to China
of executive jets; and Honeywell, which recently opened a and other nations where labor costs are cheaper. Indeed, China
$40 million center in the city. Engineering in Mexicali is has become the United States’ second-largest importer.42 On
booming, with the enrollment of the engineering department the other hand, high transportation costs, intellectual prop-
at Mexicali’s Universidad Autonoma de Baja California dou- erty theft, quality failures, and the difficulty management often
bling within the last five years. Other companies that have an incurs in controlling a business so far away and under a com-
interest in Mexico include Eurocopter and Lenovo, which has munist regime are now causing some manufacturers to recon-
a plant in Monterrey.37 With the maquiladoras and the influx sider opting for Mexican factories over China, even going so far
of foreign technological industries, Mexico became the world’s as to relocate from China back to Mexico.43
12th-largest economy.38
Although NAFTA has been controversial, it has become a posi-
However, there is great disparity within Mexico. The country’s tive factor for U.S. firms wishing to engage in international mar-
southern states cannot seem to catch up with the more afflu- keting. Because licensing requirements have been relaxed under
ent northern states on almost any socioeconomic indicator. the pact, smaller businesses that previously could not afford
For example, 47 percent of rural Mexicans in the south are to invest in Mexico and Canada will be able to do business in
considered extremely poor, compared with just 12 percent in those markets without having to locate there. NAFTA’s long

European Union
(EU) a union of European
nations established in 1958
phase-in period provides ample time for adjustment by those downturn served to decrease the to promote trade among its
firms affected by reduced tariffs on imports. Furthermore, euro’s value. This had a profound members; one of the largest
increased competition should lead to a more efficient market, effect on other countries in the single markets today
and the long-term prospects of including most countries in the Euro zone (the Euro zone refers
Western Hemisphere in the alliance promise additional oppor- collectively to European member Asia-Pacific
tunities for U.S. marketers. countries that have adopted the Economic
euro as their form of currency). Cooperation
The European Union Ireland, Spain, and Portugal were (APEC) an international
trade alliance that promotes
The European Union (EU), also called the European Com- particularly vulnerable as they had
open trade and economic
munity or Common Market, was established in 1958 to pro- some of the region’s largest defi- and technical cooperation
47
mote trade among its members, which initially included cits. Ireland began experienc- among member nations
Belgium, France, Italy, West Germany, Luxembourg, and the ing problems similar to Greece,
Netherlands. East and West Germany united in 1991, and by including a debt crisis, failing eco-
1995 the United Kingdom, Spain, Denmark, Greece, Portugal, nomic health, and rising bond yields.48 It too required a bailout
Ireland, Austria, Finland, and Sweden had joined as well. The package from the IMF. Spain’s housing bust and a collapse in the
Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, construction sector negatively affected its economy as well.49
Slovakia, and Slovenia joined in 2004. In 2007, Bulgaria and Much as the United States created new agencies to ensure the
Romania also became members, and Cyprus and Malta joined future stability of U.S. financial markets, the European Union
in 2008, which brought total membership to 27. Croatia, the created the European Financial Stability Facility (EFSF) to “safe-
Former Yugoslav Republic of Macedonia, Iceland, and Turkey guard financial stability in the Euro zone.” EFSF will be able to
are candidate countries that hope to join the European Union raise funds through the issuing of capital such as bonds in order
in the near future.44 Until 1993 each nation functioned as a to finance loans for European Union member countries.50 It is
separate market, but at that time the members officially unified hoped that this organization will maintain stability in the region
into one of the largest single world markets.45 and prevent such a crisis from reoccurring in the future.
To facilitate free trade among members, the EU is working
toward standardization of business regulations and require- Asia-Pacific Economic
ments, import duties, and value-added taxes; the elimination of
customs checks; and the creation of a standardized currency for Cooperation
use by all members. Many European nations (Austria, Belgium, The Asia-Pacific Economic Cooperation (APEC), estab-
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, lished in 1989, promotes open trade and economic and tech-
the Netherlands, Portugal, Spain, and Slovenia) link their nical cooperation among member nations, which initially
exchange rates together to a common currency, the euro; how- included Australia, Brunei Darussalam, Canada, Indonesia,
ever, several EU members have rejected use of the euro in their Japan, Korea, Malaysia, New Zealand, the Philippines, Singa-
countries. Although the common currency requires many mar- pore, Thailand, and the United States. Since then the alliance
keters to modify their pricing strategies and will subject them to has grown to include China, Hong Kong, Chinese Taipei, Mex-
increased competition, the use of a single currency frees com- ico, Papua New Guinea, Chile, Peru, Russia, and Vietnam. The
panies that sell goods among European countries from the nui- 21-member alliance represents approximately 41 percent of the
sance of dealing with complex exchange rates.46 The long-term world’s population, 44 percent of world trade, and 54 percent
goals are to eliminate all trade barriers within the EU, improve of world GDP. APEC differs from other international trade alli-
the economic efficiency of the EU nations, and stimulate eco- ances in its commitment to facilitating business and its practice
nomic growth, thus making the union’s economy more com- of allowing the business/private sector to participate in a wide
petitive in global markets, particularly against Japan and other range of APEC activities.51
Pacific Rim nations, and North America. However, several dis-
Companies of the APEC have become increasingly com-
putes and debates still divide the member nations, and many
petitive and sophisticated in global business in the last three
barriers to completely free trade remain. Consequently, it may
decades. The Japanese and South Koreans in particular have
take many years before the EU is truly one deregulated market.
made tremendous inroads on world markets for automobiles,
The prosperity of the EU has suffered in recent years. EU mem- motorcycles, watches, cameras, and audio and video equip-
bers experienced a severe economic crisis in 2010 that required ment. Products from Samsung, Sony, Sanyo, Toyota, Daewoo,
steep bailouts from the International Monetary Fund (IMF). Mitsubishi, Suzuki, and Toshiba are sold all over the world and
The first country to come to the forefront was Greece, which had have set standards of quality by which other products are often
so much debt that it risked default. With an increase in Greek judged. The People’s Republic of China, a country of 1.3 bil-
bond yields and credit risks—along with a severe deficit and lion people, has launched a program of economic reform to
other negative economic factors—the country’s economy plum- stimulate its economy by privatizing many industries, restruc-
meted. Since Greece uses the euro as its currency, the massive turing its banking system, and increasing public spending on

World Bank an International countertrade
organization established by Monetary Fund agreements foreign
the industrialized nations (IMF) organization trade agreements that
of higher prices. This brings up a key ethical
in 1946 to loan money established in 1947 to involve bartering products
to underdeveloped and promote trade among for other products instead
concern for consumers and businesses: Would
developing countries; member nations by of for currency they be willing to accept higher priced items
formally known as the eliminating trade barriers if it means better conditions for workers in
International Bank for and fostering financial different countries?54
Reconstruction and cooperation
Increased industrialization has also caused
Development
China to become the world’s largest emitter
of greenhouse gases in 2008. China mainly
uses coal-fired power plants; in fact, it builds
infrastructure (including railways and telecommunications).52 a new one every 10 days, so it has become the world’s largest
As a result, China has become a manufacturing powerhouse, emitter of carbon dioxide. As companies transfer their manu-
with an estimated economic growth rate of 8 to 10 percent facturing to China, they increase their CO2 emissions because
a year.53 China’s export market has consistently outpaced China emits 22 percent more than the global average of carbon
its import growth in recent years and its GDP is the world’s per kilowatt-hour.55 On the other hand, China has also begun a
second-largest behind the United States. As China continues quest to become a world leader in green initiatives and renew-
to prosper, working conditions are also beginning to improve. able energy. This is an increasingly important quest as the
Strikes and calls for unions are increasing among Chinese fac- country becomes more polluted.
tory workers, prompting the government to improve wages
and labor standards. On the other hand, this rise in labor Less visible Pacific Rim regions, such as Thailand, Singapore,
costs concerns some international companies. Minimum wage Taiwan, Vietnam, and Hong Kong, have also become major
increases are estimated to push labor costs up 5 to 15 percent manufacturing and financial centers. Vietnam, with one of
on average, which may be passed onto consumers in the form the world’s most open economies, has bypassed its communist
The ship Cosco Ran transports cargo from one side of the globe to the other.

government with private firms moving ahead despite bureau- because these countries use private markets as a major source
cracy, corruption, and poor infrastructure. In a country of of capital.58
85 million barely able to feed themselves, Vietnamese firms
now compete internationally with an agricultural miracle, mak-
ing the country one of the world’s main providers of farm pro-
duce. Coach, Inc. wants to increase its presence in Vietnam,
GETTING INVOLVED IN
while Guess, Inc. is considering an expansion of its production
facilities in Vietnam along with Cambodia and Indonesia.56
INTERNATIONAL BUSINESS
Businesses may get involved in international trade at many
levels—from a small Kenyan firm that occasionally exports
World Bank African crafts to a huge multinational corporation such as Shell
The World Bank, more formally known as the International Oil that sells products around the globe. The degree of commit-
Bank for Reconstruction and Development, was established by ment of resources and effort required increases according to the
[ “The IMF is the closest thing the world has to an

international central bank.”
the industrialized nations, including the United States, in 1946
]
level at which a business involves itself in international trade.
to loan money to underdeveloped and developing countries. This section examines exporting and importing, trading com-
panies, licensing and franchising, contract manufacturing, joint
It loans its own funds or borrows funds from member countries
ventures, direct investment, and multinational corporations.
to finance projects ranging from road and factory construction
to the building of medical and educational facilities. The World
Bank and other multilateral development banks (banks with
Exporting and Importing
international support that provide loans to developing coun- Many companies first get involved in international trade when
tries) are the largest source of advice and assistance for devel- they import goods from other countries for resale in their own
oping nations. The International Development Association businesses. For example, a grocery store chain may import
and the International Finance Corporation are associated with bananas from Honduras and coffee from Colombia. A business
the World Bank and provide loans to private businesses and may get involved in exporting when it is called upon to supply
member countries. a foreign company with a particular product. Such exporting
enables enterprises of all sizes to participate in international busi-
International Monetary Fund ness. Exporting to other countries becomes a necessity for estab-
lished countries that seek to grow continually. Products often have
The International Monetary Fund (IMF) was established in
higher sales growth potential in foreign countries than they have
1947 to promote trade among member nations by eliminating
in the parent country. For example, Heinz exports its ketchup to
trade barriers and fostering financial cooperation. It also makes
other countries, including Mexico, Africa, and the Middle East,
short-term loans to member countries that have balance-of-
because there exists much greater potential for growth. Retail
payment deficits and provides foreign currencies to member
sales of packaged food have risen 32 percent in Asian-Pacific
nations. The International Monetary Fund tries to avoid finan-
countries and 27 percent in Africa, while rising only a mere 4
cial crises and panics by alerting the international community
percent in Europe and declining 1 percent in North America.
about countries that will not be able to repay their debts. The
Mexico in particular has become a crucial part of Heinz’s growth
IMF’s Internet site provides additional information about the
strategy because Mexicans consume more ketchup than all but
organization, including news releases, frequently asked ques-
eight other nations.59 Table 3.4 shows the number of U.S. export-
tions, and members.
ers and the export value by company size, while Figure 3.2 shows
The IMF is the closest thing the world has to an international some of the world’s largest exporting countries.
central bank. If countries get into financial trouble, they can
Exporting sometimes takes place through countertrade agree-
borrow from the World Bank. However, the global economic
ments, which involve bartering products for other products
crisis created many challenges for the IMF as it was forced to
instead of for currency. Such arrangements are fairly common in
significantly increase its loans to both emerging economies
international trade, especially between Western companies and
and more developed nations. Ireland accepted a bailout pack-
eastern European nations. An estimated 40 percent or more of all
age worth up to £77 billion (120 billion USD) from the IMF
international trade agreements contain countertrade provisions.
and the EU. Similarly, the IMF also loaned 30 billion euros
(39 billion USD) to help rescue Greece’s struggling economy.57 Although a company may export its wares overseas directly or
The usefulness of the IMF for developed countries is limited import goods directly from its manufacturer, many choose to

trading company a
firm that buys goods in one
country and sells them to
deal with an intermediary, com- An advantage of trading through an agent instead of directly
buyers in another country
monly called an export agent. Export is that the company does not have to deal with foreign curren-
licensing a trade agents seldom produce goods them- cies or the red tape (paying tariffs and handling paperwork) of
agreement in which one selves; instead, they usually handle international business. A major disadvantage is that, because
company—the licensor— international transactions for other the export agent must make a profit, either the price of the
allows another company— firms. Export agents either purchase product must be increased or the domestic company must pro-
the licensee—to use its products outright or take them on vide a larger discount than it would in a domestic transaction.
company name, products, consignment. If they purchase them
patents, brands, trademarks,
raw materials, and/or
outright, they generally mark up the Trading Companies
price they have paid and attempt to A trading company buys goods in one country and sells them
production processes in
exchange for a fee or royalty sell the product in the international to buyers in another country. Trading companies handle all activ-
marketplace. They are also respon- ities required to move products from one country to another,
sible for storage and transportation. including consulting, marketing research, advertising, insurance,
product research and design, warehous-
T A B L E 3 . 4 U.S. Exporters and Value by Company Size ing, and foreign exchange services to
Number of Value (millions companies interested in selling their
Exporters Percentage of dollars) Percentage products in foreign markets. Trading
Unknown 101,765 35.2 93,146 8.1 companies are similar to export agents,
but their role in international trade is
Small (< 100 employees) 161,959 56.2 163,505 14.3
larger. By linking sellers and buyers of
Medium (100–499) 17,944 6.2 102,999 9.0 goods in different countries, trading
Large (> 500) 7,079 2.5 788,019 68.7 companies promote international trade.
Source: “A Profile of U.S. Exporting Companies, 2007–2008,” U.S. Census Bureau News, April 13, 2010, www. The best known U.S. trading company is
census.gov/foreign-trade/Press-Release/edb/2008/edbrel.pdf (accessed January 10, 2011). Sears World Trade, which specializes in
consumer goods, light industrial items,
and processed foods.
FIGURE 3.2
Top Exporting Countries
Licensing and
1,600
Franchising
Licensing is a trade arrangement in
1,400 which one company—the licensor—
allows another company—the licensee—
1,200 to use its company name, products,
patents, brands, trademarks, raw mate-
1,000 rials, and/or production processes
in exchange for a fee or royalty. The
Coca-Cola Company and PepsiCo
800 frequently use licensing as a means to
market their soft drinks, apparel, and
600 other merchandise in other countries.
Licensing is an attractive alternative
to direct investment when the politi-
400
cal stability of a foreign country is in
doubt or when resources are unavail-
200 able for direct investment. Licensing is
especially advantageous for small man-
0 ufacturers wanting to launch a well-
known brand internationally. Yoplait
da
ce
ly
es
an
nd
in
pa
re
is a French yogurt that is licensed for

Ita
do
at
na
an
Ch
Ko
rm
la
Ja
ng
St
Ca
Fr
er
production in the United States.

Ge
Ki
d
th
ut
ite
d
Ne
So
te
Un
i
Un
Franchising is a form of licensing

*2010 estimates in billions, calculated on an exchange rate basis. in which a company—the franchiser—
Source: “Country Comparison: Exports,” CIA, The World Factbook, https://www.cia.gov/library/publications/ agrees to provide a franchisee the name,
the-world-factbook/rankorder/2078rank.html (accessed March 2, 2011). logo, methods of operation, advertising,

franchising a form contract offshoring the
of licensing in which a manufacturing relocation of business
company—the franchiser— the hiring of a foreign processes by a company
products, and other elements associated with
agrees to provide a company to produce a or subsidiary to another
the franchiser’s business, in return for a finan- franchisee a name, logo, specified volume of the country. Offshoring is
cial commitment and the agreement to conduct methods of operation, initiating company’s different than outsourcing
business in accordance with the franchiser’s advertising, products, and product to specification; because the company
standard of operations. Wendy’s, McDon- other elements associated the final product carries the retains control of the
ald’s, Pizza Hut, and Holiday Inn are well- with a franchiser’s domestic firm’s name offshored processes.
known franchisers with international visibility. business, in return for a
Table 3.5 lists some of the top global franchises. financial commitment and
the agreement to conduct
Licensing and franchising enable a company business in accordance
to enter the international marketplace without with the franchiser’s
spending large sums of money abroad or hiring standard of operations
or transferring personnel to handle overseas
affairs. They also minimize problems asso-
ciated with shipping costs, tariffs, and trade
different than outsourcing: the company retains control of
restrictions. And, they allow the firm to establish goodwill for its
the process because it is not subcontracting to a different
products in a foreign market, which will help the company if it
company. Companies may choose to offshore for a number
decides to produce or market its products directly in the foreign
of reasons, ranging from lower wages, skilled labor, or taking
country at some future date. However, if the licensee (or franchi-
see) does not maintain high standards of quality, the product’s
image may be hurt; therefore, it is important for the licensor to
monitor its products overseas and to enforce its quality standards.
Contract Manufacturing
Contract manufacturing occurs when a company hires a
foreign company to produce a specified volume of the firm’s
product to specification; the final product carries the domestic
firm’s name. Spalding, for example, relies on contract manufac-
turing for its sports equipment; Reebok uses Korean contract
manufacturers to manufacture many of its athletic shoes.
Outsourcing
Earlier, we defined outsourcing as transferring manufactur-
ing or other tasks (such as information technology operations)
to companies in countries where labor and supplies are less
expensive. Many U.S. firms have outsourced tasks to India, Ire-
land, Mexico, and the Philippines, where there are many well- The Canadian frozen yogurt franchise Yogen Fruz has operations on four
educated workers and significantly lower labor costs. Experts continents.
estimate that 80 percent of Fortune 500 companies have some
relationship with an offshore company.60 T A B L E 3 . 5 Top Global Franchises
Although outsourcing has become politically controversial in Franchise Country Ranking
recent years amid concerns over jobs lost to overseas workers,
foreign companies transfer tasks and jobs to U.S. companies— McDonald’s United States 1
sometimes called insourcing—far more often than U.S. compa- Subway United States 2
nies outsource tasks and jobs abroad.61 However, some firms Intercontinental Hotels Group United Kingdom 6
are bringing their outsourced jobs back after concerns that for- Yogen Fruz Canada 15
eign workers were not adding enough value. For example, some
Kumon Japan 22
of the bigger banks are now choosing to set up offshore opera-
tions themselves rather than outsource. This has to do with Cartridge World Australia 33
increased regulations in foreign countries and concerns over Engel & Völkers Germany 38
data security. One instance of fraud at the Indian outsourcer Pita Pit Canada 43
Satyam amounted to more than $1 billion.62
Ben & Jerry’s United States 55
Offshoring Naturhouse Spain 77
Offshoring is the relocation of a business process by a Source: “Top 100 Global Franchises—Ranking,” Franchise Direct, www.
company, or a subsidiary, to another country. Offshoring is franchisedirect.com/top100globalfranchises/rankings/ (accessed January 10, 2011).

CHINA’S MONEY Orange Sky Golden Harvest Entertainment’s exposure. Yet with China gaining more
$25 million investment in Legendary Pictures expertise in filmmaking, is there a pos-
AND HOLLYWOOD (known for The Dark Knight and other block- sibility that China could one day become
FILMS MAKE FOR A busters) for a 3.3 percent stake in the com- a competitor with Hollywood? Rumor has
pany. In addition, China’s movie audience is it that China may be looking into direct
PARTNERSHIP growing, up 80 percent from 2009, and the investment by purchasing a Hollywood film
government is driving a large expansion in studio to solidify the partnership. Time will
C hina and Hollywood are forging a deep-

ening bond thanks to money and market
demand. Hollywood, which relies heavily on
movie theater construction. With China get-
ting more in-depth knowledge of the movie-
tell whether the increased knowledge that
Chinese filmmakers will receive from co-
making industry and Hollywood receiving production will one day lead to the creation
investors, has recently discovered the deep more capital to make its movies, the situa- of China’s own Hollywood.63
pockets of both the Chinese government and tion appears to be a win-win for both parties.
individual Chinese investors. At the same However, as with any partnership, there Discussion Questions
time, China, determined to grow its own film is often a certain degree of conflict. The 1. Why are the Chinese investing in Holly-
industry, is looking toward Hollywood for Chinese government, for instance, prefers wood films?
knowledge and audience expansion. to show Chinese-made movies within China 2. How is the Chinese government limiting
China’s economy is booming, creating and currently permits only 20 foreign films opportunities for the U.S. film industry?
a new market heavy on capital and enthu- into the country each year. This makes
siasm for film. Recent endeavors include 3. Should Hollywood movie companies
co-producing more ideal as co-produced
government-backed China Film’s $5 million be concerned about competition from
films do not fall under this ruling and give
investment in The Karate Kid remake and Chinese filmmakers?
Chinese filmmakers more international
advantage of time zone differences in order to offer services

around the clock. Some banks have chosen not to outsource
because of concerns about data security in other countries.
These institutions may instead engage in offshoring, which
allows a company more control over international operations
because the offshore office is an extension of the company.
Barclays Bank, for instance, has an international offshore
banking unit called Barclays Wealth International. This
branch helps the company better serve wealthy clients with
international banking needs.64
Joint Ventures
and Alliances
Many countries, particularly LDCs, do not permit direct invest-
ment by foreign companies or individuals. A company may
also lack sufficient resources or expertise to operate in another
country. In such cases, a company that wants to do business in
another country may set up a joint venture by finding a local
partner (occasionally, the host nation itself) to share the costs
and operation of the business. The French hypermarket chain
Carrefour, for example, has a joint venture with Majid al Futtaim Lenovo chief executive Yang Yuanqing (China) shakes hands with NEC
(MAF), a group of companies that has become a highly success- President Nobuhiro Endo (Japan) during an agreement to form a joint
ful Middle Eastern business. The venture between Carrefour and venture between the two PC companies.
MAF resulted in the expansion of MAF–Carrefour hypermar-
kets in the United Arab Emirates, Qatar, Oman, Saudi Arabia,
create competitive advantage on a worldwide basis. In such
and Egypt. The partnership has allowed Carrefour to become
industries, international competition is so fierce and the costs
one of the most popular retailers in Egypt.65
of competing on a global basis are so high that few firms have
In some industries, such as automobiles and computers, the resources to go it alone, so they collaborate with other
strategic alliances are becoming the predominant means of companies. An example of a strategic alliance is the partner-
competing. A strategic alliance is a partnership formed to ship between Australian airlines Virgin Blue and Skywest.

joint venture the strategic alliance multinational multinational global strategy
sharing of the costs and a partnership formed corporation (MNC) strategy a plan, used (globalization) a
operation of a business to create competitive a corporation that operates by international companies, strategy that involves
between a foreign company advantage on a worldwide on a worldwide scale, that involves customizing standardizing products
and a local partner basis without significant ties to products, promotion, and (and, as much as possible,
any one nation or region distribution according to their promotion and
direct investment cultural, technological, distribution) for the whole
the ownership of overseas regional, and national world, as if it were a single
facilities differences entity
By forming an alliance, the two airlines hope to tap into the

increased demand from the mining industry for flights to INTERNATIONAL
distant mining sites. As part of the agreement, Skywest can
use as many as 18 Virgin Blue turbo-prop aircraft for 10 BUSINESS STRATEGIES
years. In addition to penetrating a lucrative market, Virgin Planning in a global economy requires businesspeople to under-
Blue hopes the alliance will help it extend its influence into stand the economic, legal, political, and sociocultural realities of
regional markets and steal market share from its competitor the countries in which they will operate. These factors will affect
QantasLink.66 the strategy a business chooses to use outside its own borders.
Developing Strategies
Direct Investment Companies doing business internationally have traditionally
Companies that want more control and are willing to invest used a multinational strategy, customizing their products,
considerable resources in international business may con- promotion, and distribution according to cultural, technological,
sider direct investment, the ownership of overseas facilities. regional, and national differences. To succeed in India, for exam-
Direct investment may involve the development and operation ple, McDonald’s had to adapt its products to respect religious
of new facilities—such as when Starbucks opens a new coffee customs. McDonald’s India does not serve beef or pork products
shop in Japan—or the purchase of all or part of an existing and also has vegetarian dishes for its largely vegetarian consumer
operation in a foreign country. India’s Tata Motors purchased base. Many soap and detergent manufacturers have adapted their
Jaguar and Land Rover from Ford Motor Company. Tata, a products to local water conditions, washing equipment, and
maker of cars and trucks, is attempting to broaden its global washing habits. For customers in some less-developed countries,
presence, including manufacturing these vehicles in the United Colgate-Palmolive Co. has developed an inexpensive, plastic,
Kingdom.67 hand-powered washing machine for use in households that have
The highest level of international business involvement is the no electricity. Even when products are standardized, advertising
multinational corporation (MNC), a corporation, such often has to be modified to adapt to language and cultural differ-
as IBM or ExxonMobil, that operates on a worldwide scale, ences. Also, celebrities used in advertising in the United States
without significant ties to any one nation or region. Table 3.6 may be unfamiliar to foreign consumers and thus would not be
lists the 10 largest multinational corporations. MNCs are effective in advertising products in other countries.
more than simple corporations. They often have greater assets More and more companies are moving from this customization
than some of the countries in which they do business. Nestlé, strategy to a global strategy (globalization), which involves
with headquarters in Switzerland, operates
more than 300 plants around the world and T A B L E 3 . 6 Top 10 Largest Corporations
receives revenues from Europe; North, Cen- Company Revenue (in millions) Country
tral, and South America; Africa; and Asia.
The Royal Dutch/Shell Group, one of the 1. Wal-Mart Stores $421,849 U.S.
world’s major oil producers, is another MNC. 2. Royal Dutch Shell $378,152 Netherlands
Its main offices are located in The Hague 3. Exxon Mobil $354,674 U.S.
and London. Other MNCs include BASF, 4. BP $308,928 Britain
British Petroleum, Matsushita, Mitsubishi,
5. Sinopec Group $273,422 China
Siemens, Texaco, Toyota, and Unilever. Many
MNCs have been targeted by antiglobal- 6. China National Petroleum $240,294 China
ization activists at global business forums, 7. State Grid $226,294 China
and some protests have turned violent. The 8. Toyota Motor $221,760 Japan
activists contend that MNCs increase the 9. Japan Post Holdings $203,958 Japan
gap between rich and poor nations, misuse
10. Chevron $196,337 U.S.
and misallocate scarce resources, exploit the
labor markets in LDCs, and harm their natu- Source: “Global 500: Fortune’s Annual Ranking of the World’s Largest Corporations,” CNNMoney,
ral environments.68 http://money.cnn.com/magazines/fortune/global500/2011/full_list/ (accessed July 20, 2011).

SO YOU WANT A JOB // in Global Business /
H ave you always dreamt of traveling the
world? Whether backpacking your way
through Central America or sipping espres-
As more and more companies sell products
around the globe, their function, design,
packaging, and promotions need to be cul-
may have sold or purchased a product on
eBay outside the United States without think-
ing about how easy and accessible interna-
sos at five-star European restaurants is your turally relevant to many different people in tional markets are to business. If you have,
style, the increasing globalization of business many different places. Products very often welcome to the world of global business.
might just give you your chance to see what cross multiple borders before reaching the To be successful you must have an idea
the world has to offer. Most new jobs will final consumer, both in their distribution and not only of differing regulations from country
have at least some global component, even through the supply chain to produce the to country, but of different languages, eth-
if located within the United States, so being products. ics, and communication styles and varying
globally aware and keeping an open mind to Jobs exist in export and import manage- needs and wants of international markets.
different cultures is vital in today’s business ment, product and pricing management, From a regulatory side, you may need to be
world. Think about the 1.3 billion consumers distribution and transportation, and adver- aware of laws related to intellectual property,
in China who have already purchased 500 mil- tising. Many “born global” companies such copyrights, antitrust, advertising, and pricing
lion mobile phones. In the future, some of the as Google operate virtually and consider in every country. Translating is never only
largest markets will be in Asia. all countries their market. Many companies about translating the language. Perhaps even
Many jobs discussed in chapters through- sell their products through eBay and other more important is ensuring that your message
out this book tend to have strong international Internet sites and never leave the United gets through. Whether on a product label or in
components. For example, product manage- States Today, communication and transpor- advertising or promotional materials, the use
ment and distribution management are dis- tation facilitates selling and buying products of images and words varies widely across the
cussed as marketing careers in Chapter 12. worldwide with delivery in a few days. You globe.
standardizing products (and, as much as possible, their promotion and opening new market opportunities. Managers who can
and distribution) for the whole world, as if it were a single entity. meet the challenges of creating and implementing effective
Examples of globalized products are American clothing, movies, and sensitive business strategies for the global marketplace
music, and cosmetics. As it has become a global brand, Star- can help lead their companies to success. For example, the
bucks has standardized its products and stores. Commercial Service is the global business
Starbucks was ranked as the world’s most solutions unit of the U.S. Department of
engaged brand in terms of online activities, Commerce that offers U.S. firms wide and
even surpassing Coca-Cola, which is another TEAM EXERCISE deep practical knowledge of international
global brand. Starbucks communicates with Visit Transparency International’s markets and industries, a unique global
fans around the world via Facebook, Twitter, Country Corruption Index website: network, inventive use of information
YouTube, and its company website. www.transparency.org/. Form groups technology, and a focus on small and mid-
and select two countries. Research sized businesses. Another example is the
Before moving outside their own borders, some of the economic, ethical, legal,
companies must conduct environmental benchmarking of best international prac-
regulatory, and political barriers that tices that benefits U.S. firms, which is con-
analyses to evaluate the potential of and prob- would have an impact on interna-
lems associated with various markets and ducted by the network of CIBERs (Centers
tional trade. Be sure to pair a fairly
to determine what strategy is best for doing ethical country with a fairly unethical
for International Business Education and
business in those markets. Failure to do so country (e.g., Sweden with Myan- Research) at leading business schools in
may result in losses and even negative public- mar, Ireland with Haiti). Report your the United States. These 30 CIBERs are
ity. Some companies rely on local managers findings. funded by the U.S. government to help U.S.
to gain greater insights and faster response to firms become more competitive globally. A
changes within a country. Astute business- major element of the assistance that these
people today “think globally, act locally.” That governmental organizations can provide
is, while constantly being aware of the total picture, they adjust firms (especially for small and medium-sized
their firms’ strategies to conform to local needs and tastes. firms) is knowledge of the internationalization process.69
Small businesses, too, can succeed in foreign markets when
their managers have carefully studied those markets and pre-
Managing the Challenges pared and implemented appropriate strategies. Being globally
of Global Business aware is therefore an important quality for today’s managers
As we’ve pointed out in this chapter, many past political and will become a critical attribute for managers of the 21st
barriers to trade have fallen or been minimized, expanding century. ■

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82 PART 2 | Starting and Growing a Business
four
options for
organizing business
he legal form of ownership LEARNING OBJECTIVES
introduction
T taken by a business is seldom of

great concern to you as a cus-
tomer. When you eat at a restaurant,
LO1 Define and examine the advantages
and disadvantages of the sole pro-
prietorship form of organization.
LO2 Identify two types of partnership,
you probably don’t care whether the and evaluate the advantages and
disadvantages of the partnership
restaurant is owned by one person (a form of organization.
sole proprietorship), has two or more LO3 Describe the corporate form of or-
owners who share the business (a ganization, and cite the advantages
and disadvantages of corporations.
partnership), or is an entity owned by
LO4 Define and debate the advantages
many stockholders (a corporation); and disadvantages of mergers,
all you want is good food. If you buy acquisitions, and leveraged buyouts.
a foreign car, you probably don’t care

whether the company that made it has
laws governing its form of organization
that are different from those for busi-
nesses in the United States. You are
buying the car because it is well made,
fits your price range, or appeals to your
sense of style. Nonetheless, a busi-
ness’s legal form of ownership affects
how it operates, how much tax it pays,
and how much control its owners have.
continued on p. 84
CHAPTER 4 | Options for Organizing Business 83

sole
proprietorships
businesses owned and
This chapter examines three
operated by one individual;
the most common form of primary forms of business
SOLE PROPRIETORSHIPS
business organization in the
Sole proprietorships, businesses owned and operated by
United States
ownership—sole proprietorship, one individual, are the most common form of business organi-
partnership, zation in the United States. Common exam-
ples include many restaurants, hair salons,
and corpora- flower shops, dog kennels, and independent
tion—and weighs the advantages and Sole grocery stores. Many sole proprietors focus
on services—small retail stores, financial
disadvantages of each. These forms are proprietorships counseling, appliance repair, child care, and
the most often used whether the busi- the like—rather than on the manufacture
constitute of goods, which often requires large sums
ness is a traditional brick-and-mortar
of money not available to most small busi-
company, an online-only one, or a com- approximately nesses. As you can see in Figure 4.1, propri-
bination of both. We also take a look at S three-fourths of all etorships far outnumber corporations, but
they net far fewer sales and less income.
corporations, limited liability companies, businesses in the Sole proprietorships are typically small
and cooperatives and discuss some
United States. businesses employing fewer than 50 people.
trends in business ownership. You may (We’ll look at small businesses in greater
detail in Chapter 5.) Sole proprietorships constitute approxi-
wish to refer to Table 4.1 to compare the various forms of
mately three-fourths of all businesses in the United States. It
business ownership mentioned in the chapter. is interesting to note that men are twice as likely as women to
T A B L E 4 . 1 Various Forms of Business Ownership
Structure Ownership Taxation Liability Use

Sole Proprietorship 1 owner Individual income taxed Unlimited Owned by a single individual
and is the easiest way to
conduct business
Partnership 2 or more owners Individual owners’ Somewhat limited Easy way for two individuals
income taxed to conduct business
Corporation Any number of Corporate and Limited A legal entity with
shareholders shareholder taxed shareholders or stockholders
S Corporation Up to 75 shareholders Taxed as a partnership Limited A legal entity with tax
advantages for restricted
number of shareholders
Limited Liability Unlimited number of Taxed as a partnership Limited A way to avoid personal
Company shareholders lawsuits
STELLA & DOT: age 24 she launched WeddingChannel. Stella & Dot was recently selected by
com and later sold it for about $60 million. a venture capitalist panel as one of the
A COMPANY FOR For a $199 investment, “stylists” inter- top five companies to watch, as it grew
WOMEN BY WOMEN ested in selling for Stella & Dot receive 3,458 percent between 2006 and 2009. The
a training kit, access to online training panel’s only caution was that a revival in
materials, and $350 of free jewelry to the economy may cause a mass exodus
S tella & Dot, a direct selling jewelry
company, puts a fresh spin on the
traditional Tupperware and Avon models
create a stock of samples. Stylists earn
roughly 30 percent commission on trunk
toward traditional jobs and benefits. Herrin,
however, firmly believes that this opportu-
of personal selling. The company was shows (home parties) and online sales. nity, designed for women by women, is just
founded by Jessica Herrin, an entrepre- The company currently has more than beginning to grow.1
neur who is no stranger to success—at 10,000 stylists.

FIGURE 4.1 Apple Computer, and Mattel.3 Comput-
Comparison of Sole Proprietorships, Partnerships, and Corporations ers, personal copiers, scanners, and other
high-tech gadgets have been a boon for
home-based businesses, permitting them
13%
to interact quickly with customers, sup-
4% 9%
10% pliers, and others. Many independent
salespersons and contractors can per-
23% 19%
form their work using a smartphone or
tablet computer as they travel. E-mail and
83% 67% 72%
social networks have made it possible for
many proprietorships to develop in the
services area. Internet connections also
allow small businesses to establish web-
sites to promote their products and even
Sales Net Income Number
to make low-cost long-distance phone
calls with voice-over Internet protocol
Corporations Proprietorships Partnerships (VOIP) technology. One of the most
famous services using VOIP is Skype,
Source: U.S. Bureau of the Census, Statistical Abstract of the United States, www.census.gov/ which allows people to make free calls
prod/2009pubs/10statab/business.pdf (accessed March 1, 2010). over the Internet.
start their own business.2 In many areas, small businesses make Secrecy Sole proprietorships make
up the vast majority of the economy. possible the greatest degree of secrecy. The proprietor, unlike
the owners of a partnership or corporation, does not have to
Advantages of Sole discuss publicly his or her operating plans, minimizing the
possibility that competitors can obtain trade secrets. Financial
Proprietorships reports need not be disclosed, as do the financial reports of
Sole proprietorships are generally managed by their own- publicly owned corporations.
ers. Because of this simple management structure, the owner/
manager can make decisions quickly. This is just one of many Distribution and Use of Profits All profits from a
advantages of the sole proprietorship form of business. sole proprietorship belong exclusively to the owner. He or she
does not have to share them with any partners or stockholders.
Ease and Cost of Formation Forming a sole pro-
The owner decides how to use the funds—for expansion of the
prietorship is relatively easy and inexpensive. In some states,
business, or salary increases, for travel to purchase additional
creating a sole proprietorship involves merely announcing the
inventory, or to find new customers.
new business in the local newspaper. Other proprietorships,
such as barber shops and restaurants, may require state and
local licenses and permits because of the nature of the busi-
Flexibility and Control of the Business The sole
proprietor has complete control over the business and can make
ness. The cost of these permits may run from $25 to $100. No
decisions on the spot without anyone else’s approval. This con-
lawyer is needed to create such enterprises, and the owner can
trol allows the owner to respond quickly to competitive busi-
usually take care of the required paperwork without outside
ness conditions or to changes in the economy. The ability to
assistance.
quickly change prices or products can provide a competitive
Of course, an entrepreneur starting a new sole proprietorship advantage for the business.
must find a suitable site from which to operate the business.
Some sole proprietors look no farther than their garage or a Government Regulation Sole proprietorships have the
spare bedroom when seeking a workshop or office. Among the most freedom from government regulation. Many government
more famous businesses that sprang to life in their founders’ regulations—federal, state, and local—apply only to businesses
homes are Google, Walt Disney, Dell, eBay, Hewlett-Packard, that have a certain number of employees, and securities laws
Sole proprietorships have the most freedom

from government regulation.

IT IS USUALLY DIFFICULT FOR A SMALL SOLE
PROPRIETORSHIP TO MATCH THE WAGES AND BENEFITS
OFFERED BY A LARGE COMPETING CORPORATION BECAUSE
THE PROPRIETORSHIP’S PROFITS MAY NOT BE AS HIGH.
apply only to corporations that issue stock. Nonetheless, sole real estate, or other personal assets to guarantee the loan. If the
proprietors must ensure that they follow all laws that do apply business fails, the owner may lose the personal assets as well as
to their business. For example, sole proprietorships must be the business. Publicly owned corporations, in contrast, not only
careful to obey employee and consumer protection regulation. can obtain funds from commercial banks but also can sell stocks
and bonds to the public to raise money. If a public company
Taxation Profits from sole proprietorships are considered goes out of business, the owners do not lose personal assets.
personal income and are taxed at individual tax rates. The
owner, therefore, pays one income tax that includes the busi- Limited Skills The sole proprietor must be able to perform
ness and individual income. Another tax benefit is that a sole many functions and possess skills in diverse fields such as man-
proprietor is allowed to establish a tax-exempt retirement agement, marketing, finance, accounting, bookkeeping, and
account or a tax-exempt profit-sharing account. Such accounts personnel management. Business owners can rely on special-
are exempt from current income tax, but payments taken after ized professionals for advice and services, such as accountants
retirement are taxed when they are received. and attorneys. Freelancers, for example, can turn to agents for
assistance in obtaining projects and assignments. One firm spe-
Closing the Business A sole proprietorship can be dis- cializing in this type of assistance for visual effects artists is the
solved easily. No approval of co-owners or partners is necessary. Digital Artists Agency, whose clients include David Lombardi,
The only legal condition is that all financial obligations must be Chris LeDoux, and Academy Award–winner Tim McGovern.
paid or resolved. The DAA represents artists, many of them freelancers, and
connects them to companies.4 In the end, however, it is up to
Disadvantages of Sole the business owner to make the final decision in all areas of the
Proprietorships business.
What may be seen as an advantage by one person may turn out Lack of Continuity The life expectancy of a sole propri-
to be a disadvantage to another. For profitable businesses man- etorship is directly linked to that of the owner and his or her
aged by capable owners, many of the following factors do not ability to work. The serious illness of the owner could result in
cause problems. On the other hand, proprietors starting out failure of the business if competent help cannot be found.
with little management experience and little money are likely to
encounter many of the disadvantages. It is difficult to arrange for the sale of a proprietorship and at
the same time assure customers that the business will continue
Unlimited Liability The sole proprietor has unlimited to meet their needs. For instance, how does one sell a veteri-
liability in meeting the debts of the business. In other words, if nary practice? A veterinarian’s major asset is patients. If the vet
the business cannot pay its creditors, the owner may be forced dies suddenly, the equipment can be sold, but the patients will
to use personal, nonbusiness holdings such as a car or a home not necessarily remain loyal to the office. On the other hand, a
to pay off the debts. There are only a few states in which houses veterinarian who wants to retire could take in a younger part-
and homesteads cannot be taken by creditors, even if the pro- ner and sell the practice to the partner over time. One advan-
prietor declares bankruptcy. The more wealth an individual tage to the partnership is that some of the customers are likely
has, the greater is the disadvantage of unlimited liability. to stay with the business, even if ownership changes.
Limited Sources of Funds Among the relatively few Lack of Qualified Employees It is usually difficult for
sources of money available to the sole proprietorship are banks, a small sole proprietorship to match the wages and benefits
friends, family, the Small Business Administration, or his or offered by a large competing corporation because the propri-
her own funds. The owner’s personal financial condition deter- etorship’s profits may not be as high. In addition, there is little
mines his or her credit standing. Additionally, sole proprietor- room for advancement within a sole proprietorship, so the
ships may have to pay higher interest rates on funds borrowed owner may have difficulty attracting and retaining qualified
from banks than do large corporations because they are con- employees. On the other hand, the trend of large corporations
sidered greater risks. Often, the only way a sole proprietor can downsizing and outsourcing tasks has created renewed oppor-
borrow for business purposes is to pledge a car, a house, other tunities for small businesses to acquire well-trained employees.

partnership a form general partnership limited partnership articles of
of business organization a partnership that involves a business organization that partnership legal
defined by the Uniform a complete sharing in both has at least one general documents that set forth the
Partnership Act as “an the management and the partner, who assumes basic agreement between
association of two or more liability of the business unlimited liability, and at least partners
persons who carry on as one limited partner, whose
co-owners of a business for liability is limited to his or her
profit” investment in the business
Taxation Although we listed taxation as an advantage for venues.5 Professionals such as lawyers, accountants, and archi-
sole proprietorships, it can also be a disadvantage, depending tects often join together in general partnerships.
on the proprietor’s income. Under current tax rates, sole propri- A limited partnership has at least one general partner, who
etors pay a higher marginal tax rate than do small corporations assumes unlimited liability, and at least one limited partner,
on income of less than $75,000. However, sole proprietorships whose liability is limited to his or her investment in the business.
avoid the double taxation that occurs with corporations. The Limited partnerships exist for risky investment projects where
tax effect often determines whether a sole proprietor chooses to the chance of loss is great. The general partners accept the risk of
incorporate his or her business. loss; the limited partners’ losses are limited to their initial invest-
ment. Limited partners do not participate in the management
of the business but share in the profits in accordance with the
PARTNERSHIPS terms of a partnership agreement. Usually the general partner
receives a larger share of the profits after the limited partners
One way to minimize the disadvantages of a sole proprietor-
ship and maximize its advantages is to have more than one have received their initial investment back. Popular examples are
owner. Most states have a model law governing partnerships oil-drilling partnerships and real estate partnerships.
based on the Uniform Partnership Act. This law defines a
partnership as “an association of two or more persons who Articles of Partnership
carry on as co-owners of a business for profit.” Partnerships Articles of partnership are legal documents that set forth
are the least used form of business (see Figure 4.1). They are the basic agreement between partners. Most states require
typically larger than sole proprietorships but smaller than articles of partnership, but even if they are not required, it
corporations. makes good sense for partners to draw them up. Articles of
partnership usually list the money or assets that each partner
Partnerships can be a fruitful form of business, as long as has contributed (called partnership capital), state each partner’s
you follow some basic keys to success, which are outlined in individual management role or duty, specify how the profits
Table 4.2. and losses of the partnership will be divided among the part-
ners, and describe how a partner may leave the partnership as
Types of Partnership well as any other restrictions that might apply to the agreement.
There are two basic types of partnership: general partnership Table 4.3 lists some of the issues and provisions that should be
and limited partnership. A general partnership involves included in articles of partnership.
a complete sharing in the manage-
ment of a business. In a general part-
T A B L E 4 . 2 Keys to Success in Business Partnerships
nership, each partner has unlimited
liability for the debts of the business. 1. Keep profit sharing and ownership at 50/50, or you have an employer/employee relationship.
For example, Cirque du Soleil grew 2. Partners should have different skill sets to complement one another.
from a group of Quebec street per-
3. Honesty is critical.
formers, who acted as partners, into
a half-billion-dollar global company. 4. Must maintain face-to-face communication in addition to phone and e-mail.
Cirque du Soleil, however, ended its 5. Maintain transparency, sharing more information over time.
16-year run as a partnership in the 6. Be aware of funding constraints, and do not put yourself in a situation where neither you nor
year 2000. Guy Laliberte bought out your partner can secure additional financial support.
the other principle partner, Daniel 7. To be successful, you need experience.
Gauthier. Laliberte maintains a con- 8. Whereas family should be a priority, be careful to minimize the number of associated problems.
trolling share of the company, and
9. Do not become too infatuated with “the idea” as opposed to implementation.
Dubai’s state-run private equity firm
Istithmar World along with real estate 10. Couple optimism with realism in sales and growth expectations and planning.
developer Nakheel picked up a 20 per- Source: Abstracted from J. Watananbe, “14 Reasons Why 80% of New Business Partnerships Would Fail Within
cent stake in Cirque du Soleil for more Their First 5 Years of Existence,” http://ezinearticles.com/?14-Reasons-Why-80-Percent-Of-New-Business-
global expansion of permanent show Partnerships-Would-Fail-Within-Their-First-5-Years-Of-Exis&id5472498 (accessed March 16, 2010).

WHEN A BUSINESS HAS SEVERAL PARTNERS, IT HAS
THE BENEFIT OF A COMBINATION OF TALENTS.
T A B L E 4 . 3 Issues and Provisions in Articles of Partnership among two or three people owning
a computer repair shop. The advan-
1. Name, purpose, location
tages must be compared with those
2. Duration of the agreement offered by other forms of business
3. Authority and responsibility of each partner organization, and not all apply to
4. Character of partners (i.e., general or limited, active or silent) every partnership.
5. Amount of contribution from each partner
Ease of Organization Start-
6. Division of profits or losses ing a partnership requires little more
7. Salaries of each partner than drawing up articles of partner-
8. How much each partner is allowed to withdraw ship. No legal charters have to be
9. Death of partner granted, but the name of the business
should be registered with the state.
10. Sale of partnership interest
11. Arbitration of disputes Availability of Capital and
12. Required and prohibited actions
Credit When a business has several
13. Absence and disability partners, it has the benefit of a combi-
14. Restrictive covenants nation of talents and skills and pooled
15. Buying and selling agreements financial resources. Partnerships tend
to be larger than sole proprietorships
Source: Adapted from “Partnership Agreement Sample,” State of New Jersey, www.state.nj.us/njbusiness/
and therefore have greater earn-
starting/basics/partnership_agreement_sample.shtml (accessed March 15, 2010).
ing power and better credit ratings.
Because many limited partnerships
Advantages of Partnerships have been formed for tax purposes
rather than for economic profits, the combined income of all
Law firms, accounting firms, and investment firms with several
U.S. partnerships is quite low, as shown in Figure 4.1. Neverthe-
hundred partners have partnership agreements that are quite
less, the professional partnerships of many lawyers, accountants,
complicated in comparison with the partnership agreement
and banking firms make quite large profits. For instance, the
partners in the international law firm Davis Polk & Wardwell
LLP take home an average of approximately $2 million a year.6
Combined Knowledge and Skills Partners in the

most successful partnerships acknowledge each other’s talents
and avoid confusion and conflict by specializing in a particu-
lar area of expertise such as marketing, production, accounting,
or service. The diversity of skills in a partnership makes it pos-
sible for the business to be run by a management team of spe-
cialists instead of by a generalist sole proprietor. Co-founders
Barry Nalebuff and Seth Goldman credit this diversity as being
a key component to the success of their company Honest
Tea. In less than a decade, Honest Tea went from $250,000 to
$13.5 million in sales and attracted the attention of Coca-Cola.
Coca-Cola bought a 40 percent stake in the company.7 Service-
oriented partnerships in fields such as law, financial planning,
and accounting may attract customers because clients may think
that the service offered by a diverse team is of higher quality
than that provided by one person. Larger law firms, for example,
In 1996 Stanford students Sergey Brin and Larry Page partnered to form often have individual partners who specialize in certain areas of
the search engine Google as part of a research project. The company was the law—such as family, bankruptcy, corporate, entertainment,
incorporated in 1998 and is now the world’s top search engine. and criminal law.

Decision Making Small partnerships can react more Limited partners have no voice in the management of the
quickly to changes in the business environment than can large partnership, and they may bear most of the risk of the business
partnerships and corporations. Such fast reactions are possible while the general partner reaps a larger share of the benefits.
because the partners are involved in day-to-day operations and There may be a change in the goals and objectives of one partner
can make decisions quickly after consultation. Large partner- but not the other, particularly when the partners are multinational
ships with hundreds of partners in many states are not com- organizations. This can cause friction, giving rise to an enterprise
mon. In those that do exist, decision making is likely to be slow. that fails to satisfy both parties or even forcing an end to the part-
However, some partnerships have been successful despite their nership. Many partnership disputes wind up in court or require
large size. The accounting firm Baird, Kurtz & Dodson is the outside mediation. A partnership can be jeopardized when two
10th largest accounting and advisory firm in the United States business partners cannot resolve disputes. In Saunders v. Firtel
with approximately 250 partners and principals and 2,000 per- (Firtel held a 51 percent stake and Saunders a 49 percent in Adco
sonnel. The company has gross revenues of over $400 million. Medical Supplies Inc.), Saunders was not only a partner, but a
Some have attributed BKD’s success to its strong diversification paid employee. When the two entered into an unresolvable dis-
techniques and ability to operate in different market niches.8 pute, Firtel fired Saunders and did not pay wages. Saunders sued
under Connecticut law, which states that “when any employer
Regulatory Controls Like a sole proprietorship, a part- fails to pay an employee’s wages . . . the employee may recover, in
nership has fewer regulatory controls affecting its activities civil action, twice the full amount of such wages.” Saunders won
than does a corporation. A partnership does not have to file the case because the trial court found the failure to pay wages was
public financial statements with government agencies or send willful.9 In some cases, the ultimate solution may be dissolving
out quarterly financial statements to several thousand owners, the partnership. Major disadvantages of partnerships include the
as do corporations such as Apple and Ford Motor Co. A part- following.
nership does, however, have to abide by all laws relevant to the
industry or profession in which it operates as well as state and Unlimited Liability In general partnerships, the general
federal laws relating to hiring and firing, food handling, and so partners have unlimited liability for the debts incurred by the
on, just as the sole proprietorship does. business, just as the sole proprietor has unlimited liability for his
or her business. Such unlimited liability can be a distinct disad-
Disadvantages of Partnerships vantage to one partner if his or her personal financial resources
Partnerships have many advantages compared to sole proprietor- are greater than those of the others. A potential partner should
ships and corporations, but they also have some disadvantages. check to make sure that all partners have comparable resources to
MICROLENDING Kiva partners with microfinance insti- loans, but Kiva wants to go even further.
tutions worldwide. These field partners It has established a five-year plan, aim-
HELPS SMALL approve entrepreneurs and send their pro- ing to reach $1 billion in global loans, help
ENTREPRENEURS files to Kiva. The entrepreneurs’ profiles 2 million entrepreneurs, and achieve organi-
are then posted on Kiva’s website, and zational sustainability. The buzz about Kiva is
START BUSINESSES people who want to lend to an entrepre- positive, and Kiva.org’s future looks bright as
neur send their donations through the site. microlending continues to receive favorable
S ending food and money to disadvan-

taged communities meets immedi-
ate needs, but ending long-term poverty
Kiva’s field partners distribute the loans,
work with the entrepreneurs, and collect
press.10
repayments. Kiva.org does not earn returns Discussion Questions

is more difficult. Kiva.org is one business on investments for lenders, but it does 1. Kiva.org has been very successful at
that seeks to tackle this problem head on. charge interest rates of between 23 and extending microlending to entrepreneurs
Founded by Stanford graduates with an 48 percent. These interest rates cover loan in need. What about Kiva.org has helped
interest in business and technology, Kiva costs, transaction costs, defaults, and infla- make it so successful?
was first designed to lend money to impov- tion rates—and are much lower than rates 2. What is unique about the way Kiva.org
erished Ugandan entrepreneurs. It soon charged by informal lenders or predatory is organized that sets it apart from more
expanded its reach to include other devel- lenders who typically supply loans to those traditional businesses?
oping countries. Kiva is a microfinance who do not qualify for bank loans.
business, which means it provides small 3. Do you think the Kiva.org model of giv-
Kiva and over 560,000 lenders have suc-
loans—as little as $25 for equipment, for ing loans would work for larger loans, or
ceeded in providing loans to over half a
example—to individuals to start their own even for other kinds of businesses?
million entrepreneurs since 2005. The com-
businesses. pany has given $200 million in worldwide

corporation a legal
entity, created by the state,
whose assets and liabilities
are separate from its owners
help the business in time of trouble. division of the profits does not reflect the work each partner
This disadvantage is eliminated for puts into the business. You may have encountered this disad-
stock shares of a limited partners, who can lose only vantage while working on a student group project: You may
corporation that may be their initial investment. have felt that you did most of the work and that the other stu-
bought or sold dents in the group received grades based on your efforts. Even
Business Responsibility the perception of an unfair profit-sharing agreement may cause
All partners are responsible for tension between the partners, and unhappy partners can have a
the business actions of all others. negative effect on the profitability of the business.
Partners may have the ability to commit the partnership to a
contract without approval of the other partners. A bad decision Limited Sources of Funds As with a sole proprietor-
by one partner may put the other partners’ personal resources ship, the sources of funds available to a partnership are limited.
in jeopardy. Personal problems such as a divorce can eliminate Because no public value is placed on the business (such as the
a significant portion of one partner’s financial resources and current trading price of a corporation’s stock), potential partners
weaken the financial structure of the whole partnership. do not know what one partnership share is worth. Moreover,
because partnership shares cannot be bought and sold easily in
Life of the Partnership A partnership is terminated public markets, potential owners may not want to tie up their
when a partner dies or withdraws. In a two-person partnership, money in assets that cannot be readily sold on short notice. Accu-
if one partner withdraws, the firm’s liabilities would be paid mulating enough funds to operate a national business, especially
[ “All partners are responsible for the business

actions of all others.” ]
off and the assets divided between the partners. Obviously, the a business requiring intensive investments in facilities and equip-
partner who wishes to continue in the business would be at a ment, can be difficult. Partnerships also may have to pay higher
serious disadvantage. The business could be disrupted, financ- interest rates on funds borrowed from banks than do large cor-
ing would be reduced, and the management skills of the depart- porations because partnerships may be considered greater risks.
ing partner would be lost. The remaining partner would have to
find another or reorganize the business as a sole proprietorship. Taxation of Partnerships
In very large partnerships such as those found in law firms and Partnerships are quasi-taxable organizations. This means that
investment banks, the continuation of the partnership may be partnerships do not pay taxes when submitting the partnership
provided for in the articles of partnership. The provision may tax return to the Internal Revenue Service. The tax return sim-
simply state the terms for a new partnership agreement among ply provides information about the profitability of the organiza-
the remaining partners. In such cases, the disadvantage to the tion and the distribution of profits among the partners. Partners
other partners is minimal. must report their share of profits on their individual tax returns
and pay taxes at the income tax rate for individuals.
Selling a partnership interest has the same effect as the death or
withdrawal of a partner. It is difficult to place a value on a part-
ner’s share of the partnership. No public value is placed on the
partnership, as there is on publicly owned corporations. What is
CORPORATIONS
When you think of a business, you probably think of a huge cor-
a law firm worth? What is the local hardware store worth? Com-
poration such as General Electric, Procter & Gamble, or Sony
ing up with a fair value that all partners can agree to is not easy.
because a large portion of your consumer dollars go to such
Selling a partnership interest is easier if the articles of partnership
corporations. A corporation is a legal entity, created by the
specify a method of valuation. Even if there is not a procedure
state, whose assets and liabilities are separate from its owners. As
for selling one partner’s interest, the old partnership must still
a legal entity, a corporation has many of the rights, duties, and
be dissolved and a new one created. In contrast, in the corporate
powers of a person, such as the right to receive, own, and transfer
form of business, the departure of owners has little effect on the
property. Corporations can enter into contracts with individuals
financial resources of the business, and the loss of managers does
or with other legal entities, and they can sue and be sued in court.
not cause long-term changes in the structure of the organization.
Corporations account for the majority of all U.S. sales and
Distribution of Profits Profits earned by the partnership income. Thus, most of the dollars you spend as a consumer
are distributed to the partners in the proportions specified in probably go to incorporated businesses (see Figure 4.1). Most
the articles of partnership. This may be a disadvantage if the corporations are not mega-companies like General Mills or

dividends profits of corporate charter private corporation
a corporation that are a legal document that the a corporation owned by
distributed in the form state issues to a company just one or a few people
Ford Motor Co.; even small busi-
of cash payments to based on information the who are closely involved in
nesses can incorporate. As we stockholders company provides in the managing the business
shall see later in the chapter, many articles of incorporation
smaller firms elect to incorporate
as “S Corporations,” which operate
under slightly different rules and 3. Classes of stock (common, preferred, voting, nonvoting) and
have greater flexibility than do traditional “C Corporations” the number of shares for each class of stock to be issued.
like General Mills.
4. Expected life of the corporation (corporations are usually
Corporations are typically owned by many individuals and orga- created to last forever).
nizations who own shares of the business, called stock (thus,
5. Financial capital required at the time of incorporation.
corporate owners are often called shareholders or stockholders).
Stockholders can buy, sell, give or receive as gifts, or inherit their 6. Provisions for transferring shares of stock between owners.
shares of stock. As owners, the stockholders are entitled to all 7. Provisions for the regulation of internal corporate affairs.
profits that are left after all the corporation’s other obligations
have been paid. These profits may be distributed in the form of 8. Address of the business office registered with the state of
cash payments called dividends. For example, if a corporation incorporation.
earns $100 million after expenses and taxes and decides to pay 9. Names and addresses of the initial board of directors.
the owners $40 million in dividends, the stockholders receive 40
10. Names and addresses of the incorporators.
percent of the profits in cash dividends. However, not all after-
tax profits are paid to stockholders in dividends. Some corpora- Based on the information in the articles of incorporation, the state
tions may retain profits to expand the business. For example, issues a corporate charter to the company. After securing this
Berkshire Hathaway has always retained its earnings and rein- charter, the owners hold an organizational meeting at which they
vested them for the shareholders. This has resulted in an average establish the corporation’s bylaws and elect a board of directors.
20 percent in per share investment over a 40-year period.11 The bylaws might set up committees of the board of directors
and describe the rules and procedures for their operation.
Creating a Corporation
A corporation is created, or incorporated, under the laws of Types of Corporations
the state in which it incorporates. The individuals creating the If the corporation does business in the state in which it is char-
corporation are known as incorporators. Each state has a spe- tered, it is known as a domestic corporation. In other states
cific procedure, sometimes called chartering the corporation, where the corporation does business, it is known as a foreign
for incorporating a business. Most states require a minimum of corporation. If a corporation does business outside the nation
A corporation may be privately or publicly owned.
three incorporators; thus, many small businesses can be and are in which it incorporated, it is called an alien corporation. A cor-
incorporated. Another requirement is that the new corporation’s poration may be privately or publicly owned.
name cannot be similar to that of another business. In most A private corporation is owned by just one or a few peo-
states, a corporation’s name must end in “company,” “corpora- ple who are closely involved in managing the business. These
tion,” “incorporated,” or “limited” to show that the owners have people, often a family, own all the corporation’s stock, and no
limited liability. (In this text, however, the word company means stock is sold to the public. Many corporations are quite large,
any organization engaged in a commercial enterprise and can yet remain private, including Cargill, a farm products business.
refer to a sole proprietorship, a partnership, or a corporation.) It is the nation’s largest private corporation with annual rev-
The incorporators must file legal documents generally referred enues of well over $100 billion. Founded at the end of the Civil
to as articles of incorporation with the appropriate state office War, descendants of the original founder have owned equity
(often the secretary of state). The articles of incorporation con- in the company for more than 140 years.12 The fifth-largest
tain basic information about the business. The following 10 items privately held company in the United States is Mars, founded
are found in the Model Business Corporation Act, issued by the by Frank C. Mars who spent time in Switzerland learning to
American Bar Association, which is followed by most states: create chocolate confectionaries. Mars recently grew signifi-
cantly through the acquisition of the Wm. Wrigley Jr. Com-
1. Name and address of the corporation.
pany. Founded in Tacoma, Washington, in 1911, Mars is now
2. Objectives of the corporation. the world’s leading confectionary company and a leader in pet

public corporation
a corporation whose stock
anyone may buy, sell, or
trade
care products with Pedigree and A public corporation is one whose stock anyone may buy,
Whiskas.13 The business was suc- sell, or trade. Table 4.4 lists the largest U.S. corporations by
initial public cessful early on because it paid revenues. Despite their high revenues, Citigroup and American
offering (IPO) selling a employees three times the nor- International Group had negative profits in 2010.15 Thousands
corporation’s stock on public mal wage for the time. The com- of smaller public corporations in the United States have sales
markets for the first time pany remains successful to this under $10 million. In large public corporations such as AT&T,
day, largely because of its estab- the stockholders are often far removed from the management
lished brands, such as M&Ms, and of the company. In other public corporations, the managers
healthy snack lines for kids, like are often the founders and the major shareholders. NASCAR,
Generation Max.14 Other well-known privately held compa- for example, was founded by William France in 1948, and ever
nies include Chrysler, Publix Supermarkets, Dollar General, since then his descendants have manned the helm as CEO.
Privately owned corporations are not required to

disclose financial information publicly, but they
must, of course, pay taxes.
and MGM Entertainment. Privately owned corporations are Grandson Brian France currently fills the post.16 Forbes Global
not required to disclose financial information publicly, but 2000 companies generate around $30 trillion in revenues,
they must, of course, pay taxes. $1.4 trillion in profits, and $124 trillion in assets. They are
worth $31 trillion in market value. The
United States still has the majority of the
T A B L E 4 . 4 The Largest U.S. Corporations, Arranged by Revenue
Global 2000 companies, but other nations
Rank Company Revenues (in millions of $) are catching up. The rankings of the
Global 2000 span across 62 countries.17
1 Wal-Mart Stores $421,849.0
Publicly owned corporations must dis-
2 Exxon Mobil $354,674.0 close financial information to the public
3 Chevron $196,337.0 under specific laws that regulate the trade
4 ConocoPhillips $184,966.0 of stocks and other securities.
5 Fannie Mae $153,825.0 A private corporation that needs more
6 General Electric $151,628.0 money to expand or to take advantage of
7 Berkshire Hathaway $136,185.0 opportunities may have to obtain financ-
ing by “going public” through an initial
8 General Motors $135,592.0
public offering (IPO), that is, becom-
9 Bank of America Corp. $134,194.0 ing a public corporation by selling stock
10 Ford Motor $128,954.0 so that it can be traded in public markets.
11 Hewlett-Packard $126,033.0 In 2010 General Motors launched the
12 AT&T $124,629.0
world’s biggest IPO estimated at about
$23.1 billion. This IPO is one step in Gen-
13 J.P. Morgan Chase & Co. $115,475.0
eral Motors’ plan to rebound from the
14 Citigroup $111,055.0 massive losses it had incurred in recent
15 McKesson $108,702.0 years. GM plans to use $11.8 billion of
16 Verizon Communications $106,565.0 the IPO proceeds to begin paying back the
$50 billion bailout it received from the
17 American International Group $104,417.0
government.18
18 International Business Machines $ 99,870.0
Also, privately owned firms are occasion-
19 Cardinal Health $ 98,601.9
ally forced to go public with stock offer-
20 Freddie Mac 98,368.0 ings when a major owner dies and the
Source: “Fortune 500,” CNNMoney, http://money.cnn.com/magazines/fortune/fortune500/2011/full_list/ heirs have large estate taxes to pay. The
(accessed July 20, 2011). tax payment may be possible only with the

quasi-public nonprofit board of directors
corporations corporations a group of individuals,
corporations owned and corporations that focus elected by the stockholders
proceeds of the sale of stock. This hap-
operated by the federal, on providing a service to oversee the general
pened to the brewer Adolph Coors Inc. operation of the corporation,
state, or local government rather than earning a profit
After Adolph Coors died, the business but are not owned by a who set the corporation’s
went public and his family sold shares government entity long-range objectives
of stock to the public in order to pay the
estate taxes.
On the other hand, public corporations can be “taken private”

when one or a few individuals (perhaps the management of the
firm) purchase all the firm’s stock so that it can no longer be
sold publicly. Taking a corporation private may be desirable
when new owners want to exert more control over the firm or
they want to avoid the necessity of public disclosure of future
activities for competitive reasons. For example, RCN Corpora-
tion, a broadband provider, was purchased by a private equity
group, Abry Partners LLC, for about $535 million in cash.
Abry’s goal with the purchase is to expand its companies offer-
ing broadband and cable service in New York, Boston, and Phil-
adelphia.19 Taking a corporation private is also one technique
for avoiding a takeover by another corporation.
Quasi-public corporations and nonprofits are two types The snack and food company Mars is privately owned by the Mars family.
of public corporations. Quasi-public corporations are Frank C. Mars founded the firm in 1911, and the company headed by
owned and operated by the federal, state, or local government. Forest Mars Sr. began selling its most popular candy, M&Ms, in 1941.
[ “Taking a corporation private is also one technique for

avoiding a takeover by another corporation.” ]
The focus of these entities is to provide a service to citizens, achieved on schedule. Board members are legally liable for the
such as mail delivery, rather than earning a profit. Indeed, mismanagement of the firm or for any misuse of funds. An
many quasi-public corporations operate at a loss. Examples important duty of the board of directors is to hire corporate
of quasi-public corporations include the National Aeronau- officers, such as the president and the chief executive officer
tics and Space Administration (NASA) and the U.S. Postal
Service.
Like quasi-public corporations, nonprofit corporations focus
on providing a service rather than earning a profit, but they are
not owned by a government entity. Organizations such as the Ses-
ame Workshop, the Elks Clubs, the American Lung Association,
the American Red Cross, museums, and private schools provide
services without a profit motive. To fund their operations and
services, nonprofit organizations solicit donations from individ-
uals and companies and grants from the government and other
charitable foundations.
Elements of a Corporation
The Board of Directors A board of directors, elected
by the stockholders to oversee the general operation of the cor- Lionsgate is a diversified entertainment corporation that provides
poration, sets the long-range objectives of the corporation. It excellent documentation on its corporate governance and financial
is the board’s responsibility to ensure that the objectives are performance.

preferred stock
a special type of stock
whose owners, though not
generally having a say in
(CEO), who are responsible to the company. Outside directors are often top executives from
running the company, have the directors for the management other companies, lawyers, bankers, even professors. Directors
a claim to profits before and daily operations of the firm. today are increasingly chosen for their expertise, competence,
other stockholders do The role and expectations of the and ability to bring diverse perspectives to strategic discussions.
board of directors took on greater Outside directors are also thought to bring more independence
common stock stock significance after the accounting to the monitoring function because they are not bound by past
whose owners have voting scandals of the early 2000s and allegiances, friendships, a current role in the company, or some
rights in the corporation, yet the passage of the Sarbanes-Oxley other issue that may create a conflict of interest. Many of the
do not receive preferential Act.20 As a result, most corpora- corporate scandals uncovered in recent years might have been
treatment regarding
tions have restructured how they prevented if each of the companies’ boards of directors had been
dividends
compensate board directors for better qualified, more knowledgeable, and more independent.
their time and expertise.
There is a growing shortage of available and qualified board
However, some experts now speculate that Sarbanes-Oxley did members. Boards are increasingly telling their own CEOs that
little to motivate directors to increase company oversight. One they should be focused on serving their company, not serving on
notable case of alleged director misconduct involves a lawsuit outside boards. Because of this, the average CEO sits on less than
filed by the SEC against three directors of DHB Industries. The one outside board. This represents a decline from a decade ago
SEC accused these directors of purposefully ignoring red flags when the average was two. Because many CEOs are turning down
that indicated company misconduct. However, such lawsuits outside positions, many companies have taken steps to ensure
are the exception to the norm. If it cannot be proven that direc- that boards have experienced directors. They have increased the
tors did not act in good faith, it is hard for the SEC to develop mandatory retirement age to 72 or older, and some have raised it
a case against them.21 At the same time, the pay rate of direc- to 75 or even older. Minimizing the amount of overlap between
tors is rising. In 2009, the median pay for directors at the 200 directors sitting on different boards helps limit conflicts of inter-
largest companies was $228,000. At Apple it is even higher at est and provides for independence in decision making.
$984,000. Analysts believe that 50 percent of boards could see
pay raises as high as 15 percent within the year. Although such Stock Ownership Corporations issue two types of stock:
pay is meant to attract top-quality directors, concerns exist preferred and common. Owners of preferred stock are
over whether excessive pay will have unintended consequences. a special class of owners because, although they generally do
Some believe that pay over $200,000 will cause directors to be not have any say in running the company, they have a claim
more complacent and overlook potential misconduct in order to profits before any other stockholders do. Other stockholders
to keep their positions.22 do not receive any dividends unless the preferred stockholders
have already been paid. Dividend payments on preferred stock
Directors can be employees of the company (inside directors) are usually a fixed percentage of the initial issuing price (set
or people unaffiliated with the company (outside directors). by the board of directors). For example, if a share of preferred
Inside directors are usually the officers responsible for running stock originally cost $100 and the dividend rate was stated at
7.5 percent, the dividend payment will be $7.50 per share per
year. Dividends are usually paid quarterly. Most preferred stock
carries a cumulative claim to dividends. This means that if the
company does not pay preferred stock dividends in one year
because of losses, the dividends accumulate to the next year.
Such dividends unpaid from previous years must also be paid
to preferred stockholders before other stockholders can receive
any dividends.
Although owners of common stock do not get such
preferential treatment with regard to dividends, they do get
some say in the operation of the corporation. Their owner-
ship gives them the right to vote for members of the board
of directors and on other important issues. Common stock
dividends may vary according to the profitability of the
business, and some corporations do not issue dividends at
all, but instead plow their profits back into the company to
fund expansion.
Common stockholders are the voting owners of a corporation.
They are usually entitled to one vote per share of common stock.
Owners of preferred stock have first claim to company profits. During an annual stockholders’ meeting, common stockholders

OF ALL THE FORMS OF BUSINESS ORGANIZATION, THE
PUBLIC CORPORATION FINDS IT EASIEST TO RAISE MONEY.
elect a board of directors. Some boards find it easier than oth- held responsible for the firm’s debts if it fails. Their liability or
ers to attract high-profile individuals. For example, the board of potential loss is limited to the amount of their original invest-
Procter & Gamble consists of Ernesto Zedillo, former president ment. Although a creditor can sue a corporation for not pay-
of Mexico; Kenneth I. Chenault, CEO of the American Express ing its debts, even forcing the corporation into bankruptcy, it
Company; the CEO of Archer Daniels Midland; the CEO of Boe- cannot make the stockholders pay the corporation’s debts out of
ing; and a director of eBay.23 Because they can choose the board their personal assets. Occasionally, the owners of a private cor-
of directors, common stockholders have some poration may pledge personal assets to secure
say in how the company will operate. Common a loan for the corporation; this would be most
stockholders may vote by proxy, which is a writ- unusual for a public corporation.
ten authorization by which stockholders assign
their voting privilege to someone else, who then Ease of Transfer of Ownership Stock-
votes for his or her choice at the stockholders’ holders can sell or trade shares of stock to other
meeting. It is a normal practice for management people without causing the termination of the
to request proxy statements from shareholders corporation, and they can do this without the
who are not planning to attend the annual meet- prior approval of other shareholders. The trans-
ing. Most owners do not attend annual meetings fer of ownership (unless it is a majority posi-
of the very large companies, such as Westing- DID YOU KNOW? tion) does not affect the daily or long-term
house or Boeing, unless they live in the city where operations of the corporation.
the meeting is held. The first corporation
with a net income of Perpetual Life A corporation usually is char-
Common stockholders have another advantage tered to last forever unless its articles of incorpo-
over preferred shareholders. In most states, when
more than $1 billion ration stipulate otherwise. The existence of the
the corporation decides to sell new shares of com- in one year was corporation is unaffected by the death or with-
mon stock in the marketplace, common stock- General Motors, with drawal of any of its stockholders. It survives until
holders have the first right, called a preemptive a net income in 1955 the owners sell it or liquidate its assets. However, in
right, to purchase new shares of the stock from the of $1,189,477,082.24 some cases, bankruptcy ends a corporation’s life.
corporation. A preemptive right is often included Bankruptcies occur when companies are unable
in the articles of incorporation. This right is to compete and earn profits. Eventually, uncom-
important because it allows stockholders to purchase new shares petitive businesses must close or seek protection from creditors in
to maintain their original positions. For example, if a stockholder bankruptcy court while the business tries to reorganize.
[ “Common stockholders are the voting owners

of a corporation.” ]
owns 10 percent of a corporation that decides to issue new shares, External Sources of Funds Of all the forms of busi-
that stockholder has the right to buy enough of the new shares to ness organization, the public corporation finds it easiest to
retain the 10 percent ownership. raise money. When a corporation needs to raise more money,
it can sell more stock shares or issue bonds (corporate “IOUs,”
Advantages of Corporations which pledge to repay debt), attracting funds from anywhere in
Because a corporation is a separate legal entity, it has some very the United States and even overseas. The larger a corporation
specific advantages over other forms of ownership. The biggest becomes, the more sources of financing are available to it. We
advantage may be the limited liability of the owners. take a closer look at some of these in Chapter 15.
Limited Liability Because the corporation’s assets (money Expansion Potential Because large public corporations
and resources) and liabilities (debts and other obligations) are can find long-term financing readily, they can easily expand
separate from its owners’, in most cases the stockholders are not into national and international markets. And, as a legal entity, a

BOB’S RED MILL ingredients. The company boasts sales of Moore regularly receives offers from those
over $70 million annually and enjoys con- looking to purchase Bob’s Red Mill for large
ENCOURAGES sistent growth of 20 to 30 percent per year. sums of money, but his dream has always
LOYALTY THROUGH With an ESOP program, Bob’s Red Mill been to reward those who truly made the
has an employee trust fund made up of company what it is today. Although he
EMPLOYEE stock shares. Employees receive shares has no intention of retiring, Moore now
OWNERSHIP based on a formula. With seniority comes believes his company will always be in the
a greater right to shares, called vesting. At hands of those who care deeply about its
Bob’s Red Mill, employees are fully vested success.25
H ow would you like to get a company
as a gift . . . on somebody else’s birth-
day? On February 15, 2010, Bob Moore,
after three years of service. With shares
often come voting rights, which gives Discussion Questions
founder of Bob’s Red Mill Products, gave employees a direct say in how the company 1. Why did Bob Moore give his employees
his employees company ownership through is run. Upon retirement from the company, ownership through an employee stock
an employee stock ownership plan (ESOP). employees receive money for their shares. ownership plan (ESOP)?
It was his 81st birthday. Bob’s Red Mill As Bob sees it, he’s selling the company to 2. What are the advantages of having
was founded over 25 years ago by Bob and his employees without any money leaving employees as owners at Bob’s Red Mill
Charlee Moore after they stumbled across their pockets. Products?
an old abandoned mill and decided to turn it Bob’s Red Mill has succeeded thanks
3. Does stock ownership help employees
into a business. Today, Bob’s Red Mill offers to its dedication to high-quality products,
understand the operations and financial
over 400 whole-grain natural food prod- excellent customer service, and a repu-
success of Bob’s Red Mill Products?
ucts, ranging from flour to cereal to baking tation for treating employees like family.
corporation can enter into contracts without as much difficulty dividends are taxed a second time as part of the individual own-
as a partnership. er’s income. This process creates double taxation for the stock-
holders of dividend paying corporations. Double taxation does
Disadvantages of Corporations not occur with the other forms of business organization.
Corporations have some distinct disadvantages resulting from
tax laws and government regulation. Forming a Corporation The formation of a corpora-
tion can be costly. A charter must be obtained, and this usually
Double Taxation As a legal entity, the corporation must requires the services of an attorney and payment of legal fees.
pay taxes on its income just like you do. When after-tax cor- Filing fees ranging from $25 to $150 must be paid to the state
porate profits are paid out as dividends to the stockholders, the that awards the corporate charter, and certain states require that
an annual fee be paid to maintain the charter. Today, a num-
ber of Internet services such as LegalZoom.com and Business.
com make it easier, quicker, and less costly to form a corpora-
tion. However, in making it easier for people to form businesses
without expert consultation, these services have increased the
risk that people will not choose the kind of organizational form
that is right for them. Sometimes, one form works better than
another. The business’s founders may fail to take into account
disadvantages, such as double taxation with corporations.
Disclosure of Information Corporations must make

information available to their owners, usually through an annual
report to shareholders. The annual report contains financial
information about the firm’s profits, sales, facilities and equip-
ment, and debts, as well as descriptions of the company’s
operations, products, and plans for the future. Public corpora-
tions must also file reports with the Securities and Exchange
Commission (SEC), the government regulatory agency that reg-
ulates securities such as stocks and bonds. The larger the firm,
the more data the SEC requires. Because all reports filed with
With revenues surpassing $380 billion, ExxonMobil is one of the world’s the SEC are available to the public, competitors can access them.
largest corporations. Additionally, complying with securities laws takes time.

joint venture a S corporation limited liability cooperative or
partnership established for corporation taxed as though company (LLC) form co-op an organization
a specific project or for a it were a partnership with of ownership that provides composed of individuals or
limited time restrictions on shareholders limited liability and taxation small businesses that have
like a partnership but banded together to reap the
places fewer restrictions on benefits of belonging to a
members larger organization
Employee–Owner Separation Many employees are not popular form of business ownership for entrepreneurs and rep-
stockholders of the company for which they work. This sepa- resent almost half of all corporate filings.27 Vista Bank Texas
ration of owners and employees may cause employees to feel is an S Corporation, and the owners get the benefits of tax
that their work benefits only the owners. Employees without an advantages and limited liability. Advantages of S corporations
ownership stake do not always see how they fit into the corpo- include the simple method of taxation, the limited liability of
rate picture and may not understand the importance of profits shareholders, perpetual life, and the ability to shift income
to the health of the organization. If managers are part owners and appreciation to others. Disadvantages include restrictions
but other employees are not, management–labor relations take on the number (75) and types (individuals, estates, and cer-
on a different, sometimes difficult, aspect from those in part- tain trusts) of shareholders and the difficulty of formation and
nerships and sole proprietorships. However, this situation is operation.
changing as more corporations establish employee stock owner-
ship plans (ESOPs), which give shares of the company’s stock to Limited Liability Companies
its employees. Such plans build a partnership between employee
A limited liability company (LLC) is a form of business
and employer and can boost productivity because they motivate
ownership that provides limited liability, as in a corporation,
employees to work harder so that they can earn dividends from
but is taxed like a partnership. Although relatively new in the
their hard work as well as from their regular wages.
United States, LLCs have existed for many years abroad. Pro-
fessionals such as lawyers, doctors, and engineers often use the
LLC form of ownership. Many consider the LLC a blend of
OTHER TYPES the best characteristics of corporations, partnerships, and sole
proprietorships. One of the major reasons for the LLC form of
OF OWNERSHIP ownership is to protect the members’ personal assets in case of
In this section we take a brief look at joint ventures, S corpora- lawsuits. LLCs are flexible, simple to run, and do not require
tions, limited liability companies, and cooperatives—businesses the members to hold meetings, keep minutes, or make resolu-
formed for special purposes. tions, all of which are necessary in corporations. For example,
Segway, which markets the Segway Human Transporter, is a
Joint Ventures limited liability company.
A joint venture is a partnership established for a specific proj-
ect or for a limited time. The partners in a joint venture may be Cooperatives
individuals or organizations, as in the case of the international Another form of organization in business is the cooperative
joint ventures discussed in Chapter 3. Control of a joint ven- or co-op, an organization composed of individuals or small
ture may be shared equally, or one partner may control deci- businesses that have banded together to reap the benefits of
sion making. Joint ventures are especially popular in situations belonging to a larger organization. Oglethorpe Power Corp.,
that call for large investments, such as extraction of natural for example, is a power cooperative based in the suburbs of
resources and the development of new products. Dow Jones, Atlanta;28 Ocean Spray is a cooperative of cranberry farmers.
owner of The Wall Street Journal, formed a joint venture with A co-op is set up not to make money as an entity but so that
financial company SBI Holdings in Tokyo to begin an online its members can become more profitable or save money. Co-
Japanese version of the WSJ site. Dow Jones has a 60 percent ops are generally expected to operate without profit or to create
stake in the venture. Each company hopes to benefit from the only enough profit to maintain the co-op organization.
venture, with Dow Jones hoping to increase Web ad sales and Many cooperatives exist in small farming communities. The
SBI Holdings wanting to expand its number of holdings.26 co-op stores and markets grain; orders large quantities of fertil-
izer, seed, and other supplies at discounted prices; and reduces
S Corporations costs and increases efficiency with good management. A co-op
An S corporation is a form of business ownership that is can purchase supplies in large quantities and pass the savings
taxed as though it were a partnership. Net profits or losses of on to its members. It also can help distribute the products of
the corporation pass to the owners, thus eliminating double its members more efficiently than each could on an individ-
taxation. The benefit of limited liability is retained. Formally ual basis. A cooperative can advertise its members’ products
known as Subchapter S Corporations, they have become a and thus generate demand. Ace Hardware, a cooperative of

merger the combination
of two companies (usually
corporations) to form a new
company
independent hardware store own- When firms that make and sell similar products to the same
ers, allows its members to share in customers merge, it is known as a horizontal merger, as when
acquisition the the savings that result from buying Martin Marietta and Lockheed, both defense contractors,
purchase of one company supplies in large quantities; it also merged to form Lockheed Martin. Horizontal mergers, how-
by another, usually by provides advertising, which indi- ever, reduce the number of corporations competing within an
buying its stock vidual members might not be able industry, and for this reason they are usually reviewed carefully
to afford on their own. by federal regulators before the merger is allowed to proceed.
When companies operating at different but related levels of

TRENDS IN BUSINESS an industry merge, it is known as a vertical merger. In many
instances, a vertical merger results when one corporation
OWNERSHIP: MERGERS merges with one of its customers or suppliers. For example, if
Burger King were to purchase a large Idaho potato farm—to
AND ACQUISITIONS ensure a ready supply of potatoes for its french fries—a vertical
merger would result.
Companies large and small achieve growth and improve profit-
ability by expanding their operations, often by developing and A conglomerate merger results when two firms in unrelated
selling new products or selling current products to new groups industries merge. For example, the purchase of Sterling Drug,
of customers in different geographic areas. Such growth, when a pharmaceutical firm, by Eastman Kodak, best-known for its
Companies large and small achieve growth and improve

profitability by expanding their operations, often by developing
and selling new products or selling current products to new
groups of customers in different geographic areas.
carefully planned and controlled, is usually beneficial to the films and cameras, represents a conglomerate merger because
firm and ultimately helps it reach its goal of enhanced profit- the two companies are of different industries (Kodak later sold
ability. But companies also grow by merging with or purchas- Sterling Drug to a pharmaceutical company).
ing other companies.
When a company (or an individual), sometimes called a cor-
A merger occurs when two companies (usually corpora- porate raider, wants to acquire or take over another company,
tions) combine to form a new company. An acquisition it first offers to buy some or all of the other company’s stock at
occurs when one company purchases another, generally by a premium over its current price in a tender offer. Most such
buying most of its stock. The acquired company may become offers are “friendly,” with both groups agreeing to the proposed
a subsidiary of the buyer, or its operations and assets may be deal, but some are “hostile,” when the second company does
merged with those of the buyer. The government sometimes not want to be taken over. CKE Restaurants, which operates
scrutinizes mergers and acquisitions in an attempt to protect Carl’s Jr. and Hardees fast-food restaurants, adopted a “poison
customers from monopolistic practices. For example, the deci- pill” plan to discourage any attempted hostile takeovers. CKE’s
sion to authorize Whole Foods’ acquisition of Wild Oats was poison pill is designed to make a hostile takeover more difficult
carefully analyzed, as was the merger of Sirius and XM Satellite and/or more expensive. The poison pill plan involved giving
Radio. In 2010, Novartis took over Alcon, an eye care company stockholders the opportunity to receive preferred stock rights
owned by Nestlé, for $52 billion. This was the largest merger in in the event of an attempt to buy a minimum of 15 percent of
Swiss history. By acquiring Alcon, Novartis hopes to tap into the company’s shares.30
the high-growth eye care market, which is expected to have
a global growth of 7 percent annually.29 Acquisitions some- To head off a hostile takeover attempt, a threatened com-
times involve the purchase of a division or some other part of pany’s managers may use one or more of several techniques.
a company rather than the entire company. The late 1990s saw They may ask stockholders not to sell to the raider; file a law-
a merger and acquisition frenzy, which is slowing in the 21st suit in an effort to abort the takeover; institute a poison pill (in
century (see Table 4.5). which the firm allows stockholders to buy more shares of stock

After rejecting a leveraged-buyout offer, Sara Lee Corporation decided to split into two separate companies. The corporation spun off its international
beverage business from its North American business.
T A B L E 4 . 5 Major Mergers and Acquisitions Worldwide 2000–2010

Transaction Value (in
Rank Year Acquirer* Target millions of U.S. dollars)
1 2000 America Online Inc. (AOL) (Merger) Time Warner $164,747
2 2000 Glaxo Wellcome Plc. SmithKline Beecham Plc. 75,961
3 2004 Royal Dutch Petroleum Co. Shell Transport & Trading Co. 74,559
4 2006 AT&T Inc. BellSouth Corporation 72,671
5 2001 Comcast Corporation AT&T Broadband & Internet Svcs. 72,041
6 2002 Pfizer Inc. Pharmacia Corporation 59.515
7 2004 JP Morgan Chase & Co. Bank One Corporation 58,761
8 2010 Kraft Cadbury 19,500
9 2008 Bank of America Countrywide 4,000
10 2008 Delta (Merger) Northwest Airlines 2,750
11 2008 JPMorgan Chase & Co. Bear Stearns Companies Inc. 1,100
*Unless noted, deal was an acquisition.
Sources: Andrew Harris, “Delta Flight Attendants Sue Airline Alleging Discrimination,” Bloomberg Businessweek, March 2, 2011, www.bloomberg.com/news/2011-
03-02/delta-flight-attendants-sue-airline-alleging-discrimination.html (accessed March 18, 2011); Institute of Mergers, Acquisitions and Alliances Research, Thomson
Financial, www.imaa-institute.org/en/publications+mergers+acquisitions+m&a.php#Reports (accessed March 16, 2010); David Mildenberg, and Guy Beaudin, “Kraft
Acquires Cadbury,” Bloomberg Businessweek, January 3, 2010, www.businessweek.com/managing/content/feb2010/ca2010028_928488.htm (accessed March 1,
2010); “JPMorgan Chase Completes Bear Stearns Acquisition,” JPMorganChase News Release, May 31, 2008, www.bearstearns.com/includes/pdfs/PressRelease_
BSC_31May08.pdf (accessed March 1, 2010).

leveraged buyout
(LBO) a purchase in
which a group of investors
at prices lower than the current as 95 percent of the buyout price is paid with borrowed money,
borrows money from banks
and other institutions to
market value) or shark repellant which eventually must be repaid.
acquire a company (or a (in which manage-
Because of the explosion of mergers, acquisi-
division of one), using the ment requires a
tions, and leveraged buyouts in the 1980s
assets of the purchased large majority
and 1990s, financial journalists coined
company to guarantee of stockhold- TEAM EXERCISE the term merger mania. Many companies
repayment of the loan ers to approve Form groups and find examples of joined the merger mania simply to enhance
the takeover); mergers and acquisitions. Mergers their own operations by consolidating them
or seek a white can be broken down into traditional with the operations of other firms. Merg-
knight (a more acceptable firm that is will- mergers, horizontal mergers, and
ers and acquisitions enabled these compa-
ing to acquire the threatened company). conglomerate mergers. When com-
panies are found, note how long the
nies to gain a larger market share in their
In some cases, management may take the
merger or acquisition took, if there industries, acquire valuable assets, such
company private or even take on more debt
were any requirements by the govern- as new products or plants and equipment,
so that the heavy debt obligation will “scare
ment before approval of the merger or and lower their costs. Mergers also repre-
off” the raider.
acquisition, and if any failed mergers sent a means of making profits quickly, as
In a leveraged buyout (LBO), a group or acquisitions were found that did not was the case during the 1980s when many
of investors borrows money from banks achieve government approval. Report companies’ stock was undervalued. Quite
your findings to the class, and explain simply, such companies represent a bargain
and other institutions to acquire a company
what the companies hoped to gain to other companies that can afford to buy
(or a division of one), using the assets of the from the merger or acquisition.
purchased company to guarantee repay- them. Additionally, deregulation of some
ment of the loan. In some LBOs, as much industries has permitted consolidation of
SO YOU’D LIKE TO // Start a Business /

I f you have a good idea and want to turn it
into a business, you are not alone. Small
businesses are popping up all over the United
your friend and split the profits, then you have
experienced a partnership. Partnerships can
be either general or limited. General partners
role and hopefully minimize conflict. Unlike a
corporation, proprietorships and partnerships
both expire upon the death of one or more of
States, and the concept of entrepreneur- have unlimited liability and share completely those involved.
ship is hot. Entrepreneurs seek opportunities in the management, debts, and profits of the Corporations tend to be larger businesses,
and creative ways to make profits. Business business. Limited partners, on the other hand, but do not need to be. A corporation can con-
emerges in a number of different organiza- consist of at least one general partner and one sist of nothing more than a small group of
tional forms, each with its own advantages or more limited partners who do not partici- family members. In order to become a corpo-
and disadvantages. Sole proprietorships are pate in the management of the company but ration you will have to file in the state under
the most common form of business organiza- share in the profits. This form of partnership which you wish to incorporate. Each state has
tion in the United States. They tend to be small is used more often in risky investments where its own procedure for incorporation, meaning
businesses and can take pretty much any the limited partner stands only to lose his or there are no general guidelines to follow. You
form—anything from a hair salon to a scuba her initial investment. Real estate limited part- can make your corporation private or pub-
shop, from an organic produce provider to a nerships are an example of how investors can lic, meaning the company issues stocks and
financial advisor. Proprietorships are every- minimize their financial exposure, given the shareholders are the owners. While incor-
where serving consumers’ wants and needs. poor performance of the real estate market in porating is a popular form of organization
Proprietorships have a big advantage in that recent years. Although it has its advantages, because it gives the company an unlimited
they tend to be simple to manage—decisions partnership is the least utilized form of busi- lifespan and limited liability (meaning that if
get made quickly when the owner and the ness. Part of the reason is that all partners your business fails you cannot lose personal
manager are the same person and they are are responsible for the actions and decisions funds to make up for losses), there is a down-
fairly simple and inexpensive to set up. Rules of all other partners, whether or not all of the side. You will be taxed as a corporation and
vary by state, but at most all you will need is a partners were involved. Usually, partners as an individual resulting in double taxation.
license from the state. will have to write up an Articles of Partner- No matter what form of organization suits
Many people have been part of a partnership that outlines respective responsibilities your business idea best, there is a world of
ship at some point in their life. Group work in in the business. Even in states where it is options out there for you if you want to be or
school is an example of a partnership. If you not required, it is a good idea to draw up this experiment with being an entrepreneur.
ever worked as a DJ on the weekend with document as a way to cement each partner’s

firms within those industries for the first time, as is the case in rather than managing effectively and profitably. Some compa-
the banking and airline industries. nies have taken on a heavy debt burden to stave off a takeover,
Some people view mergers and acquisitions favorably, pointing later to be forced into bankruptcy when economic downturns
out that they boost corporations’ stock prices and market value, left them unable to handle the debt. Mergers and acquisitions
to the benefit of their stockholders. In many instances, merg- also can damage employee morale and productivity, as well as
ers enhance a company’s ability to meet foreign competition in the quality of the companies’ products.
an increasingly global marketplace. Additionally, companies Many mergers have been beneficial for all involved; others have
that are victims of hostile takeovers generally streamline their had damaging effects for the companies, their employees, and
operations, reduce unnecessary staff, cut costs, and otherwise customers. No one can say if mergers will continue to slow, but
become more efficient with their operations, which benefits many experts say the utilities, telecommunications, financial
their stockholders whether or not the takeover succeeds. services, natural resources, computer hardware and software,
Critics, however, argue that mergers hurt companies because gaming, managed health care, and technology industries are
they force managers to focus their efforts on avoiding takeovers likely targets. ■
GET ONLINE
mhhe.com/FerrellM3e
and video

five
small business,
entrepreneurship,
+ franchising
lthough many business stu- though China remains a Communist
introduction
A dents go to work for large

corporations upon gradua-
tion, others may choose to start their
country, private companies employ over
90 percent of the country’s workers.2
continued on p.104
own business or to find employment
LEARNING OBJECTIVES
opportunities in small organizations
LO1 Define entrepreneurship and small
with 500 or fewer employees. Small
business.
businesses employ more than half of LO2 Investigate the importance of small
all private-sector employees.1 Each business in the U.S. economy and why
certain fields attract small business.
small business represents the vision of
LO3 Specify the advantages of small-
its owners to succeed through provid-
business ownership.
ing new or better products. Small busi- LO4 Summarize the disadvantages of
nesses are the heart of the U.S. eco- small-business ownership, and ana-
lyze why many small businesses fail.
nomic and social system because they
LO5 Describe how you go about starting
offer opportunities and demonstrate the a small business and what resources
freedom of people to make their own are needed.
destinies. Today, the entrepreneurial LO6 Evaluate the demographic, techno-
logical, and economic trends that are
spirit is growing around the world, from
affecting the future of small business.
Russia and China to India, Germany, LO7 Explain why many large businesses
Brazil, and Mexico. For instance, even are trying to “think small.”
CHAPTER 5 | Small Business, Entrepreneurship, and Franchising 103

enterpreneurship small business Small Business
the process of creating and any independently owned Administration
managing a business to and operated business (SBA) an independent
achieve desired objectives that is not dominant in its
Gates (Microsoft), Larry Page and Sergey Brin
agency of the federal
competitive area and does (Google), and the late Steve Jobs (Apple) are
government that offers
not employ more than 500 managerial and financial
some of the most well known.
people assistance to small The entrepreneurship movement is acceler-
businesses ating, and many new, smaller businesses are
emerging. Technology once available only
to the largest firms can now be obtained by a
This chapter surveys the world of entrepreneurship and small business. Websites, podcasts, online videos, social media,
cellular phones, and even expedited delivery services enable
small business. First, we define entrepreneurship and small
small businesses to be more competitive with today’s giant cor-
business and examine the role of small business in the Ameri- porations. Small businesses can also form alliances with other
can economy. Then we explore the advantages and disad- companies to produce and sell products in domestic and global
markets.
vantages of small-business ownership and analyze why small
businesses succeed or fail. Next, we discuss how an entrepre- What Is a Small Business?
neur goes about starting a business and the challenges facing This question is difficult to answer because smallness is relative.
In this book, we will define a small business as any indepen-
small businesses today. Finally, we look at entrepreneurship in dently owned and operated business that is not dominant in its
larger organizations. competitive area and does not employ more than 500 people. A
local Mexican restaurant may be the most patronized Mexican
restaurant in your community, but because it does not domi-
THE NATURE nate the restaurant industry as a whole, the restaurant can be
considered a small business. This definition is similar to the
OF ENTREPRENEURSHIP one used by the Small Business Administration (SBA),
an independent agency of the federal government that offers
AND SMALL BUSINESS managerial and financial assistance to small businesses. On its
In Chapter 1, we defined an entrepreneur as a person who risks website, the SBA outlines the first steps in starting a small busi-
his or her wealth, time, and effort to develop for profit an inno- ness and offers a wealth of information to current and potential
vative product or way of doing something. Entrepreneurship small-business owners.
is the process of creating and managing a business to achieve
desired objectives. Many large businesses you may recognize The Role of Small Business
(Levi Strauss and Co., Procter & Gamble, McDonald’s, Dell in the American Economy
Computers, Microsoft, and Google) all began as small businesses
No matter how you define a small business, one fact is clear:
based on the visions of their founders. Some entrepreneurs who
They are vital to the American economy. As you can see in
start small businesses have the ability to see emerging trends;
Table 5.1, more than 99 percent of all U.S. firms are classified as
in response, they create a company to provide a product that
small businesses, and they employ 50 percent of private work-
serves customer needs. For example, rather than inventing a
ers. Small firms are also important as exporters, representing
major new technology, an innovative company may take advan-
97.5 percent of U.S. exporters of goods and contributing 31 per-
tage of technology to create new markets, such as Amazon.com.
cent of the value of exported goods.4 In addition, small businesses
Or it may offer a familiar product that has been improved or
are largely responsible for fueling job creation and innovation.
placed in a unique retail environment, such as Starbucks and
Small businesses also provide opportunities for minorities and
its coffee shops. A company may innovate by focusing on a
women to succeed in business. Women-owned businesses are
particular market segment and delivering a combination of
responsible for more than 23 million American jobs and con-
features that consumers in that segment could not find any-
tribute almost $3 trillion to the national economy. Women own
where else. For example, Patagonia, a company that uses many
more than 8 million businesses nationwide, with great success
organic materials in its clothing, has pledged 1 percent of sales
in the professional services, retail, communication, and admin-
to the preservation and restoration of the natural environment.
istrative industries.5 Minority-owned businesses have been
For example, customers can return their worn-out Capilene®
growing faster than other classifiable firms as well, representing
Performance Baselayers for recycling.3
21.3 percent of all small businesses. The number of minority-
Of course, smaller businesses do not have to evolve into such owned businesses is increasing at a rate of 30 percent, even
highly visible companies to be successful, but those entre- higher than for women-owned firms. Hispanics own the most
preneurial efforts that result in rapidly growing businesses small businesses (8.3 percent), followed by African Americans
gain visibility along with success. Entrepreneurs who have (7.1 percent), Asian Americans (5.7 percent), American Indians
achieved success, like Michael Dell (Dell Computers), Bill and Native Alaskans (0.9 percent), and Native Hawaiians and other

TERRACYCLE Terracycle soon went from selling worm material that would otherwise end up in
poop to making products from non- landfills. Those interested can visit the
CONVERTS TRASH recyclables like chip bags, pens, and drink Terracycle website and join a brigade (a
INTO PROFITS containers. Terracycle takes the junk that group dedicated to recycling a specific
no one wants and turns it into new items item). Brigades earn two cents per item for
such as backpacks, laptop cases, and trash their organizations. After being prompted
T om Szaky views trash not as waste, but
as opportunity. In 2001, 19-year-old Szaky
used this opportunity to launch TerraCycle.
cans, which are then sold to retailers like
Home Depot. Today, Terracycle utilizes
by Kraft to expand operations, Terracycle
now operates in six countries with plans to
Starting out as an organic fertilizer company, over three billion pieces of non-recyclable expand into 11 more by next year.6
Pacific Islanders (0.1 percent).7 For exam- T A B L E 5 . 1 Importance of Small Businesses to Our Economy
ple, Sacred Power is a Native American–
owned power and telecommunications Small firms represent 99.7 percent of all employer firms.
company that generates solar, thermal, and Small firms have generated 65 percent of net new jobs over the past 17 years.
wind energy. As a small business, Sacred Small firms hire approximately 43 percent of high-tech workers (such as scientists,
Power produces and sells alternative energy engineers, computer programmers, and others).
to larger power companies for distribution Small firms produce 13 times more patents per employee than large patenting firms.
to consumers around the Southwest.
Small firms employ half of all private sector employees
The energy, creativity, and innovative Small firms pay 44 percent of the total U.S. private payroll.
abilities of small-business owners have
resulted in jobs for many people. In fact, Source: “FAQs,” U.S. Small Business Administration, http://web.sba.gov/faqs/faqindex.cfm?areaID=24
(accessed March 18, 2011).
in the last 15 years, 65 percent of net
new jobs annually were created by small
businesses.8 Table 5.2 indicates that 99.7 T A B L E 5 . 2 Number of Firms by Employment Size
percent of all businesses employ fewer
than 500 people, and businesses employ- Firm Size Number of Firms Percentage of All Firms
ing 19 or fewer people account for 89.4 0–19 employees 5,410,367 89.4
percent of all businesses.9
20–99 employees 532,391 8.8
Many small businesses today are being 100–499 employees 88,586 1.5
started because of encouragement from
500 + employees 18,311 0.3
larger ones. Many new jobs are also created
by big-company/small-company alliances. Source: “Statistics of U.S. Businesses (SUSB)” U.S. Census Bureau, Updated December 21, 2010,
Whether through formal joint ventures, www.census.gov/econ/susb/ (accessed January 11, 2011).
supplier relationships, or product or mar-
keting cooperative projects, the rewards of collaborative rela- of $2.3 billion as one of the most recognizable figures in global
tionships are creating many jobs for small-business owners and media. After 26 years on her CBS talk show, she created the
their employees. In India, many small information technology Oprah Winfrey Network. Oprah refused to take her company
(IT) firms provide IT services to global markets. Because of public in order to maintain maximum control, and she pro-
lower costs, international companies often can find Indian busi- tected her brand and media products by refusing to let retailers
nesses to provide their information processing solutions.10 or other businesses use her name.11
Innovation Perhaps one of the most significant strengths of The innovation of successful firms take many forms. For
small businesses is their ability to innovate and to bring signifi- instance, small firms make up approximately 52 percent of
cant benefits to customers. Small firms produce over half of all home-based businesses and 2 percent of franchises. Many of
innovations. Among the important 20th-century innovations today’s largest businesses started off as small firms that used
by U.S. small firms are the airplane, the audio tape recorder, innovation to achieve success.12 Small businessman Ray Kroc
fiber-optic examining equipment, the heart valve, the optical found a new way to sell hamburgers and turned his ideas into
scanner, the pacemaker, the personal computer, soft contact one of the most successful fast-food franchises in the world—
lenses, the Internet, and the zipper. Not all innovations are McDonald’s. Small businesses have become an integral part of
based on new technology. Consider Oprah Winfrey’s success. our lives. James Dyson’s name is synonymous with high-quality
She developed her own brand image and media production vacuum cleaners. Today, his $1 billion company produces a
company. She went from having nothing to amassing a fortune bagless vacuum cleaner that commands 25 percent of the U.S.

THE SERVICE SECTOR INCLUDES BUSINESSES THAT
DO NOT ACTUALLY PRODUCE TANGIBLE GOODS
market. However, it took a lot of work to achieve such success. boutiques, drugstores, restaurants, caterers, service stations, and
Dyson developed 5,127 prototypes before he got the design and hardware stores that sell directly to consumers. Retailing attracts
function right. He recently created a successful hand dryer and entrepreneurs because gaining experience and exposure in
is working to develop other innovative appliances. Entrepre- retailing is relatively easy. Additionally, an entrepreneur open-
neurs provide fresh ideas and usually have greater flexibility to ing a new retail store does not have to spend the large sums of
change than do large companies. money for the equipment and distribution systems that a man-
ufacturing business requires. All that a new retailer needs is a
Industries That Attract lease on store space, merchandise, money to sustain the busi-
Small Business ness, knowledge about prospective customers’ needs and desires,
and basic management and marketing skills. Some small retail-
Small businesses are found in nearly every industry, but retailing
ers are also taking their businesses online. For example, Susan
and wholesaling, services, manufacturing, and high technology
Brown invented a donut-shaped pillow with an opening in one
are especially attractive to entrepreneurs. These fields are relatively
side called the “Boppy.” The product is sold online and in Babies
easy to enter and require low initial financing. Small-business
‘R’ Us and Pottery Barn Kids stores. Although approached by
owners in these industries also find it easier to focus on specific
Walmart, Brown declined the offer in a desire to keep a more
groups of consumers; new firms in these industries initially suffer
upscale feel. The Boppy has annual sales of around $50 million
less from heavy competition than do established firms.
and was provided startup capital through a microloan of $25,000
from the Colorado Enterprise Fund (a nonprofit, community-
Retailing and Wholesaling Retailers acquire goods from
development institution).13 The Boppy was voted the number-
producers or wholesalers and sell them to consumers. Main
one baby product by American Baby magazine a record seven
streets and shopping centers and malls are generally lined with
times since the award was created in 1998. It remains the indus-
independent music stores, sporting-goods stores, dry cleaners,
try leader among baby feeding and support pillows.14
Wholesalers supply products to industrial, retail, and institutional
users for resale or for use in making other products. Wholesal-
ing activities range from planning and negotiating for supplies,
promoting, and distributing (warehousing and transporting) to
providing management and merchandising assistance to clients.
Wholesalers are extremely important for many products, espe-
cially consumer goods, because of the marketing activities they
perform. Although it is true that wholesalers themselves can be
eliminated, their functions must be passed on to some other orga-
nization such as the producer, or another intermediary, often a
small business. Frequently, small businesses are closer to the final
customers and know what it takes to keep them satisfied. Some
smaller businesses start out in manufacturing, but find their real
niche as a supplier or distributor of larger firms’ products.
Services The service sector includes businesses that do not

actually produce tangible goods. The service sector accounts
for 80 percent of U.S. jobs, excluding farmworkers.15 Real estate,
insurance and personnel agencies, barbershops, banks, televi-
sion and computer repair shops, copy centers, dry cleaners, and
accounting firms are all service businesses. Similarly, Bikram
Choudhury’s name is associated with yoga. Bikram Yoga uses a
sequence of 26 signature poses, and the business has expanded
to training courses, books, CDs, clothing, and numerous fran-
Most of America’s new jobs aren’t created by big corporations. They are chises. Choudhury is credited with popularizing yoga in the
created by small businesses such as Rush Trucking. Rush Trucking was United States and with turning “his particular brand of yoga into
founded in Detroit in the 1980s by Andra Rush after she interned with the McDonald’s of a $3 billion industry.”16 Services also attract
a transportation company and decided she could do the job better. individuals—such as beauticians, morticians, jewelers, doctors,

The Geek Squad, a subsidiary of Best Buy, is an example of a business in the service sector. The Geek Squad specializes in technological repair and
support services. Its services are available 24/7.
and veterinarians—whose skills are not usually required by large and engineering knowledge. People who were able to innovate or
firms. Many of these service providers are retailers who provide identify new markets in the fields of computers, biotechnology,
their services to ultimate consumers. genetic engineering, robotics, and other markets have become
today’s high-tech giants. Mark Zuckerberg, the CEO of Facebook
Manufacturing Manufacturing goods can (a social networking website), for instance, has
provide unique opportunities for small businesses. created a company that is one of the fastest grow-
Started in 1988, the Malcolm Baldrige Award rec- ing dot-coms in history. Facebook has more than
ognizes achievements in quality and performance 500 million active users, and half of all active users
in businesses of all sizes. It is designed to spur com- log on to the site on any given day.19 In general,
petitive business practices in American industry. high-technology businesses require greater capital
In 2010 consulting firm Freese and Nichols Inc. and have higher initial startup costs than do other
(Fort Worth, Texas), restaurant development firm small businesses. Many of the biggest, nonethe-
K&N Management (Austin, Texas), and health less, started out in garages, basements, kitchens,
care consulting firm Studer Group (Gulf Breeze, and dorm rooms.
Florida) won the award in the small-business cat- DID YOU KNOW?
egory. This is the first case where three small busi-
nesses were awarded the Malcolm Baldrige Award Small businesses hire ADVANTAGES OF
at the same time.17 Small businesses sometimes 43 percent of high-
have an advantage over large firms because they tech workers in the SMALL-BUSINESS
can customize products to meet specific customer United States?18
needs and wants. Such products include custom OWNERSHIP
artwork, jewelry, clothing, and furniture. There are many advantages to establishing and
running a small business. These can be categorized into per-
High Technology High technology is a broad term used to sonal advantages and business advantages. Table 5.3 lists some
describe businesses that depend heavily on advanced scientific of the traits that can help entrepreneurs succeed.

T A B L E 5 . 3 10 Successful Traits of Young Entrepreneurs first research what consumers want, then develop the product
and test it before introducing it nationwide—a process that
Intuitive Persistent
sometimes takes years. An independent snack shop, however,
Creative Innovative can develop and introduce a new product (perhaps to meet a
Productive Frugal customer’s request) in a much shorter time.
Patient Friendly
Charismatic Fearless
Focus
Small firms can focus their efforts on a precisely defined market
Source: Yan Susanto, “10 Successful Traits of Young Entrepreneurs,” Retire niche—that is, a specific group of customers. Many large cor-
@ 21, April 10, 2009, www.retireat21.com/blog/10-successful-traits-of-young- porations must compete in the mass market or for large market
entrepreneurs (accessed March 17, 2011).
segments. Smaller firms can develop products for particular
groups of customers or to satisfy a need that other companies
have not addressed. For example, Fatheadz, based in India-
Independence napolis, Indiana, focuses on producing sunglasses for people
Independence is probably one of the leading reasons that entre- with big heads. To be an official “fathead” you need a ball cap
preneurs choose to go into business for themselves. Being a size of at least 7⅝ and a head circumference above the ear of at
small-business owner means being your own boss. Many peo- least 23.5 inches. The idea arose when Rico Elmore was walk-
ple start their own businesses because they believe they will do ing down the Las Vegas strip with his brother and realized that
better for themselves than they could do by remaining with he had lost his sunglasses. He went to a nearby sunglass shop,
their current employer or by changing jobs. They may feel stuck and out of 300 pairs of glasses, he could not find one that fit. He
on the corporate ladder and that no business would take them decided to start a company addressing this need, and Fatheadz
seriously enough to fund their ideas. Sometimes people who now distributes its designs in Walmart optical stores through-
venture forth to start their own small business are those who out the country.20 By targeting small niches or product needs,
simply cannot work for someone else. Such people may say that small businesses can sometimes avoid competition from larger
they just do not fit the “corporate mold.” firms, helping them grow into stronger companies.
More often, small-business owners just want the freedom to Reputation
choose whom they work with, the flexibility to pick where and
Small firms, because of their capacity to focus on narrow niches,
when to work, and the option of working in a family setting. The
can develop enviable reputations for quality and service. A
availability of the computer, copy machine, fax, and Internet has
good example of a small business with a formidable reputation
permitted many people to work at home. In the past, most of
is W. Atlee Burpee and Co., which has the country’s premier
them would have needed the support that an office provides.
bulb and seed catalog. Burpee has an unqualified returns policy
(complete satisfaction or your money back) that demonstrates
Costs a strong commitment to customer satisfaction.
As already mentioned, small businesses often require less
money to start and maintain than do large ones. Obviously, a
firm with just 25 people in a small factory spends less money on
wages and salaries, rent, utilities, and other expenses than does
DISADVANTAGES
a firm employing tens of thousands of people in several large
facilities. Rather than maintain the expense of keeping separate
OF SMALL-BUSINESS
departments for accounting, advertising, and legal counseling,
small businesses often hire other firms (sometimes small busi-
OWNERSHIP
The rewards associated with running a small business are so
nesses themselves) to supply these services as they are needed. enticing that it’s no wonder many people dream of it. How-
Additionally, small-business owners can sometimes rely on ever, as with any undertaking, small-business ownership has its
friends and family members to help them save money by vol- disadvantages.
unteering to work on a difficult project.
High Stress Level
Flexibility A small business is likely to provide a living for its owner,
With small size comes the flexibility to adapt to changing mar- but not much more (although there are exceptions as some
ket demands. Small businesses usually have only one layer of examples in this chapter have shown). There are ongoing wor-
management—the owners. Decisions therefore can be made ries about competition, employee problems, new equipment,
and executed quickly. In larger firms, decisions about even expanding inventory, rent increases, or changing market
routine matters can take weeks because they must pass through demand. In addition to other stresses, small-business owners
multiple levels of management before action is authorized. tend to be victims of physical and psychological stress. The
When Taco Bell introduces a new product, for example, it must small-business person is often the owner, manager, sales force,

Entrepreneurs experience a great deal of independence but also a great deal of stress. Many fail.
shipping and receiving clerk, bookkeeper, and custodian. often people start such a business without identifying a real
Having to multitask can result in long hours for most small- need for the goods or services. Other notable causes of small-
business owners. Many creative persons fail, not because of business failure include the burdens imposed by government
their business concepts, but rather because of difficulties in regulation, insufficient funds to withstand slow sales, and
managing their business. vulnerability to competition from larger companies. However,
three major causes of small-business failure deserve a close
High Failure Rate
Despite the importance of small businesses T A B L E 5 . 4 10 Common Mistakes That Startup and Small Companies Make
to our economy, there is no guarantee of
1. Overestimating the enthusiasm for their product or service.
success. Half of all new employer firms fail
within the first five years.21 Restaurants 2. Not validating demand and interest in the product.
are a case in point. Look around your own 3. Starting to work with customers only when the product is ready for sale.
neighborhood, and you can probably spot 4. Underestimating the difficulty in penetrating the market.
the locations of several restaurants that are
5. Overestimating the product’s uniqueness and underestimating the competition.
no longer in business.
6. Underestimating the effort needed to build the product.
Small businesses fail for many reasons (see 7. Hiring “big-company types” who are used to having a support staff.
Table 5.4). A poor business concept—such 8. Not focusing on the main product and being tempted by side projects.
as insecticides for garbage cans (research
9. Under- or overpricing the product.
found that consumers are not concerned
with insects in their garbage)—will pro- 10. Not having a vision for long-term growth.
duce disaster nearly every time. Expand- Source: David Lavenda, “10 Common Mistakes That Startup and Small Companies Make,” FC Expert Blog
ing a hobby into a business may work if (Fast Company), September 8, 2009, www.fastcompany.com/blog/david-lavenda/whatever-it-takes/10-
a genuine market niche exists, but all too common-mistakes-startupsmall-companies-make (accessed March 17, 2011).

ANOTHER TYPE OF Although social entrepreneurship has long Despite noble missions, those running
been privately funded, both the American SIF and the Big Society Bank are likely to
ENTREPRENEURSHIP and British governments are recognizing its be met with resistance, primarily political.
importance. The Obama administration has For this reason, social entrepreneurs may
E ntrepreneurs do not just operate in

business. The entrepreneurial spirit
can also be found in the social sector. A
formed the Social Innovation Fund (SIF),
with $50 million in public money matched
need to develop new skills enabling them
to break through bureaucracy. It is hopeful
by philanthropic donations, to be distributed that uniting the public and private funding
social entrepreneur is someone who is among nonprofits. The SIF seeks to unite sectors will empower more social entrepre-
driven to create social change by identify- social entrepreneurs, private capital, the neurs to bring their ideas to life.22
ing and implementing solutions to social government, and the public to create solu-
problems. An emphasis is being placed on tions for positive social change. The admin- Discussion Questions
the social entrepreneur as a necessary istration also founded the Office of Social 1. What are the potential benefits of social
component for future economic growth. Innovation and Civic Participation (OSICP). entrepreneurship in our society?
One of the most famous social entrepre- In Britain, the government has launched 2. Given that the primary resistance to
neurs is Muhammad Yunus, founder of the Big Society Bank, which is similar to the social entrepreneurship is political, how
microfinance bank Grameen. Another SIF. Both governments aim to unite the pri- can our government minimize resistance
example is Mimi Silbert, founder of the vate and public sectors to encourage social and create incentives for investment?
Delancey Street Foundation. Silbert pro- innovation, which they see as both doing
vides residency and life-work skills educa- 3. What social areas do you feel social
good and providing jobs to those in need. To
tion to former felons, substance abusers, entrepreneurs should invest in?
motivate innovation, the OSICP is hoping to
the homeless, and more. offer monetary rewards to social innovators.
look: undercapitalization, managerial inexperience or incom- shots to give up control. It has often been said that the great-
petence, and inability to cope with growth. est impediment to the success of a business is the entrepre-
neur. Similarly, growth requires specialized management skills
Undercapitalization The shortest path to failure in busi- in areas such as credit analysis and promotion—skills that the
ness is undercapitalization, the lack of funds to operate a founder may lack or not have time to apply. The founders of
business normally. Too many entrepreneurs think that all they many small businesses, including Dell Computers, found that
need is enough money to get started and that the business can they needed to bring in more experienced managers to help
survive on cash generated from sales soon thereafter. But almost manage their companies through growing pains.
all businesses suffer from seasonal variations in sales, which
Poorly managed growth probably affects a company’s reputa-
make cash tight, and few businesses make money from the start.
tion more than anything else, at least initially. And products
Many small rural operations cannot obtain financing within
that do not arrive on time or goods that are poorly made can
their own communities because small rural banks often lack the
quickly reverse a success. The principle immediate threats to
necessary financing expertise or assets sizable enough to coun-
small and mid-sized businesses include rising inflation, energy
ter the risks involved with small-business loans. Without suf-
and other supply shortages or cost escalations, and excessive
ficient funds, the best small-business idea in the world will fail.
household and/or corporate debt.
Managerial Inexperience or Incompetence Poor
management is the cause of many business failures. Just because
an entrepreneur has a brilliant vision for a small business does STARTING A
not mean he or she has the knowledge or experience to manage
a growing business effectively. A person who is good at creat- SMALL BUSINESS
ing great product ideas and marketing them may lack the skills We’ve told you how important small businesses are, and why
and experience to make good management decisions in hiring, they succeed and fail, but how do you go about starting your
negotiating, finance, and control. Moreover, entrepreneurs may own business in the first place? To start any business, large or
neglect those areas of management they know little about or small, you must have some kind of general idea. Sam Walton,
find tedious, at the expense of the business’s success. founder of Walmart stores, had a vision of a discount retailing
enterprise that spawned the world’s largest retailing empire and
Inability to Cope with Growth Sometimes, the very changed the way companies look at business. Next, you need
factors that are advantages for a small business turn into seri- to devise a strategy to guide planning and development in the
ous disadvantages when the time comes to grow. Growth often business. Finally, you must make decisions about form of own-
requires the owner to give up a certain amount of direct author- ership, the financial resources needed, and whether to acquire
ity, and it is frequently hard for someone who has called all the an existing business, start a new one, or buy a franchise.

undercapitalization
the lack of funds to operate
a business normally
The Business Plan Equity Financing The most
A key element of business success is a business plan—a pre- important source of funds for any business plan a
cise statement of the rationale for the business and a step-by- new business is the owner. Many precise statement of the
step explanation of how it will achieve its goals. The business owners include among their per- rationale for a business and
sonal resources ownership of a a step-by-step explanation of
plan should include an explanation of the business, an analysis
home, the accumulated value in a how it will achieve its goals
of the competition, estimates of income and expenses, and other
information. It should also establish a strategy for acquiring suf- life-insurance policy, or a savings
venture capitalists
ficient funds to keep the business going. Many financial institu- account. A new business owner
persons or organizations
tions decide whether to loan a small business money based on may sell or borrow against the value that agree to provide some
its business plan. A good business plan should act as a guide of such assets to obtain funds to funds for a new business in
and reference document—not a shackle that limits the busi- operate a business. Additionally, exchange for an ownership
ness’s flexibility and decision-making ability. The business plan the owner may bring useful per- interest or stock
must be revised periodically to ensure that the firm’s goals and sonal assets—such as a computer,
strategies adapt to changes in the environment. Business plans desks and other furniture, a car or
allow companies to assess market potential, determine price truck—as part of his or her ownership interest in the firm. Such
and manufacturing requirements, identify optimal distribu- financing is referred to as equity financing because the owner uses
tion channels, and refine product selection. Ben and Matthew real personal assets rather than borrowing funds from outside
Freund, who grew up on their father’s dairy farm in Connecti- sources to get started in a new business. The owner can also pro-
cut, developed an innovative way to deal vide working capital by reinvesting profits
with their abundance of cow manure. They into the business or simply by not drawing
created a digestion and dehydration pro- a full salary.
cess to eliminate the odor and to form the The most Small businesses can also obtain equity
product into CowPots, which can be bur- financing by finding investors for their
ied in the ground to fertilize plants. Cow- important source operations. They may sell stock in the busi-
Pots will last for months above ground but ness to family members, friends, employ-
begin to degrade when planted.23 Business of funds for any ees, or other investors. For instance, Petra
plans allow for companies such as Ben Cooper was the 41-year-old president
and Matthew’s to assess market potential,
new business is of McGraw-Hill Ryerson Publishing in
determine price, identify manufacturing the owner. Toronto when she decided to make a dra-
possibilities and requirements, identify matic career change. After researching
optimal distribution channels, and brand small-business opportunities, she decided
the products. The Small Business Administration website pro- to start a creamery, Fifth Town Artisan Cheese. Before quit-
vides an overview of a plan for small businesses to use to gain ting McGraw-Hill, she took two years of vacation time to study
financing. cheese making and constructed a model, energy-efficient dairy
on 20 acres in Prince Edward Island, Canada. Cooper exceeded
Forms of Business Ownership her initial $500,000 budget, but found an investor and obtained
After developing a business plan, the entrepreneur has to decide a bridge loan from a bank. By the end of her first year, Cooper
on an appropriate legal form of business ownership—whether already had $1 million in revenues and nearly broke even on
it is best to operate as a sole proprietorship, partnership, or the investment.24 Venture capitalists are persons or orga-
corporation—and to examine the many factors that affect that nizations that agree to provide some funds for a new business
decision, which we explored in Chapter 4. in exchange for an ownership interest or stock. Venture capi-
talists hope to purchase the stock of a small business at a low
price and then sell the stock for a profit after the business has
Financial Resources grown successful. The renewable energy industry has recently
The expression “it takes money to make money” holds espe- become a popular investment option among venture capitalists,
cially true in developing a business enterprise. To make money who have invested over $20 billion in “cleantech,” or renewable
from a small business, the owner must first provide or obtain energy technology, since 2005.25 Although these forms of equity
money (capital) to get started and to keep it running smoothly. financing have helped many small businesses, they require that
Even a small retail store will probably need at least $50,000 the small-business owner share the profits of the business—and
in initial financing to rent space, purchase or lease necessary sometimes control, as well—with the investors.
equipment and furnishings, buy the initial inventory, and pro-
vide working capital. Often, the small-business owner has to Debt Financing New businesses sometimes borrow more
put up a significant percentage of the necessary capital. Few than half of their financial resources. Banks are the main suppli-
new business owners have a large amount of their own capital ers of external financing to small businesses. On the federal level,
and must look to other sources for additional financing. the Small Business Administration offers financial assistance to

franchise a license to franchiser the company franchisee the
sell another’s products or that sells a franchise purchaser of a franchise
to use another’s name in
business, or both
Banks and other financial institutions can
also grant a small business a line of credit—an
agreement by which a financial institution
promises to lend a business a predetermined sum on demand.
A line of credit permits an entrepreneur to take quick advantage
of opportunities that require external funding. Small businesses
may obtain funding from their suppliers in the form of a trade
credit—that is, suppliers allow the business to take possession
of the needed goods and services and pay for them at a later
date or in installments. Occasionally, small businesses engage
in bartering—trading their own products for the goods and
services offered by other businesses. For example, an accoun-
tant may offer accounting services to an office supply firm in
exchange for office supplies and equipment.
Additionally, some community groups sponsor loan funds to
encourage the development of particular types of businesses. State
and local agencies may guarantee loans, especially to minority
business people or for development in certain areas.
Approaches to Starting
1-800-GOT-JUNK? will haul away what your garbage collector won't.
a Small Business
The company has more than 175 franchises, throughout Canada, the Starting from Scratch versus Buying an Existing
United States, and Australia. Business Although entrepreneurs often start new small
businesses from scratch much the way we have discussed in this
qualifying businesses. They can also look to family and friends section, they may elect instead to buy an existing business. This
as sources for long-term loans or other assets, such as comput- has the advantage of providing a built-in network of customers,
ers or an automobile, that are exchanged for an ownership inter- suppliers, and distributors and reducing some of the guesswork
est in a business. In such cases, the business owner can usually inherent in starting a new business from the ground up. How-
structure a favorable repayment schedule and sometimes nego- ever, an entrepreneur who buys an existing business also takes
tiate an interest rate below current bank rates. If the business on any problems the business already has.
goes bad, however, the emotional losses for all concerned may
greatly exceed the money involved. Anyone lending a friend or Franchising Many small-business owners find entry
family member money for a venture should state the agreement into the business world through franchising. A license to sell
clearly in writing before any money changes hands. another’s products or to use another’s name in business, or
both, is a franchise. The company that sells a franchise is the
The amount a bank or other institution is willing to loan depends
franchiser. Dunkin’ Donuts, Subway, and Jiffy Lube are well-
on its assessment of the venture’s likelihood of success and of
known franchisers with national visibility. The purchaser of a
the entrepreneur’s ability to repay the loan. The bank will often
franchise is called a franchisee.
require the entrepreneur to put up collateral, a financial interest
in the property or fixtures of the business, to guarantee payment The franchisee acquires the rights to a name, logo, methods of
of the debt. Additionally, the small-business owner may have to operation, national advertising, products, and other elements
Many small-business owners find entry into the

business world through franchising.
provide personal property as collateral, such as his or her home, associated with the franchiser’s business in return for a financial
in which case the loan is called a mortgage. If the small business commitment and the agreement to conduct business in accor-
fails to repay the loan, the lending institution may eventually dance with the franchiser’s standard of operations. The initial
claim and sell the collateral or mortgage to recover its loss. fee to join a franchise varies greatly. In addition, franchisees buy

equipment, pay for training, and obtain a mortgage or lease. The entrepreneurial training programs and programs sponsored by
franchisee also pays the franchiser a monthly or annual fee based the Small Business Administration. Such programs provide small-
on a percentage of sales or profits. In return, the franchisee often business owners with invaluable assistance in managing their
receives building specifications and designs, site recommenda- businesses, often at little or no cost to the owner.
tions, management and accounting support, and perhaps most
Entrepreneurs can learn critical marketing, management, and
importantly, immediate name recognition. Visit the website of the
finance skills in seminars and college courses. In addition,
International Franchise Association to learn more on this topic.
knowledge, experience, and judgment are necessary for suc-
The practice of franchising first began in the United States cess in a new business. While knowledge can be communicated
in the 19th century when Singer used it to sell sewing machines. and some experiences can be simulated in the classroom, good
The method of goods distribution soon became commonplace judgment must be developed by the entrepreneur. Local cham-
in the automobile, gasoline, soft drink, and hotel industries. The bers of commerce and the U.S. Department of Commerce offer
concept of franchising grew especially rapidly during the 1960s, information and assistance helpful in operating a small busi-
when it expanded to diverse industries. Table 5.5 shows the 10 ness. National publications such as Inc. and Entrepreneur share
fastest growing franchises and the top 10 new franchises. statistics, advice, tips, and success/failure stories. Additionally,
The entrepreneur will find that franchising has both advantages most urban areas have weekly business journals/newspapers
and disadvantages. Franchising allows a franchisee the opportu- that provide stories on local businesses as well as on business
nity to set up a small business relatively quickly, and because of techniques that a manager or small business can use.
its association with an established brand, a franchise outlet often The Small Business Administration offers many types of man-
reaches the breakeven point faster than an independent business agement assistance to small businesses, including counseling
would. Franchisees commonly report the following advantages: for firms in difficulty, consulting on improving operations, and
• Management training and support. training for owners/managers and their employees. Among its
• Brand-name appeal. many programs, the SBA funds Small Business Development
Centers (SBDCs). These are business clinics, usually located
• Standardized quality of goods and services.
on college campuses, that provide counseling at no charge and
• National and local advertising programs. training at only a nominal charge. SBDCs are often the SBA’s
• Financial assistance. principal means of providing direct management assistance.
• Proven products and business formats. The Service Corps of Retired Executives (SCORE) and the
• Centralized buying power. Active Corps of Executives (ACE) are volunteer agencies funded
by the SBA to provide advice for owners of small firms. Both are
• Site selection and territorial protection.
staffed by experienced managers whose talents and experience
• Greater chance for success.26 the small firms could not ordinarily afford. SCORE has 12,400
However, the franchisee must sacrifice some freedom to the fran- volunteers at nearly 400 locations in the United States and has
chiser. Some shortcomings experienced by franchisees include: served more than 8.5 million small businesses.28 The SBA also
has organized Small Business Institutes (SBIs) on almost 500
• Franchise fees and profit sharing with the franchiser.
university and college campuses in the United States. Seniors,
• Strict adherence to standardized operations.
• Restrictions on purchasing. T A B L E 5 . 5 Fastest Growing and Hottest New Franchises
• Limited product line.
Top 10 Fastest Growing Franchises Top 10 New Franchises
• Possible market saturation.
Stratus Building Solutions HealthSource Chiropractic and Progressive Rehab
• Less freedom in business decisions.27
Jan-Pro Franchising International Inc. Oreck Clean Home Center
Strict uniformity is the rule rather than
Subway Oxi Fresh Franchising Co.
the exception. Entrepreneurs who want
to be their own bosses are often frus- CleanNet USA Inc. Always Best Care Senior Services
trated with the restrictions of a franchise. Anago Cleaning Systems The Senior’s Choice Inc.
Pizza Hut Inc. Accessible Home Health Care
Help for Small- Liberty Tax Service Caring Transitions
Business Managers Vanguard Cleaning Systems Yogurtland Franchising Inc.
Because of the crucial role that small busi-
Bonus Building Care Murphy Business & Financial Corp.
ness and entrepreneurs play in the U.S.
economy, a number of organizations offer System4 Retro Fitness LLC
programs to improve the small-business Sources: “2011 Fastest-Growing Franchises,” Entrepreneur, www.entrepreneur.com/franchises/
owner’s ability to compete. These include fastestgrowing/index.html (accessed January 11, 2011).

graduate students, and faculty at each SBI provide on-site man- will pass that mark. The baby boomer generation represents
agement counseling. 26.1 percent of Americans and includes about 78 million peo-
ple.30 This segment of the population is wealthy, but many small
Finally, the small-business owner can obtain advice from other
businesses do not actively pursue it. Some exceptions, how-
small-business owners, suppliers, and even customers. A cus-
ever, include Gold Violin, which sells designer canes and other
tomer may approach a small business it frequents with a request
products online and through a catalog, and LifeSpring, which
for a new product, for example, or a supplier may offer suggestions
delivers nutritional meals and snacks directly to the customer.
for improving a manufacturing process. Networking—building
Industries such as travel, financial planning, and health care
relationships and sharing information with colleagues—is vital
will continue to grow as boomers age. Many experts believe that
for any businessperson, whether you work for a huge corpora-
the boomer demographic is the market of the future.
tion or run your own small business. Communicating with other
business owners is a great way to find ideas for dealing with Another market with huge potential for small business is the echo
employees and government regulation, improving processes, or boomers, also called millennials or Generation Y. Millennials
solving problems. New technology is making it easier to network. number around 75 million and possess a number of unique char-
For example, some states are establishing social networking sites acteristics. Born between 1977 and 1994, this cohort is not solely
for the use of their businesses to network and share ideas. concerned about money. Those who fall into this group are also
concerned with advancement, recognition, and improved capa-
bilities. They need direct, timely feedback and frequent encourage-
THE FUTURE FOR ment and recognition. Millennials do well when training sessions
SMALL BUSINESS29 combine entertainment with learning. Working remotely is more

acceptable to this group than previous generations, and virtual com-
Although small businesses are crucial to the economy, their size munication may become as important as face-to-face meetings.31
and limited resources can make them more vulnerable to tur-
Yet another trend is the growing number of immigrants living
bulence and change in the marketplace than large businesses.
in the United States, who now represent about one-eighth, or
Next, we take a brief look at the demographic, technological,
12 percent, of the population. If this trend continues, by 2050
and economic trends that will have the most impact on small
nearly one in five Americans will be classified as immigrants.
business in the future.
The Latino population, the nation’s largest minority group, is
Demographic Trends expected to triple in size by 2050.32
America’s baby boom started in 1946 and ended in 1964. Many This vast group provides still another greatly untapped mar-
boomers are over 50, and in the next few years, millions more ket for small businesses. Retailers who specialize in ethnic
GUITAR SYNDICATE, product via Facebook, Core Commerce soft- viral and create negative publicity for the
ware takes the customer directly to Guitar company.
INC. LEARNS TO SELL Syndicate’s website to complete payment. Despite these risks, Facebook has helped
ON FACEBOOK Guitar Syndicate sales have grown by generate business for Guitar Syndicate on a
almost 20 percent since its Facebook store more consistent basis. With the average user
was added. spending over an hour a day on Facebook,
F acebook fan pages have become a
popular way for companies to connect
with consumers. Yet some small businesses
Having a Facebook fan page has cre-
ated many advantages for Guitar Syndicate.
the social networking site offers a significant
opportunity for newer companies like Guitar
are taking the Facebook phenomenon a step Fan pages are inexpensive and easy to pro- Syndicate to get their names out there.33
further: they are using the site to sell actual duce, making them accessible to both small
products. One of these early adopters is businesses and large corporations. On the Discussion Questions
Guitar Syndicate, Inc., a brick-and-mortar other hand, having an effective Facebook 1. How has Facebook increased awareness
music business based in Kansas City. The fan page requires commitment. Facebook of Guitar Syndicate, Inc. as well as sales?
company has been gathering Facebook fans friends want to feel like an important part 2. How would you critique the cost of
through weekly contests and giveaways of the company. This requires a company “Facebook marketing"?
since 2009. Recently, it joined forces with like Guitar Syndicate to be dedicated in
3. What do you think are the keys of
Core Commerce and discovered Facebook’s responding to fan posts. Facebook pages
success for small businesses like Guitar
online store. Guitar Syndicate now uploads also carry risks. It is easy for dissatisfied
Syndicate to become profitable through
inventory right onto its Facebook page. customers to post negative comments
social media like Facebook?
Should a “fan” purchase a Guitar Syndicate on Facebook, which can easily become

COMMUNICATING WITH OTHER BUSINESS OWNERS
IS A GREAT WAY TO FIND IDEAS FOR DEALING WITH
EMPLOYEES AND GOVERNMENT REGULATION, IMPROVING
PROCESSES, OR SOLVING PROBLEMS.
products, and service providers who offer bi- or multilingual quickly to change and can stay close to their customers. While
employees, will find a large amount of business potential in this well-funded dot-coms were failing, many small businesses
market. Table 5.6 ranks top cities in the United States for small were learning how to use the Internet to promote themselves
businesses and startups. and sell products online. For example, arts and crafts dealers
Technological
and Economic Trends
Advances in technology have opened up many new markets
to small businesses. Undoubtedly, the Internet will continue to
provide new opportunities for small businesses. Arianna Huff-
ington launched the popular Huffington Post, a news and blog-
ging website, in 2005. The site has broken a number of important
news stories. Partly because of its accessible format and the way
it agglomerates news stories from many sites, HuffPo attracts
approximately 25 million views a month. In 2011, AOL agreed
to acquire the Huffington Post for $315 million.34
Technological advances and an increase in service exports have
created new opportunities for small companies to expand their
operations abroad. Changes in communications and technology
can allow small companies to customize their services quickly
for international customers. Also, free-trade agreements and
trade alliances are helping create an environment in which small
businesses have fewer regulatory and legal barriers.
In recent years, economic turbulence has provided both oppor-
tunities and threats for small businesses. As large information
technology companies such as Cisco, Oracle, and Sun Micro-
systems had to recover from an economic slowdown and an
oversupply of Internet infrastructure products, some smaller
firms found new niche markets. Smaller companies can react
T A B L E 5 . 6 Top Cities to Launch a Small Business
1. Pittsburgh, PA
2. Miami, FL
3. Menlo Park, CA
4. Arlington, VA
5. Chattanooga, TN
6. Littleton, CO
7. Ventura, CA
Jack Dorsey founded the idea for Twitter on a sketchpad. Dorsey
8. Gahanna, OH
says the idea was based on how dispatched vehicles, such as cabs,
Source: “8 great cities to start a business,” CNNMoney, http://money.cnn. communicate with one another. Via radio, they are constantly squawking
com/smallbusiness/best places launch/2010/ (accessed March 21, 2011). to each other about where they are and what they are doing.

intrapreneurs
individuals in large firms
who take responsibility
and makers of specialty products In addition, many small businesses have the desire and
for the development of
innovations within the found they could sell their wares employee commitment to purchase such environmentally
organizations on existing websites, such as eBay. friendly products. New Belgium Brewing Company received
Service providers related to tour- the U.S. Environmental Protection Agency and Department
ism, real estate, and construction of Energy Award for leadership in conservation for making
also found they could reach customers through their own or a 10-year commitment to purchase wind energy. The com-
existing websites. pany’s employees unanimously agreed to cover the increased
costs of wind-generated electricity from the employee profit-
Deregulation of the energy market and interest in alterna- sharing program.
tive fuels and in fuel conservation have spawned many small
businesses. Southwest Windpower Inc. manufactures and The future for small business remains promising. The opportu-
markets small wind turbines for producing electric power nities to apply creativity and entrepreneurship to serve custom-
for homes, sailboats, and telecommunications. Solar Attic ers are unlimited. While large organizations such as Walmart,
Inc. has developed a process to recover heat from home which has more than 2.1 million employees, typically must
attics to use in heating water or swimming pools. As entre- adapt to change slowly, a small business can adapt immediately
preneurs begin to realize that worldwide energy markets are to customer and community needs and changing trends. This
valued in the hundreds of billions of dollars, the number flexibility provides small businesses with a definite advantage
of innovative companies entering this market will increase. over large companies.
SO YOU WANT TO BE // An Entrepreneur or Small-Business

Owner /
I n times when jobs are scarce, many people
turn to entrepreneurship as a way to find
employment. As long as there are unfulfilled
money is tight. Reduced revenues and expen-
sive materials can hurt a small business more
than a large one because small businesses
their customers, do not let this be a temp-
tation to give things away for free. Make
it clear to your customers what the basic
needs from consumers, there will be a demand have fewer resources. When people are feeling price is for what you are selling and charge
for entrepreneurs and small businesses. the pinch from rising food and fuel prices, they for extra features, extra services, etc.
Entrepreneurs and small-business owners tend to cut back on other expenditures—which • Make sure the office has the conveniences
have been, and will continue to be, a vital could potentially harm your small business. The employees need—like a good coffee maker
part of the U.S. economy, whether in retail- increased cost of materials will also affect your and other drinks and snacks. This will not
ing, wholesaling, manufacturing, technology, bottom line. However, several techniques can only make your employees happy, but it will
or services. Creating a business around your help your company survive: also help maintain productivity up by keep-
idea has a lot of advantages. For many peo- ing employees closer to their desks.
• Set clear payment schedules for all clients.
ple, independence is the biggest advantage of • Use your actions to set an example. If
Small businesses tend to be worse about
forming their own small business, especially money is tight, show your commitment to
collecting payments than large ones, espe-
for those who do not work well in a corporate cutting costs and making the business work
cially if the clients are acquaintances. How-
setting and like to call their own shots. Smaller by doing simple things like taking the bus to
ever, you need to keep cash flowing into the
businesses are also cheaper to start up than work or bringing a sack lunch every day.
company in order to keep business going.
large ones in terms of salaries, infrastructure,
• Take the time to learn about tax breaks. A lot • Don’t forget to increase productivity in
and equipment. Smallness also provides a
of people do not realize all of the deductions addition to cutting costs. Try not to focus
lot of flexibility to change with the times. If
they can claim on items such as equipment so much attention on cost cutting that you
consumers suddenly start demanding new
and health insurance. don’t try to increase sales.
and different products or services, a small
business is more likely to deliver quickly. • Focus on your current customers, and don’t In unsure economic times, these mea-
Starting your own business is not easy, spend a lot of time looking for new ones. It is sures should help new entrepreneurs and
especially in slow economic times. Even in a far less expensive for a company to keep its small-business owners sustain their busi-
good economy, taking an idea and turning it into existing customers happy. nesses. Learning how to run a business on a
a business has a very high failure rate. The pos- • Although entrepreneurs and small-business shoestring is a great opportunity to cut the fat
sibility of failure can increase even more when owners are more likely to be friends with and to establish lean, efficient operations.35

MAKING BIG competitiveness, as have German, Brit-
ish, and Japanese firms. Other firms have
TEAM EXERCISE
BUSINESSES Explore successful global franchises.
sought to make their businesses “smaller”
by making their operating units function
Go to the companies’ websites and
ACT “SMALL” find the requirements for applying for
three franchises. The chapter provides
more like independent small businesses,
each responsible for its profits, losses, and
The continuing success and competitive- resources. Of course, some large corpo-
ness of small businesses through rapidly examples of successful franchises.
rations, such as Southwest Airlines, have
What do the companies provide, and
changing conditions in the business world acted like small businesses from their
what is expected to be provided by
have led many large corporations to take the franchiser? Compare and contrast inception, with great success.
a closer look at what makes their smaller each group’s findings for the fran-
rivals tick. More and more firms are emulat- Trying to capitalize on small-business
chises researched. For example, at
ing small businesses in an effort to improve success in introducing innovative new
Subway, the franchisee is responsible
their own bottom line. Beginning in the products, more and more companies are
for the initial franchise fee, finding
1980s and continuing through the pres- locations, leasehold improvements attempting to instill a spirit of entrepre-
ent, the buzzword in business has been to and equipment, hiring employees and neurship into even the largest firms. In
downsize or right-size to reduce manage- operating restaurants, and paying an 8 major corporations, intrapreneurs, like
ment layers, corporate staff, and work tasks percent royalty to the company and a entrepreneurs, take responsibility for, or
in order to make the firm more flexible, fee into the advertising fund. The com- “champion,” the development of innova-
pany provides access to formulas and tions of any kind within the larger organiza-
resourceful, and innovative. Many well-
known U.S. companies, including IBM,
operational systems, store design and tion.36 Often, they use company resources
equipment ordering guidance, a train- and time to develop a new product for the
Ford, Apple Inc., General Electric, Xerox, ing program, an operations manual, a
and 3M, have downsized to improve their company. ■
representative on-site during opening,
periodic evaluations and ongoing sup-
port, and informative publications.
GET ONLINE
mhhe.com/FerrellM3e
and video

118 PART 3 | Managing for Quality and Competitiveness
six
the nature of
management
introduction
or any organization—small or LEARNING OBJECTIVES
F large, for profit or nonprofit—to

achieve its objectives, it must
have equipment and raw materials to
LO1 Define management, and explain
its role in the achievement of
organizational objectives.
LO2 Describe the major functions of
management.
turn into products to market, employ-
LO3 Distinguish among three levels of
ees to make and sell the products, management and the concerns of
and financial resources to purchase managers at each level.
LO4 Specify the skills managers need in
additional goods and services, pay
order to be successful.
employees, and generally operate the LO5 Summarize the systematic approach
business. To accomplish this, it must to decision making used by many
business managers.
also have one or more managers to
plan, organize, staff, direct, and control
the work that goes on.
This chapter introduces the field of
management. It examines and surveys
the various functions, levels, and areas
of management in business. The skills
that managers need for success and
the steps that lead to effective decision
making are also discussed.
CHAPTER 6 | The Nature of Management 119

management a managers those planning the process
process designed to achieve individuals in organizations of determining the
an organization’s objectives who make decisions about organization’s objectives
by using its resources the use of resources and and deciding how to
firms reach global markets, companies such as
effectively and efficiently in who are concerned with accomplish them; the first Walmart, Union Pacific, and Cargill enlist hun-
a changing environment planning, organizing, staffing, function of management dreds of diverse suppliers that provide goods
directing, and controlling the and services to support operations. A good
organization’s activities to supplier maximizes efficiencies and provides
reach its objectives creative solutions to help the company reduce
expenses and reach its objectives. Finally, the
manager needs adequate financial resources to
pay for essential activities: Primary funding comes from owners
THE IMPORTANCE OF and shareholders, as well as banks and other financial institu-
tions. All these resources and activities must be coordinated and
MANAGEMENT controlled if the company is to earn a profit. Organizations must
also have adequate supplies of resources of all types, and manag-
Management is a process designed to achieve an organiza-
tion’s objectives by using its resources effectively and effi- ers must carefully coordinate their use if they are to achieve the
ciently in a changing environment. Effectively means having organization’s objectives.
the intended result; efficiently means accomplishing the objec-
tives with a minimum of resources. Managers make decisions
about the use of the organization’s resources and are concerned
MANAGEMENT
with planning, organizing, staffing, directing, and controlling
the organization’s activities so as to reach its objectives. The
FUNCTIONS
To harmonize the use of resources so that the business can
decision to introduce new products in order to reach objectives
develop, produce, and sell products, managers engage in a
is often a key management duty. After several years of decline
series of activities: planning, organizing, staffing, directing, and
in the automobile industry, Ford management introduced the
controlling (Figure 6.1). Although this book discusses each of
Ford Fiesta from Europe into the United States. The car pro-
the five functions separately, they are interrelated; managers
vides good driving dynamics, European styling, a low price, and
may perform two or more of them at the same time.
up to 38 mpg. The car fits well with Ford’s existing product mix
in the United States.1 Management is universal. It takes place Planning
not only in business, but also in government, the military, labor
Planning, the process of determining the organization’s objec-
unions, hospitals, schools, and religious groups—any organiza-
tives and deciding how to accomplish them, is the first func-
tion requiring the coordination of resources.
tion of management. Planning is a crucial activity, for it designs
Every organization must acquire resources (people, raw materi- the map that lays the groundwork for the other functions. It
als and equipment, money, and information) to effectively pur- involves forecasting events and determining the best course of
sue its objectives and coordinate their use to turn out a final good action from a set of options or choices. The plan itself specifies
or service. Employees are one of the most important resources what should be done, by whom, where, when, and how. For
in helping a business attain its objectives. Successful companies example, General Electric implemented a plan to improve its
recruit, train, compensate, and provide benefits (such as shares reputation for sustainability and to reduce costs resulting from
of stock and health insurance) to foster employee loyalty. Acquir- inefficiencies. Its planning resulted in a program called “Eco-
ing suppliers is another important part of managing resources magination,” which addresses sustainability through calling
and in ensuring that products are made available to customers. As attention to GE’s solar energy programs, hybrid locomotives,
ENTREPRENEUR’S Larry O’Toole’s message to his employ- Giant, and many of his former employees
ees is to give 100 percent, regardless are highly successful. Ninety-five percent
LEADERSHIP GUIDES of the situation. The company nurtures of those employees still with the company
COMPANY TOWARD its customers—even the more difficult now hold management positions. Today,
ones—by giving advice on topics such as Gentle Giant Movers is a $27 million com-
EXCEPTIONAL how to prepare children for a move and pany with its own foundation focused
CUSTOMER SERVICE offering money-back satisfaction guar- upon youth leadership and homeless pre-
antees. O’Toole also loves and solicits vention. Gentle Giant’s goal is to win life-
feedback, positive or negative, and uses long customers, and O’Toole has created
W hile customer satisfaction is
important for all industries, Gen-
tle Giant Movers lives by it. Founder
the information to constantly improve ser-
vice. To his credit, customers love Gentle
an empowering environment in which he
and his employees can do just that.2

mission the statement
of an organization’s
fundamental purpose and
fuel cell development, lower-emissions aircraft, and develop- the complex nature of business. basic philosophy
ment of lighter and stronger materials, among many other proj- A goal has three key components:
ects. Ecomagination is part of GE’s specific plans to produce an attribute sought, such as prof-
products with an emphasis on clean technology and renewable its, customer satisfaction, or product quality; a target to be
energy.3 All businesses—from the smallest restaurant to the achieved, such as the volume of sales or extent of manage-
largest multinational corporation—need to develop plans for ment training to be achieved; and a time frame, which is the
achieving success. But before an organization can plan a course time period in which the goal is to be achieved. Walmart, for
of action, it must first determine what it wants to achieve. example, under its former CEO Lee Scott, set goals of improv-
ing its reputation as an environmentally friendly company.
Mission A mission, or mission statement, is a declaration of Some of its goals involve reducing greenhouse gas emissions,
an organization’s fundamental purpose and basic philosophy. It increasing the fuel efficiency of its fleet, and requiring its
seeks to answer the question: “What business are we in?” Good suppliers to use less packaging. To be successful, company
mission statements are clear and concise goals should be specific. Walmart plans
statements that explain the organization’s to improve the fuel efficiency of its truck
reason for existence. A well-developed mis- fleet by 25 percent within a specified time
frame. It also has systems in place to mea-
sion statement, no matter what the industry Objectives sure its progress toward these goals. To be
or size of business, will answer five basic
questions: [are] the ends or successful at achieving goals, it is neces-
sary to know what is to be achieved, how
1. Who are we? results desired by much, when, and how succeeding at a goal
2. Who are our customers? is to be determined.
an organization.
3. What is our operating philosophy (basic
beliefs, values, ethics, etc.)?
Objectives Objectives, the ends or
results desired by an organization, derive from the organi-
4. What are our core competencies and competitive advantages? zation’s mission. A business’s objectives may be elaborate
5. What are our responsibilities with respect to being a good stew- or simple. Common objectives relate to profit, competitive
ard of environmental, financial, and human resources? advantage, efficiency, and growth. The principal difference
between goals and objectives is that objectives are generally
A mission statement that delivers a clear answer to these ques- stated in such a way that they are measurable. Organizations
tions provides the foundation for the development of a strong with profit as an objective want to have money and assets left
organizational culture, a good marketing plan, and a coherent over after paying off business expenses. Objectives regarding
business strategy. The tea company Celestial Seasonings states competitive advantage are generally stated in terms of per-
that its mission is to provide “the highest quality, most envi- centage of sales increase and market share, with the goal of
ronmentally responsible product possible” and to “be an active increasing those figures. Efficiency objectives involved mak-
participant in making the world a better place.”4 ing the best use of the organization’s resources. Dalhousie
University has developed energy calculators for small and
Goals A goal is the result that a firm wishes to achieve. A medium-sized businesses to help them become more aware
company almost always has multiple goals, which illustrates of their energy usage and to reduce their energy expenditure.
Growth objectives relate to an orga-
nization’s ability to adapt and to get
FIGURE 6.1 new products to the marketplace in a
The Functions of Management timely fashion. Other organizational
objectives include service and social
responsibility goals. AT&T, Campbell
Managers Soup Company, Intel Corporation,
and Old National Bank received the
2010 Corporate Engagement Award of
Excellence from Points of Light Insti-
Planning Organizing Staffing Directing Controlling tute for their commitment to employee
activities to resources and the employees' the volunteerism, which helps the commu-
achieve the activities to organization activities organization's nity, improves stakeholder relations,
organization's achieve the with qualified toward activities and motivates employees.5 Recogni-
objectives organization's people achievement to keep it
objectives of objectives on course tion such as this helps show achieve-
ment of social responsibility objectives.
Objectives provide direction for all

strategic plans those tactical plans short- operational plans crisis management organizing the
plans that establish the range plans designed to very short-term plans or contingency structuring of resources
long-range objectives and implement the activities and that specify what actions planning an element and activities to accomplish
overall strategy or course objectives specified in the individuals, work groups, in planning that deals with objectives in an efficient
of action by which a firm strategic plan or departments need to potential disasters such as and effective manner
fulfills its mission accomplish in order to product tampering, oil spills,
achieve the tactical plan and fire, earthquake, computer
ultimately the strategic plan virus, or airplane crash
stopped offering plastic bags altogether. Walmart and Kroger

also began to offer reusable canvas and nylon bags in response
to this problem.7 A fast-paced and ever-changing market
requires companies to develop short-run or tactical plans to
deal with stakeholder concerns.
A retailing organization with a five-year strategic plan to invest

$5 billion in 500 new retail stores may develop five tactical
plans (each covering one year) specifying how much to spend
to set up each new store, where to locate, and when to open
Southwest Airlines acquired AirTran as a part of its strategic plan to each new store. Tactical plans are designed to execute the over-
expand operations. all strategic plan. Because of their short-term nature, they are
easier to adjust or abandon if changes in the environment or
the company’s performance so warrant.
managerial decisions; additionally, they establish criteria by
which performance can be evaluated. Operational plans are very short term and specify what
actions specific individuals, work groups, or departments need
Plans There are three general types of plans for meeting to accomplish in order to achieve the tactical plan and ulti-
objectives—strategic, tactical, and operational. A firm’s high- mately the strategic plan. They may apply to just one month,
est managers develop its strategic plans, which establish the week, or even day. For example, a work group may be assigned a
long-range objectives and overall strategy or course of action weekly production quota to ensure there are sufficient products
by which the firm fulfills its mission. Strategic plans gener- available to elevate market share (tactical goal) and ultimately
ally cover periods ranging from 2 to 10 years or even longer. help the firm be number one in its product category (strategic
They include plans to add products, purchase companies, sell goal). Returning to our retail store example, operational plans
unprofitable segments of the business, issue stock, and move may specify the schedule for opening one new store, hiring and
into international markets. Faced with stiff competition, rising training new employees, obtaining merchandise, and opening
costs, and slowing sales, some companies are closing U.S. plants for actual business.
and moving production to factories abroad. For example, Con-
verse Inc. (tennis shoes), Lionel LLC (model trains), and Zebco Another element of planning is crisis management or
(fishing reels) all stopped U.S. production in favor of Asian fac- contingency planning, which deals with potential disas-
tories. Strategic plans must take into account the organization’s ters such as product tampering, oil spills, fire, earthquake,
capabilities and resources, the changing business environment, computer viruses, or even a reputation crisis due to unethi-
and organizational objectives. Plans should be market-driven, cal or illegal conduct by one or more employees. After the
matching customers’ desire for value with operational capabili- Deepwater Horizon oil rig exploded in 2010, BP PLC dem-
ties, processes, and human resources.6 onstrated the weaknesses of its contingency plan. It was soon
found that the 582-page response plan that BP had adopted
Tactical plans are short range and designed to implement the in case of a Gulf spill was outdated and contained numerous
activities and objectives specified in the strategic plan. These errors, including the listing of a wildlife expert as an emer-
plans, which usually cover a period of one year or less, help gency responder who had been dead since 2005. As part of
keep the organization on the course established in the strate- its contingency plan, BP had claimed the company could
gic plan. Because tactical plans allow the organization to react recover approximately 500,000 barrels of oil a day should
to changes in the environment while continuing to focus on a spill occur. The leak released far below that rate into the
the company’s overall strategy, management must periodically Gulf, but despite the company’s claims it took months for
review and update them. Declining performance or failure to BP to contain it. BP is an example of a company that had an
meet objectives set out in tactical plans may be one reason for ineffective and out-of-date contingency plan.8 Businesses
revising them. When public concern emerged over Americans’ that have contingency plans tend to respond more effectively
high level of plastic bag consumption, which stands at more when problems occur than do businesses that lack such plan-
than 110 billion bags a year, the grocery chain Whole Foods ning, hopefully avoiding a BP–level disaster.

staffing the hiring of
people to carry out the
work of the organization
Many companies, including Ashland Oil, H. J. Heinz, and Staffing
Johnson & Johnson (J&J), have crisis management teams to downsizing the
Once managers have determined
deal specifically with problems, permitting other managers elimination of a significant
what work is to be done and how
to continue to focus on their regular duties. Some companies number of employees from
it is to be organized, they must an organization
even hold periodic disaster drills to ensure that their employ-
ensure that the organization has
ees know how to respond when a crisis does occur. After the
enough employees with appropri-
horrific earthquake in Japan, many companies in U.S. earth-
ate skills to do the work. Hiring people to carry out the work
quake zones reevaluated their crisis management plans. Cri-
of the organization is known as staffing. Beyond recruiting
sis management plans generally cover maintaining business
people for positions within the firm, managers must determine
operations throughout a crisis and communicating with the
what skills are needed for specific jobs, how to motivate and
public, employees, and officials about the nature of and
train employees, how much to pay, what benefits to provide,
the company’s response to the problem. Communication is
and how to prepare employees for higher-level jobs in the firm
especially important to minimize panic and damaging rumors;
at a later date. These elements of staffing will be explored in
it also demonstrates that the company is aware of the problem
detail in Chapters 9 and 10.
and plans to respond. Johnson & Johnson failed to respond
adequately when it was forced to issue a massive number of Another aspect of staffing is downsizing, the elimination
recalls due to manufacturing errors at its McNeil Laboratories of significant numbers of employees from an organization,
plants. Contamination was found in over 40 types of children’s which has been a pervasive and much-talked-about trend.
medications; recalled products included Tylenol, Benadryl, Staffing can be outsourced to companies that focus on hiring
and Sudafed, among others. Not only did J&J receive criticism
for its defective products, it was also criticized by the govern-
ment for not acting quickly enough to recall the products.
Even after the recalls took place, McNeil was found to be in
violation of several federal laws. J&J signed an agreement to
fix the deficiencies. The crisis cost the company over $900 mil-
lion in sales.9 Incidents such as this highlight the importance
of tactical planning for crises and the need to respond publicly
and quickly when a disaster occurs.
Organizing
Rarely are individuals in an organization able to achieve com-
mon goals without some form of structure. Organizing is the
structuring of resources and activities to accomplish objectives
in an efficient and effective manner. Managers organize by
reviewing plans and determining what activities are necessary
to implement them; then, they divide the work into small units
and assign it to specific individuals, groups, or departments.
As companies reorganize for greater efficiency, more often
than not, they are organizing work into teams to handle core
processes such as new product development instead of orga-
nizing around traditional departments such as marketing and
production.
Organizing is important for several reasons. It helps create syn-
ergy, whereby the effect of a whole system equals more than
that of its parts. It also establishes lines of authority, improves
communication, helps avoid duplication of resources, and can
improve competitiveness by speeding up decision making.
When media company Thompson, a business information
giant, purchased Reuters Group, a news agency and finan-
cial data group, a new organizational structure was needed in
order to merge core services for customers. The new organi-
zation resulted in four customer divisions: financial data and Downsizing workers and outsourcing their jobs isn’t a popular move by
trading, legal and tax, scientific and health care, and media.10 companies. But it can help a firm rapidly reduce its costs and stay in
Because organizing is so important, we’ll take a closer look at business. Adecco is one of many companies that outsources part of its
it in Chapter 7. operations.

directing motivating
and leading employees
to achieve organizational
objectives
and managing employees. For the implementation of deadlines, and then encouraging them to
instance, the Bartech Group pro- do their work. For example, as a sales manager you would need
controlling the vides search and staffing services, to learn how to motivate salespersons; provide leadership; teach
process of evaluating and workforce solutions, business pro- sales teams to be responsive to customer needs; manage organi-
correcting activities to keep cesses outsourcing, and consult- zational issues; as well as evaluate sales results. Finally, direct-
the organization on course ing services. The Bartech Group ing also involves determining and administering appropriate
bills and manages $1 billion for rewards and recognition. All managers are involved in direct-
customers such as General Motors ing, but it is especially important for lower-level managers who
and Eaton.11 Many firms downsize by outsourcing production, interact daily with the employees operating the organization.
sales, and technical positions to companies in other countries For example, an assembly-line supervisor for Frito-Lay must
with lower labor costs. Downsizing has helped numerous firms ensure that her workers know how to use their equipment prop-
reduce costs quickly and become more profitable (or become erly and have the resources needed to carry out their jobs safely
profitable after lengthy losses) in a short period of time. and efficiently, and she must motivate her workers to achieve
Whether it is called downsizing, rightsizing, trimming the fat, their expected output of packaged snacks.
or the new reality in business, the implications of downsizing
Managers may motivate employees by providing incentives—
have been dramatic. During the recent economic recession,
such as the promise of a raise or promotion—for them to do
many companies laid off workers to cut costs, and the nation-
a good job. But most workers want more than money from
wide unemployment rate climbed above 10 percent.12
their jobs: They need to know that their employer values
Downsizing and outsourcing, however, have painful conse- their ideas and input. Smart managers, therefore, ask work-
quences. Obviously, the biggest casualty is those who lose their ers to contribute ideas for reducing costs, making equip-
jobs, along with their incomes, insurance, and pensions. Some ment more efficient, improving customer service, or even
find new jobs quickly; others do not. Another victim is the developing new products. This participation makes workers
morale of the remaining employees at downsized firms. Those feel important, and the company benefits. Recognition and
[ “Participation makes workers feel important,

and the company benefits.” ]
left behind often feel insecure, angry, and sad, and their produc- appreciation are often the best motivators. Employees who
tivity may decline as a result, the opposite of the effect sought. understand more about their effect on the financial success
Managers can expect that 70 to 80 percent of those surviving of the company may be induced to work harder for that suc-
a downsize will take a “wait-and-see” attitude and will require cess, and managers who understand the needs and desires of
active leadership. Ten to 15 percent will be openly hostile or try workers can encourage their employees to work harder and
to sabotage change in order to return to the way things were more productively. The motivation of employees is discussed
before. The remaining 10 to 15 percent will be the leaders who in detail in Chapter 9.
will try proactively to help make the situation work.13
After a downsizing situation, an effective manager will pro-
Controlling
Planning, organizing, staffing, and directing are all important to
mote optimism and positive thinking and minimize criticism
the success of an organization, whether its objective is earning
and fault-finding. Management should also build teamwork
a profit or something else. But what happens when a firm fails
and encourage positive group discussions. Honest communica-
to reach its goals despite a strong planning effort? Controlling
tion is important during a time of change and will lead to trust.
is the process of evaluating and correcting activities to keep
In reality, when departments are downsized, the remaining
the organization on course. Control involves five activities: (1)
employees end up working harder to fill the gaps left by layoffs.
measuring performance, (2) comparing present performance
Truthfulness about what has happened and also about future
with standards or objectives, (3) identifying deviations from
expectations is essential.
the standards, (4) investigating the causes of deviations, and (5)
Directing taking corrective action when necessary.
Once the organization has been staffed, management must Controlling and planning are closely linked. Planning estab-
direct the employees. Directing is motivating and leading lishes goals and standards. By monitoring performance and
employees to achieve organizational objectives. Good directing comparing it with standards, managers can determine whether
involves telling employees what to do and when to do it through performance is on target. When performance is substandard,

management must determine why and take appropriate actions levels. Large businesses have many managers at each level to
to get the firm back on course. In short, the control function coordinate the use of the organization’s resources. Managers at
helps managers assess the success of their plans. You might all three levels perform all five management functions, but the
relate this to your performance in this class. If you did not per- amount of time they spend on each function varies, as we shall
form as well on early projects or exams, you must take correc- see (Figure 6.3).
tive action such as increasing studying
or using website resources to achieve
your overall objective of getting an A FIGURE 6.2
or B in the course. When the outcomes Levels of Management
of plans do not meet expectations, the
control process facilitates revision of
the plans. Control can take many forms
such as visual inspections, testing, and
statistical modeling processes. The basic
idea is to ensure that operations meet
requirements and are satisfactory to Top
reach objectives. Management
President, CEO,
The control process also helps managers Executive
deal with problems arising outside the Vice Presidents
firm. For example, if a firm is the subject
of negative publicity, management should
use the control process to determine why Middle Management
and to guide the firm’s response. Plant Managers, Division Managers,
Department Managers
TYPES OF
MANAGEMENT First-Line Management
Foremen, Supervisors, Office Managers
All managers—whether the sole proprietor
of a restaurant or the hundreds of manag-
ers of a large company such as Paramount
Pictures—perform the five functions just
discussed. In the case of the restaurant, the FIGURE 6.3
owner handles all the functions, but in a Importance of Management Functions to Managers in Each Level
large company with more than one man-
ager, responsibilities must be divided and Top Middle First-Line
delegated. This division of responsibility is Managers Managers Managers
generally achieved by establishing levels of
management and areas of specialization— Most
finance, marketing, and so on. Important
Levels of
Management
As we have hinted, many organizations
have multiple levels of management—
top management, middle management,
and first-line, or supervisory manage-
ment. These levels form a pyramid, as
shown in Figure 6.2. As the pyramid
shape implies, there are generally more Least
middle managers than top managers, Important
Planning
Organizing
Staffing
Directing
Controlling
Planning
Organizing
Staffing
Directing
Controlling
Planning
Organizing
Staffing
Directing
Controlling
and still more first-line managers. Very

small organizations may have only one
manager (typically, the owner), who
assumes the responsibilities of all three

top managers the middle managers first-line managers
president and other top those members of an those who supervise
executives of a business, organization responsible for both workers and the
such as the chief executive the tactical planning that daily operations of an
officer (CPO). The position of privacy offi-
officer (CEO), chief financial implements the general organization cer has grown so widespread that the Inter-
officer (CFO), and chief guidelines established by national Association of Privacy Professionals
operations officer (COO), who top management boasts 7,700 members in 52 countries.15 In
have overall responsibility for government, top management refers to the
the organization president, a governor, or a mayor or city man-
ager; in education, a chancellor of a university
or a superintendent of education.
Top Management In businesses, top managers include Top-level managers spend most of their time planning. They
the president and other top executives, such as the chief execu- make the organization’s strategic decisions, decisions that focus
tive officer (CEO), chief financial officer (CFO), and chief on an overall scheme or key idea for using resources to take
operations officer (COO), who have overall responsibility for advantage of opportunities. They decide whether to add prod-
the organization. For example, Mark Zuckerberg, CEO and ucts, acquire companies, sell unprofitable business segments,
founder of Facebook, manages every aspect of and move into foreign markets. For instance,
the company, from finance and advertising to top managers at PAI Partners and Sodiaal made
product design and corporate strategy. Under the choice to sell a 51 percent interest in Yoplait
Zuckerberg’s direction, Facebook revolutionized SAS to General Mills. For its acquisition of 51
the social media industry. Less than a decade percent of the company, General Mills has
after it was founded, the company has achieved agreed to pay over $1.13 billion.17 Top managers
a value of approximately $60 billion, has a user also represent their company to the public and
base of over 500 million, and expects its adver- to government regulators.
tising revenue to double to $4.05 billion annu-
Given the importance and range of top manage-
ally. Facebook is also in talks to hold an IPO
DID YOU KNOW? ment’s decisions, top managers generally have
to generate additional revenue.14 In public cor-
many years of varied experience and command
porations, even chief executive officers have a Only 3 percent of top salaries. In addition to salaries, top manag-
boss—the firm’s board of directors. With tech-
Fortune 500 CEOs are ers’ compensation packages typically include
nological advances accelerating and privacy con- 16
women. bonuses, long-term incentive awards, stock,
cerns increasing, some companies are adding a
and stock options. Table 6.1 lists the 10 highest
new top management position—chief privacy
paid CEOs including bonuses, stock options,
and other compensation. Top management
may also get perks and special treatment that is criticized by
stakeholders.
Compensation committees are increasingly working with
boards of directors and CEOs to attempt to keep pay in line
with performance in order to benefit stockholders and key
stakeholders. The majority of major companies cite their
concern about attracting capable leadership for the CEO and
other top executive positions in their organizations. Sixty-
seven percent are concerned about their ability to attract and
retain the most competent leadership. Many companies are
attempting to curb high CEO pay by connecting compensa-
tion and job performance. James P. Gorman, CEO of Morgan
Stanley, received a compensation package based on a variety of
stocks and options. The total package could be worth almost
$9 million. Many of the units are tied to his performance,
such as meeting financial and corporate goals and remaining
at Morgan Stanley for the length of his contract.18 Successful
management translates into happy stockholders who are will-
ing to compensate their top executives fairly and in line with
performance.
High compensation for CEOs is often necessary to attract the top talent. Workforce diversity is an important issue in today’s corpora-
Larry Ellison, chief executive officer of Oracle, is the second-highest tions for top managers. Effective managers at enlightened cor-
paid CEO. porations have found that diversity is good for workers and for

the bottom line. Putting together different T A B L E 6 . 1 The Highest Paid CEOs
kinds of people to solve problems often
Rank CEO Company Pay ($ in millions)
results in better solutions. Betsy Holden, a
former CEO of Kraft Foods, said, “When 1. H Lawrence Culp Jr Danaher 141.36
we look at the composition of teams within 2. Lawrence J. Ellison Oracle 130.23
our company, we have found that those
3. Aubrey K McClendon Chesapeake Energy 114.291
with a variety of perspectives are simply
the most creative.”19 A diverse workforce 4. Ray R. Irani Occidental Petroleum 103.07
is better at making decisions regarding 5. David C Novak Yum Brands 76.49
issues related to consumer diversity. W. 6. John C Martin Gilead Sciences 60.40
Garrison Jackson runs a multicultural 7. Sol J Barer Celgene 59.311
public relations and advertising agency
8. Keith A Hutton XTO Energy 54.781, 2
that helps corporate America reach black,
Hispanic, Asian, and other minority con- 9. Richard C Adkerson Freeport Copper 48.751
sumers. These fast growing demographic 10. Jen-Hsun Huang Nvidia 31.40
groups are key target markets for many 1
Prior-year data.
companies including Colgate-Palmolive, 2
New CEO; compensation may be for another executive office.
General Mills, and IBM.20 Managers from
Source: “CEO Compensation,” Forbes, April 28, 2010, www.forbes.com/lists/2010/12/boss-10
companies devoted to workforce diver- CEO-Compensation Rank.html (accessed January 12, 2011).
sity devised five rules that make diversity
recruiting work (see Table 6.2). Diversity
is explored in greater detail in Chapter 10. in a university, and the head of a state pub-
lic health department are all middle man-
agers. The ranks of middle managers have
Middle Management Rather than Most been shrinking as more and more compa-
making strategic decisions about the whole
organization, middle managers are people get their nies downsize to be more productive.
responsible for tactical planning that will
implement the general guidelines estab- first managerial First-Line Management Most peo-
lished by top management. Thus, their ple get their first managerial experience as
responsibility is more narrowly focused
experience as first- first-line managers, those who super-
than that of top managers. Middle manag- line managers. vise workers and the daily operations of the
ers are involved in the specific operations organization. They are responsible for imple-
of the organization and spend more time menting the plans established by middle
organizing than other managers. In business, plant managers, management and directing workers’ daily performance on the job.
division managers, and department managers make up middle They spend most of their time directing and controlling. Common
management. The product manager for laundry detergent at a titles for first-line managers are foreman, supervisor, and office
consumer products manufacturer, the department chairperson manager.
T A B L E 6 . 2 Five Rules of Successful Diversity Recruiting
Rule Action
1. Get everyone involved. Educate all employees on the tangible benefits of diversity recruiting to garner support and
enthusiasm for those initiatives.
2. Showcase your diversity. Prospective employees are not likely to become excited about joining your company just because
you say that your company is diversity-friendly; they need to see it.
3. Work with diversity groups within your By supporting community-based diversity organizations, your company will generate the priceless
community. word-of-mouth publicity that will lead qualified diversity candidates to your company.
4. Spend money. If you are serious about diversity recruiting, you will need to spend some money getting your
message out to the right places.
5. Sell, sell, sell—and measure your Employers need to sell their company to prospective diversity employees and present them with a
return on investment. convincing case as to why their company is a good fit for the diversity candidate.
Source: Adapted from Juan Rodriguez, “The Five Rules of Successful Diversity Recruiting,” Diversityjobs.com, www.diversityjobs.com/Rules-of-Successful-Diversity-
Recruiting (accessed February 25, 2010).

financial managers production human resources marketing information
those who focus on and operations managers those who managers those technology (IT)
obtaining needed funds for managers those who handle the staffing function who are responsible for managers those
the successful operation develop and administer and deal with employees in planning, pricing, and who are responsible for
of an organization and the activities involved in a formalized manner promoting products and implementing, maintaining,
using those funds to further transforming resources into making them available to and controlling technology
organizational goals goods, services, and ideas customers applications in business,
ready for the marketplace such as computer networks
Areas of Management programs; and deal with government regulations concerning

At each level, there are managers who specialize in the basic employment practices. For example, some companies recog-
functional areas of business: finance, production and operations, nize that their employees’ health affects their costs. Therefore,
human resources (personnel), marketing, and administration. more progressive companies provide health care facilities and
outside health club memberships, encourage proper nutri-
Financial Management Financial managers focus tion, and discourage smoking in an effort to improve employee
on obtaining the money needed for the successful operation health and lower the costs of providing health care benefits.
of the organization and using that money in accordance with
organizational goals. Among the responsibilities of financial Marketing Management Marketing managers are
managers are projecting income and expenses over a speci- responsible for planning, pricing, and promoting products
fied period, determining short- and long-term financing needs and making them available to customers through distribution.
and finding sources of financing to fill those needs, identifying The marketing manager who oversees Samsung televisions, for
and selecting appropriate ways to invest extra funds, monitor- example, must make decisions regarding a new television’s size,
ing the flow of financial resources, and protecting the finan- features, name, price, and packaging, as well as plan what type
cial resources of the organization. A financial manager at Ford, of stores to distribute the television through and the advertis-
for example, may be asked to analyze the costs and revenues of ing campaign that will introduce the new television to consum-
a car model to determine its contribution to Ford’s profitabil- ers. General Motors must determine a way to make the vehicles
ity. All organizations must have adequate financial resources that consumers want to buy while still turning a profit. This will
to acquire the physical and human resources that are necessary require top management to get rank-and-file employees to under-
to create goods and services. Consequently, financial resource stand and support a fleet of green, eco-friendly cars, including the
management is of the utmost importance. Volt, a plug-in hybrid.22 Within the realm of marketing, there are
several areas of specialization: product development and man-
Production and Operations Management Production agement, pricing, promotion, and distribution. Specific jobs are
and operations managers develop and administer the activ- found in areas such as marketing research, advertising, personal
ities involved in transforming resources into goods, services, selling, retailing, telemarketing, and Internet marketing.
and ideas ready for the marketplace. Production and opera-
tions managers are typically involved in planning and designing Information Technology (IT) Management
production facilities, purchasing raw materials and supplies, Information technology (IT) managers are responsible
managing inventory, scheduling processes to meet demand, for implementing, maintaining, and controlling technology
and ensuring that products meet quality standards. Because no applications in business, such as computer networks. Google,
business can exist without the production of goods and services, the world’s largest online search engine, employs more than
production and operations managers are vital to an organiza- 10,000 employees, many of whom are IT managers. Google
tion’s success. Production can be a complicated process because searches for IT managers and employees who are enthusiastic
companies, no matter what the size, must balance different con- about their field and Google’s products. To keep their engineers
siderations such as cost, performance, extra features, and styling. motivated, Google allows them to spend up to 20 percent of
For example, the Tesla Roadster Sport is faster than the Porsche their time working on personal projects.23 One major task in IT
Boxter Spyder, but it does not handle as well. Both companies management is securing computer systems from unauthorized
face the challenges inherent in producing products that balance users while making the system easy to use for employees, sup-
high performance and maintaining quality standards in order to pliers, and others who have legitimate reasons to access the sys-
gain competitive advantage from their designs, production, and tem. Another crucial task is protecting the systems’ data, even
operations excellence. An additional challenge to small compa- during a disaster such as a fire. IT managers are also responsible
nies is to do all these things while remaining profitable.21 for teaching and helping employees use technology resources
efficiently through training and support. At many companies,
Human Resources Management Human resources some aspects of IT management are outsourced to third-party
managers handle the staffing function and deal with employ- firms that can perform this function expertly and efficiently.
ees in a formalized manner. Once known as personnel man-
agers, they determine an organization’s human resource Administrative Management Administrative man-
needs; recruit and hire new employees; develop and admin- agers are not specialists; rather they manage an entire business
ister employee benefits, training, and performance appraisal or a major segment of a business. Such managers coordinate

administrative
managers those who
manage an entire business
the activities of specialized managers, which would include skills, analytical skills, and human or a major segment of
marketing managers, production managers, and financial relations skills. Table 6.3 describes a business; they are not
managers. Because of the broad nature of their responsibilities, some of the roles managers may specialists but coordinate
administrative managers are often called general managers. fulfill. the activities of specialized
However, this does not mean that administrative managers lack managers
expertise in any particular area. Many top executives have risen
through the ranks of financial management, production and Leadership leadership the ability to
operations management, or marketing management; but most Leadership is the ability to influ- influence employees to work
toward organizational goals
top managers are actually administrative managers, employing ence employees to work toward
skills in all areas of management. organizational goals. Strong lead-
Strong leaders manage and pay attention to the culture of their

organizations and the needs of their customers.
ers manage and pay attention to the culture of their organiza-

SKILLS NEEDED tions and the needs of their customers. Table 6.4 offers some
tips for successful leadership, while Table 6.5 on page 131 lists
BY MANAGERS America’s 10 most admired companies and their CEOs. The
Managers are typically evaluated using the metrics of how effec- list is compiled annually for Fortune magazine by executives
tive and efficient they are. Managing effectively and efficiently and analysts who grade companies according to nine attri-
requires certain skills—leadership, technical expertise, conceptual butes, including quality of management.
T A B L E 6 . 3 Managerial Roles
Type of Role Specific Role Examples of Role Activities
Decisional Entrepreneur Commit organizational resources to develop innovative goods and services; decide to expand
internationally to obtain new customers for the organization’s products.
Disturbance handler Move quickly to take corrective action to deal with unexpected problems facing the organization
from the external environment, such as a crisis like an oil spill, or from the internal environment,
such as producing faulty goods or services.
Resource allocator Allocate organizational resources among different functions and departments of the organization;
set budgets and salaries of middle and first-level managers.
Negotiator Work with suppliers, distributors, and labor unions to reach agreements about the quality and
price of input, technical, and human resources; work with other organizations to establish
agreements to pool resources to work on joint projects.
Informational Monitor Evaluate the performance of managers in different functions and take corrective action to
improve their performance; watch for changes occurring in the external and internal environment
that may affect the organization in the future.
Disseminator Inform employees about changes taking place in the external and internal environment that
will affect them and the organization; communicate to employees the organization’s vision and
purpose.
Spokesperson Launch a national advertising campaign to promote new goods and services; give a speech to
inform the local community about the organization’s future intentions.
Interpersonal Figurehead Outline future organizational goals to employees at company meetings; open a new corporate
headquarters building; state the organization’s ethical guidelines and the principles of behavior
employees are to follow in their dealings with customers and suppliers.
Leader Provide an example for employees to follow; give direct commands and orders to subordinates;
make decisions concerning the use of human and technical resources; mobilize employee
support for specific organizational goals.
Liaison Coordinate the work of managers in different departments; establish alliances between different
organizations to share resources to produce new goods and services.
Source: Gareth R. Jones and Jennifer M. George, Essentials of Contemporary Management, 3rd ed. (Burr Ridge, IL: McGraw-Hill/Irwin, 2007), p. 14.

technical expertise conceptual analytical skills the
the specialized knowledge skills the ability to think ability to identify relevant
and training needed to in abstract terms and to see issues, recognize their
to do it. They generally use their authority
perform jobs that are how parts fit together to importance, understand the
and economic rewards to get employees to
related to particular areas of form the whole relationships between them,
management and perceive the underlying comply with their directions. Democratic
causes of a situation leaders involve their employees in deci-
sions. The manager presents a situation and
encourages his or her subordinates to express
opinions and contribute ideas. The manager
then considers the employees’ points of view
T A B L E 6 . 4 Seven Tips for Successful Leadership and makes the decision. Free-rein leaders let their employees
work without much interference. The manager sets perfor-
• Build effective and responsive interpersonal relationships. mance standards and allows employees to find their own ways
• Communicate effectively—in person, print, e-mail, etc. to meet them. For this style to be effective, employees must
• Build the team and enable employees to collaborate effectively. know what the standards are, and they must be motivated to
attain them. The free-rein style of leadership can be a power-
• Understand the financial aspects of the business.
ful motivator because it demonstrates a great deal of trust and
• Know how to create an environment in which people experience confidence in the employee.
positive morale and recognition.
• Lead by example. The effectiveness of the autocratic, democratic, and free-rein
styles depends on several factors. One consideration is the type
• Help people grow and develop.
of employees. An autocratic style of leadership is generally
Source: Susan M. Heathfield, “Seven Tips About Successful Management,” best for stimulating unskilled, unmotivated employees; highly
About.com, http://humanresources.about.com/cs/managementissues/qt/ skilled, trained, and motivated employees may respond better to
mgmtsuccess.htm (accessed February 25, 2010).
democratic or free-rein leadership styles. Employees who have
been involved in decision making generally require less supervi-
sion than those not similarly involved. Other considerations are
Managers often can be classified into three types based on the manager’s abilities and the situation itself. When a situation
their leadership style. Autocratic leaders make all the deci- requires quick decisions, an autocratic style of leadership may be
sions and then tell employees what must be done and how best because the manager does not have to consider input from a
NICK’S PIZZA & ethically. The result is termed a “trust and the company. Whereas turnover is roughly
track” management style. 200 percent for the industry, Nick’s Pizza &
PUB SUCCEEDS Although Sarillo continually tracks what Pub experiences 20 percent. The annual
ON “TRUST AND is going on inside the restaurant, he gives operating profit rate is also high at 14 per-
his employees responsibility over certain cent, compared to the 6.6 percent experi-
TRACK” SYSTEM OF managerial functions. New hires at Nick’s enced by competitors. Sarillo’s unusual but
MANAGEMENT Pizza & Pub attend a two-day orientation, effective management style has created a
where they learn about the company’s cul- corporate culture that translates into dedi-
ture and are certified for particular jobs. cated employees, satisfied customers, and
A t Nick’s Pizza & Pub, working with
pizza is fun, rewarding, and challeng-
ing. Much of the company’s success can be
Employees are expected to take respon-
sibility for tasks that might traditionally be
over $7 million in annual sales.24
attributed to the strong management tech- part of the supervisor’s job. Sarillo wants Discussion Questions
niques of founder Nick Sarillo. When Sarillo his employees to feel like they are actively 1. Why is Nick Sarillo a good manager?
started Nick’s Pizza & Pub in 1995, he knew involved in the company’s success and 2. Of the basic functions in recruiting and
from the beginning that he wanted to create treats his mostly teenage workforce with staffing a pizza restaurant, which of the
an environment with a dedicated workforce respect. Nick’s Pizza & Pub also cares for following do you think is most important
and a culture defined by honesty, loyalty, its customers. During the recession when and why: hiring, training, evaluating, or
and excellent customer service. Sarillo unemployment was high, the restaurant compensating?
rejected the traditional “command and con- gave customers half off on pizzas on Mon-
3. How would you defend Nick Sarillo’s
trol” management style in favor of creating days and Tuesdays.
management approach from a financial
a company culture in which he could trust The result of the “trust and track” style
point of view?
his employees to work hard and behave is happier workers who choose to stick with

EMPLOYEES WHO HAVE BEEN INVOLVED IN DECISION
MAKING GENERALLY REQUIRE LESS SUPERVISION THAN
THOSE NOT SIMILARLY INVOLVED.
T A B L E 6 . 5 America’s Most Admired Companies manager may not actually perform a job, he or she needs
and Their CEOs technical expertise to train employees, answer questions, pro-
vide guidance, and solve problems. Technical skills are most
Company Chief Executive Officer
needed by first-line managers and least critical to top-level
Apple Steve Jobs/Tim Cook* managers.
Google Eric Schmidt Today, most organizations rely on computers to perform rou-
Berkshire Hathaway Warren Buffett tine data processing, simplify complex calculations, organize and
Johnson & Johnson William Weldon maintain vast amounts of information to communicate, and help
Amazon.com Jeff Bezos managers make sound decisions. For this reason, most managers
have found computer expertise to be an essential skill in doing
Procter & Gamble Robert McDonald
their jobs well.
Toyota Motor Akio Toyoda
Goldman Sachs Lloyd Blankfein
Conceptual Skills
Walmart Mike Duke Conceptual skills, the ability to think in abstract terms, and
Coca-Cola Muhtar Kent to see how parts fit together to form the whole, are needed
by all managers, but particularly top-level managers. Top
*Steve Jobs resigned as CEO of Apple in 2011 and passed away in October management must be able to evaluate continually where the
2011. Tim Cook has taken his place.
company will be in the future. Conceptual skills also involve
Source: Adapted from “America’s Most Admired Companies 2010,” Fortune,
the ability to think creatively. Recent scientific research has
http://money.cnn.com/magazines/fortune/mostadmired/2010/index.html
(accessed January 12, 2011). revealed that creative thinking, which is behind the develop-
ment of many innovative products and ideas, including fiber
optics and compact disks, can be learned. As a result, IBM,
lot of people. If a special task force must be set up to solve a qual- AT&T, GE, Hewlett-Packard, Intel, and other top U.S. firms
ity-control problem, a normally democratic manager may give hire creative consultants to teach their managers how to think
free rein to the task force. Many managers, however, are unable creatively.
to use more than one style of leadership. Some are incapable of
allowing their subordinates to participate in decision making, let
alone make any decisions. Thus, what leadership style is “best”
Analytical Skills
Analytical skills refer to the ability to identify relevant issues
depends on specific circumstances, and effective managers will
and recognize their importance, understand the relation-
strive to adapt their leadership style as circumstances warrant.
ships between them, and perceive the underlying causes of a
Many organizations offer programs to develop goal leadership
situation. When managers have identified critical factors and
skills. When plans fail, very often leaders are held responsible for
causes, they can take appropriate action. All managers need
what goes wrong. For example, banking giant Citigroup’s CFO
to think logically, but this skill is probably most important to
Charles Prince resigned after the subprime credit meltdown
the success of top-level managers. To be analytical, it is neces-
forced Citigroup to write down billions of dollars. While at Citi-
sary to think about a broad range of issues and to weigh differ-
group, Prince had focused on improving ethics. He also supported
ent options before taking action. Because analytical skills are
a corporate creed that leaders should “accept accountability for
so important, questions that require analytical skills are often
our failures.”25
a part of job interviews. Questions such as “How would you
resolve a problem at work if you had access to a large amount of
Technical Expertise data?” may be part of the interview process. The answer would
Managers need technical expertise, the specialized knowl- require the interviewee to try to explain how to sort data to find
edge and training required to perform jobs related to their relevant facts that could resolve the issue. Analytical thinking is
area of management. Accounting managers need to be able required in complex or difficult situations where the solution is
to perform accounting jobs, and production managers need often not clear. Resolving ethical issues often requires analyti-
to be able to perform production jobs. Although a production cal skills.

human relations
skills the ability to deal
with people, both inside and
outside the organization Human Relations WHERE DO MANAGERS
Skills
People skills, or human relations COME FROM?
skills, are the ability to deal with people, both inside and out- Good managers are not born; they are made. An organization
side the organization. Those who can relate to others, commu- acquires managers in three ways: promoting employees from
nicate well with others, understand the needs of others, and within, hiring managers from other organizations, and hiring
show a true appreciation for others are generally more suc- managers straight out of universities.
cessful than managers who lack such skills. People skills are
especially important in hospitals, airline companies, banks, Promoting people within the organization into management
and other organizations that provide services. For example, positions tends to increase motivation by showing employees
at Southwest Airlines, every new employee attends “You, that those who work hard and are competent can advance in the
Promoting people within the organization into

management positions tends to increase motivation by
showing employees that those who work hard and are
competent can advance in the company.
Southwest and Success,” a day-long class designed to teach company. Internal promotion also provides managers who are
employees about the airline and its reputation for impeccable already familiar with the company’s goals and problems. Procter
customer service. All employees in management positions & Gamble prefers to promote managers from within, which cre-
at Southwest take mandatory leadership classes that address ates managers who are familiar with the company’s products,
skills related to listening, staying in touch with employees, policies, and culture and builds company loyalty. Promoting
and handling change without compromising values. from within, however, can lead to problems: It may limit innova-
tion. The new manager may continue the practices and policies
of previous managers. Thus it is vital for companies—even com-
panies committed to promotion from within—to hire outside
people from time to time to bring fresh ideas to the table.
Finding managers with the skills, knowledge, and experience
required to run an organization or department can be difficult.
Specialized executive employment agencies—sometimes called
headhunters, recruiting managers, or executive search firms—
can help locate candidates from other companies. The down-
side is that even though outside people can bring fresh ideas to
Flight attendant David Holmes became a YouTube sensation by rapping

passenger instructions on Southwest Airlines flights. Southwest Airlines’ General Electric’s excellent managerial training programs are renowned
managers and employees are well known for their excellent human around the world. The company knows good managers aren’t born. They
relations skills and for making the workplace fun. are made.

WALMART GOES Smaller formats are not new to Walmart. The focus will be on groceries, although
The company runs 152 Neighborhood Mar- consumers will be able to order other
SMALLER kets (at roughly 42,000 square feet) and four items online and pick them up at the store.
Marketside groceries in the United States, Whether Walmart is successful in Chicago
W ith thousands of Walmart stores

across the United States, it is hard
to imagine any region without the familiar
along with many smaller formats in Mexico.
Yet in areas where space is a significant
issue and sentiments for small businesses
will likely pave the way for the company’s
future plans for stores in the big city.26
big-box retailer. However, there is one mar- are high, Walmart is being forced to adapt Discussion Questions
ket where Walmart is notably absent: urban its strategy and go smaller. These moves 1. Why do you think there has been so
areas. Cities like Chicago, New York City, are starting to pay off. After six years of try- much resistance to Walmart’s expansion
and Detroit have been against the idea of ing to break into Chicago, the city’s zoning in urban areas?
Walmart Supercenters within their limits. committee recently approved plans for a 2. How has Walmart’s management
This is becoming a problem for Walmart, as Walmart on its south side. The desperate changed its tactics and objectives to
it has recently lost 2 percent of U.S. same- need for jobs and Walmart’s agreement to begin to win the approval of zoning com-
store sales while its competitor Target has raise entry-level pay to 50 cents above min- missions and committees?
gained. With suburbs and smaller towns imum wage seem to have made this pos-
3. From an operations management point-
becoming increasingly saturated, Walmart sible. To succeed in the city, Walmart will
of-view, what challenges will Walmart
is looking toward urban areas. In order have to abandon the look and feel of the big
face running significantly smaller stores,
to do so, Walmart is planning to open up box. Management says it will scale down
and how could this impact the consumer?
stores on a smaller scale. these urban stores to 8,000 square feet.
a company, hiring them may cause resentment among existing to charge for a product. Decision making is important in all
employees as well as involve greater expense in relocating an management functions and at all levels, whether the decisions
individual to another city or state. are on a strategic, tactical, or operational level. A systematic
approach using the following six steps usually leads to more
Schools and universities provide a large pool of potential manag-
effective decision making: (1) recognizing and defining the
ers, and entry-level applicants can be screened for their develop-
decision situation, (2) developing options to resolve the situ-
mental potential. People with specialized management skills such
ation, (3) analyzing the options, (4) selecting the best option,
as those with an MBA (master’s of business administration) degree
(5) implementing the decision, and (6) monitoring the conse-
may be good candidates. Business students in the 21st century
quences of the decision (Figure 6.4).
must remain flexible during their job searches. Before applying
for a job, graduates should understand the company, the people,
and the company’s core values to ascertain whether they would
Recognizing and Defining
be a good fit. Students may not have the exact skills for which the the Decision Situation
company is searching, but if they fit well with the culture, they The first step in decision making is recognizing and defining
can be trained. On-the-job training and socialization can help the situation. The situation may be negative—for example, huge
new recruits achieve success in their position and can help them losses on a particular product—or positive—for example, an
reach their objectives. Finding employees who are trainable and a opportunity to increase sales.
good fit with corporate culture means
that organizations have a workforce
staffed with potential future managers. FIGURE 6.4
Businesses that are recovering from the Steps in the Decision-Making Process
most recent economic recession should
be willing to embrace new ideas and new
employees willing to undergo change. Recognize and
Develop Analyze
define the
options options
decision situation
DECISION
MAKING
Managers make many different kinds of Select the Implement Monitor the
decisions, such as the hours in a work- best option the decision consequences
day, which employees to hire, what
products to introduce, and what price

AFTER DEVELOPING A LIST OF POSSIBLE COURSES
OF ACTION, MANAGEMENT SHOULD ANALYZE THE
PRACTICALITY AND APPROPRIATENESS OF EACH OPTION.
Situations calling for small-scale decisions often occur without Other options may be more practical for the computer com-
warning. Situations requiring large-scale decisions, however, pany: It may consider selling its technology to another com-
generally occur after some warning signs. Effective manag- puter company that has adequate resources, or it may allow
ers pay attention to such signals. Declining profits, small- itself to be purchased by a larger company that can introduce
scale losses in previous years, inventory buildup, and retailers’ the new technology.
unwillingness to stock a product are signals that may fore-
When assessing appropriateness, the decision maker should
shadow huge losses to come. If managers pay attention to such
consider whether the proposed option adequately addresses
signals, problems can be contained.
the situation. When analyzing the consequences of an option,
Once a situation has been recognized, management must managers should consider its impact on the situation and on
define it. Losses reveal a problem—for example, a failing prod- the organization as a whole. For example, when considering
uct. One manager may define the situation as a product quality a price cut to boost sales, management must think about the
problem; another may define it as a change in consumer prefer- consequences of the action on the organization’s cash flow and
ence. These two viewpoints may lead to vastly different solu- consumers’ reaction to the price change.
tions. The first manager, for example, may seek new sources
of raw materials of better quality. The second manager may Selecting the Best Option
believe that the product has reached the end of its lifespan and When all courses of action have been analyzed, management
decide to discontinue it. This example emphasizes the impor- must select the best one. Selection is often a subjective pro-
tance of carefully defining the problem rather than jumping to cedure because many situations do not lend themselves to
conclusions. quantitative analysis. Of course, it is not always necessary to
select only one option and reject all others; it may be possible
Developing Options to select and use a combination of several options. William
Once the decision situation has been recognized and defined, Wrigley Jr. made a decision to sell his firm to Mars for
the next step is to develop a list of possible courses of action. $23 billion. The firm was founded by his great-grandfather
The best lists include both standard and creative plans. As a in 1891, but hard times forced Wrigley to take what was con-
general rule, more time and expertise are devoted to the devel- sidered to be the best option. This option was to create the
opment stage of decision making when the decision is of major Mars-Wrigley firm, currently the world’s largest confection-
importance. When the decision is of lesser importance, less ary company with a distribution network in 180 countries.28
time and expertise will be spent on this stage. Options may be A different set of choices would have been available to the
developed individually, by teams, or through analysis of simi- company had it been able to purchase Hershey for $12 billion
lar situations in comparable organizations. Creativity is a very a few years earlier.
important part of selecting the most viable option. Creativity
depends on new and useful ideas, regardless of where they orig- Implementing the Decision
inate or the method used to create them. The best option can To deal with the situation at hand, the selected option or
range from a required solution to an identified problem or vol- options must be put into action. Implementation can be fairly
unteered solution, to an observed problem by an outside work simple or very complex, depending on the nature of the deci-
group member.27 sion. Effective implementation of a decision to abandon a
product, close a plant, purchase a new business, or something
Analyzing Options similar requires planning. For example, when a product is
After developing a list of possible courses of action, manage- dropped, managers must decide how to handle distributors
ment should analyze the practicality and appropriateness of and customers and what to do with the idle production facil-
each option. An option may be deemed impractical because ity. Additionally, they should anticipate resistance from people
of a lack of financial resources, legal restrictions, ethical and within the organization (people tend to resist change because
social responsibility considerations, authority constraints, they fear the unknown). Finally, management should be ready
technological constraints, economic limitations, or simply a to deal with the unexpected consequences. No matter how well
lack of information and expertise. For example, a small com- planned implementation is, unforeseen problems will arise.
puter manufacturer may recognize an opportunity to introduce Management must be ready to address these situations when
a new type of computer but lack the financial resources to do so. they occur.

agenda a calendar,
containing both specific
and vague items, that
Monitoring the Consequences they discuss anything and every- covers short-term goals
thing remotely connected with and long-term objectives
After managers have implemented the decision, they must
their business.
determine whether it has accomplished the desired result.
networking the
Without proper monitoring, the consequences of decisions Managers spend a lot of time estab- building of relationships
may not be known quickly enough to make efficient changes. lishing and updating an agenda of and sharing of information
If the desired result is achieved, management can reasonably goals and plans for carrying out with colleagues who can
conclude that it made a good choice. If the desired result is their responsibilities. An agenda help managers achieve the
not achieved, further analysis is warranted. Was the decision contains both specific and vague items on their agendas
simply wrong, or did the situation change? Should some other items, covering short-term goals
option have been implemented? and long-term objectives. Like a
calendar, an agenda helps the manager figure out what must be
If the desired result is not achieved, management may discover
done and how to get it done to meet the objectives set by the
that the situation was incorrectly defined from the beginning.
organization. Technology tools such as smart phones can help
That may require starting the decisionmaking process all over
managers manage their agendas, contacts, communications,
again. Finally, management may determine that the decision
and time.
was good even though the desired results have not yet shown
Managers also spend a lot of time networking—building

relationships and sharing information with colleagues who can
help them achieve the items on their agendas.
up, or it may determine a flaw in the decision’s implementa- Managers also spend a lot of time networking—building
tion. In the latter case, management would not change the deci- relationships and sharing information with colleagues who
sion but would change the way in which it is implemented. can help them achieve the items on their agendas. Managers
spend much of their time communicating with a variety of
people and participating in activities that on the surface do not
THE REALITY OF seem to have much to do with the goals of their organization.
Nevertheless, these activities are crucial to getting the job done.
MANAGEMENT Networks are not limited to immediate subordi-
Management is not a cut-and-dried pro- nates and bosses; they include other people
cess. There is no mathematical formula for in the company as well as customers, sup-
managing an organization and achieving TEAM EXERCISE pliers, and friends. These contacts provide
organizational goals, although many man- Form groups and assign the respon- managers with information and advice on
agers passionately wish for one! Managers sibility of locating examples of crisis diverse topics. Managers ask, persuade,
plan, organize, staff, direct, and control, management implementation for com- and even intimidate members of their net-
but management expert John P. Kotter says panies dealing with natural disasters work in order to get information and to get
even these functions can be boiled down to (explosions, fires, earthquakes, etc), things done. Networking helps managers
two basic activities: technology disasters (viruses, plane carry out their responsibilities. Andrea Nie-
crashes, compromised customer data, renberg, independent business consultant
1. Figuring out what to do despite uncer- etc), or ethical or legal disasters. How
tainty, great diversity, and an enormous
and founder of Nierenberg Group Inc., has
did these companies communicate been called a “networking success story” by
amount of potentially relevant informa- with key stakeholders? What meas-
tion, and The Wall Street Journal. She writes three
ures did the company take to provide
notes a day: one to a client, one to a friend,
2. Getting things done through a large and support to those involved in the crisis?
Report your findings to the class. and one to a prospective client. She main-
diverse set of people despite having little
tains a database of 3,000 contacts. However,
direct control over most of them.29
she believes that it isn’t how many people
Managers spend as much as 75 percent of you know, but how many you have helped
their time working with others—not only with subordinates and who know you well enough to recommend you that really
but with bosses, people outside their hierarchy at work, and count. Opportunity can knock almost anywhere with such
people outside the organization itself. In these interactions extensive networking. Grateful for numerous referrals to her

Websites like LinkedIn are helping managers and employees network with one another to achieve their professional goals.
friends, Nierenberg’s dentist introduced her to a Wall Street responsibility, the impact of social media, the changing nature
executive who happened to be in the dentist’s office at the of the workforce, new laws and regulations, increased global
same time as Nierenberg. She followed up on the meeting and competition and more challenging foreign markets, declining
later landed four consulting projects at the executive’s firm.30 educational standards (which may limit the skills and knowl-
Her clients include Citigroup, Time Inc., TIAA-CREF, Food edge of the future labor and customer pool), and time itself—
Network, Coach, and Tiffany.31 that is, making the best use of it. But such diverse issues cannot
simply be plugged into a computer program that supplies cor-
Finally, managers spend a great deal of time confronting the
rect, easy-to-apply solutions. It is only through creativity and
complex and difficult challenges of the business world today.
imagination that managers can make effective decisions that
Some of these challenges relate to rapidly changing technol-
benefit their organizations. ■
ogy (especially in production and information processing),
increased scrutiny of individual and corporate ethics and social

SO YOU WANT TO BE A MANAGER // What Kind of Manager
Do You Want to Be?/
M anagers are needed in a wide variety
of organizations. Experts suggest that
employment will increase by millions of jobs
2016. Financial managers will be in even more
demand, with jobs increasing 13 percent in
the same time period. Computer and IT man-
Financial Managers: $106,200
Marketing Managers: $113,400
Human Resources Managers: $99,810
by 2016. But the requirements for the jobs agers will continue to be in strong demand,
Operations Managers: $103,780
become more demanding with every pass- with the number of jobs increasing 16 percent
ing year—with the speed of technology and between 2006 and 2016.32 Medical/Health Services Managers: $84,980
communication increasing by the day, and Salaries for managerial positions remain Administrative Managers: $76,370
the stress of global commerce increasing strong overall. While pay can vary signifi- Sales Managers: $106,79033
pressures to perform. However, if you like a cantly depending on your level of experience,
In short, if you want to be a manager, there
challenge and if you have the right kind of per- the firm where you work, and the region of the
are opportunities in almost every field. There
sonality, management remains a viable field. country where you live, below is a list of the
may be fewer middle-management positions
Even as companies are forced to restructure, nationwide average incomes for a variety of
available in firms, but managers remain a
management remains a vital role in business. different managers:
vital part of most industries and will continue
In fact, the Bureau of Labor Statistics predicts
Chief Executives: $151,370 to be long into the future—especially as navi-
that management positions in public relations,
Computer and Information Systems Man- gating global business becomes ever more
marketing, and advertising are set to increase
agers: $113, 880 complex.
around 12 percent overall between 2006 and
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and video

seven
organization, teamwork,
+ communication
n organization’s structure deter- on legal issues, strategy, and human
A
introduction
LEARNING OBJECTIVES
mines how well it makes deci- resources operating above each of the LO1 Define organizational structure,
and relate how organizational
sions and responds to problems, lines of business.1 structures develop.
and it influences employees’ attitudes Because a business’s structure can so LO2 Describe how specialization and
departmentalization help an
toward their work. A suitable structure profoundly affect its success, this chapter
organization achieve its goals.
can minimize a business’s costs and will examine organizational structure in LO3 Distinguish between groups
maximize its efficiency. Even companies detail. First, we discuss how an organiza- and teams, and identify the types
of groups that exist in organizations.
that operate within the same industry tion’s culture affects its operations. Then
LO4 Determine how organizations
may utilize different organizational struc- we consider the development of struc- assign responsibility for tasks
and delegate authority.
tures. For example, in the medical device ture, including how tasks and responsibili-
LO5 Compare and contrast some
industry, 3M is organized by line of busi- ties are organized through specialization common forms of organizational
ness (health care products, office prod- and departmentalization. Next, we explore structure.
LO6 Describe how communication
ucts, security tools), whereas Medtronic some of the forms organizational structure
occurs in organizations.
has similar business groups, but it also may take. Finally, we consider communi-
has top-level, functional units that focus cations within business.
CHAPTER 7 | Organization, Teamwork, and Communication 139

ORGANIZATIONAL CULTURE of thousands of shoes to children around the world each year, cre-
ating a strong organizational culture of giving back and corporate
One of the most important aspects of organizing a business is social responsibility. His company operates with a program that
determining its organizational culture, a firm’s shared val- for every shoe purchased, a shoe will be donated to children in
ues, beliefs, traditions, philosophies, rules, and role models for need.3 Disneyland/DisneyWorld and McDonald’s have organiza-
behavior. Also called corporate culture, an organizational cul- tional cultures focused on cleanliness, value, and service. At M5
ture exists in every organization, regardless of size, organiza- Networks, a $32 million company that sells VoIP phone systems,
tional type, product, or profit objective. Sometimes behaviors, employees are encouraged to learn how to play musical instru-
programs, and policies enhance and support the organizational ments as part of their company culture. The organization hires
culture. For example, when U.S. unemployment hit 10 per- music instructors to come to the office in the afternoons. CEO
cent during the last recession, Pfizer implemented a program Dan Hoffman believes that company bands will bring together
whereby customers who had lost their jobs and did not have workers from different areas of the firm who normally would not
prescription coverage could get 70 of its brand name drugs interact. He also sees this as a way to encourage his employees to
(Lipitor, Celebrex, Zoloft, Lyrica, etc.) for free for one year. learn new things, which he feels is essential for company growth.4
According to Pfizer CEO Jeffrey Kindler, “We did it because When such values and philosophies are shared by all members of
we thought it was the right thing to do. But, it was motivational an organization, they will be expressed in its relationships with
for our employees and got a great response from customers. In stakeholders. However, organizational cultures that lack such
the long run it will help our business.”2 A firm’s culture may positive values may result in employees who are unproductive
be expressed formally through its mission statement, codes of and indifferent and have poor attitudes, which will be reflected
ethics, memos, manuals, and ceremonies, but it is more com- externally to customers. The corporate culture may have contrib-
monly expressed informally. Examples of informal expressions uted to the misconduct at a number of well-known companies.
of culture include dress codes (or the lack thereof), work habits, For example, a survey found that executives in financial and tech-
extracurricular activities, and stories. Employees often learn the nology companies are mostly cutthroat in collecting intelligence
accepted standards through discussions with co-workers. about competition, leading to unethical acts.5
TOMS Shoes’ organizational culture is determined by the found- Organizational culture helps ensure that all members of a com-
er’s desire to provide as many shoes as possible to children in pany share values and suggests rules for how to behave and
developing countries (where shoeless children walk for miles to deal with problems within the organization. Table 7.1 confirms
get water, food, and medical care). Blake Mycoskie gives hundreds that executives in this study believe that corporate culture has a
CHANGING THE experiences offer students perspectives recruiting interviews, causing some to
that go beyond academic theory, focus- question the point of such educational ini-
ORGANIZATIONAL ing instead on real-world situations. This tiatives. On the other hand, some of the
CULTURE BY REACHING involvement has the potential to change world’s most ethical and socially respon-
organizational cultures by changing values sible companies are the most profitable.
POTENTIAL EMPLOYEES about social responsibility. Training individuals to think and act more
Taking this movement one step fur- responsibly will likely yield positive results
W ith corporate social responsibility

becoming a hot topic in the business
world, companies are looking for talented
ther, IBM and Columbia University have
joined forces through Smarter Students
for a Smarter Planet, an initiative aimed
in corporate America. Many students
involved in these programs are looking to
utilize what they learn to make business,
individuals to create a positive impact on at training students to one day enter posi- and the world, a better place.6
society. As this focus has grown, corporations within the green sector. IBM will
tions have begun working with universities donate the technology needed to train
to incorporate social responsibility and such students. Graduate students will have
sustainability into curriculum as a way to opportunities to work side-by-side with 1. How does training future employees
train potential employees before they leave IBM researchers and other professionals before they leave campus have the poten-
campus. Some, such as Campbell Soup Co., in their chosen fields. With the green tech tial to influence an organization’s culture?
are partnering with universities to offer stu- industry growing, corporate responsibility 2. How do real-world social responsibility
dents real-world projects involving these as a whole is generating new opportunities projects help students prepare for their
issues. Others, such as Dow Chemical Co. for business majors. business careers?
and Intel Corp., are sending their social Despite these partnerships, specializa- 3. Is there a conflict of interest between
responsibility and sustainability experts tion in social responsibility and sustain- using resources to improve the social
to lecture on university campuses. These ability is rarely featured in many traditional responsibility culture and making profits?

organizational
culture a firm’s shared
values, beliefs, traditions,
significant impact on organizational performance and the abil- organization with an explicit for- philosophies, rules, and
ity to retain good employees. The key to success in any organiza- mal structure that guides the team’s role models for behavior
tion is satisfying stakeholders, especially customers. Establishing activities so that it can increase
a positive organizational culture sets the tone for all other deci- game attendance, win games, structure the arrange-
sions, including building an efficient organizational structure. and sell souvenirs such as t-shirts. ment or relationship of
But even an informal group play- positions within an
ing softball for fun has an orga- organization
DEVELOPING nization that specifies who will
pitch, catch, bat, coach, and so on.
ORGANIZATIONAL
STRUCTURE T A B L E 7 . 1 Impact of Corporate Culture on Business Performance
Structure is the arrangement or relationship Culture has a strong or very strong impact on an organization’s performance 82%
of positions within an organization. Rarely is My corporate culture has a strong impact on the ability to retain top talent 68
an organization, or any group of individuals
My organization’s culture drives sales and increases revenue 61
working together, able to achieve common
objectives without some form of structure, My organization’s culture creates a sense of belonging 57
whether that structure is explicitly defined or My organization’s culture lowers turnover 53
only implied. A professional baseball team Source: “Ten Most Admired Corporate Cultures,” February 10, 2010, http://cthrc.ca/en/member_area/
such as the Colorado Rockies is a business member_news/ten_most_admired_corporate_cultures.aspx (accessed March 1, 2010).
The organizational structure at TOMS Shoes consists of two parts. The for-profit component of the company manages overall operations. Its nonprofit
component, Friends of TOMS, is responsible for volunteer activities and shoe donations.

GROWTH REQUIRES ORGANIZING—THE
STRUCTURING OF HUMAN, PHYSICAL, AND FINANCIAL
RESOURCES TO ACHIEVE OBJECTIVES IN AN EFFECTIVE
AND EFFICIENT MANNER.
Governments and nonprofit organizations also have formal orga- the owner must designate someone to manage the salespeople
nizational structures to facilitate the achievement of their objec- and maintain the accounting, payroll, and tax functions. If the
tives. Getting people to work together efficiently and coordinating owner decides to expand by opening more stores, still more
the skills of diverse individuals require careful planning. Devel- managers will be needed. Figure 7.1 shows these stages of growth
oping appropriate organizational structures is therefore a major with three organizational charts (visual displays of organi-
challenge for managers in both large and small organizations. zational structure, chain of command, and other relationships).
An organization’s structure develops when managers assign work Growth requires organizing—the structuring of human, physi-
tasks and activities to specific individuals or work groups and coor- cal, and financial resources to achieve objectives in an effective
dinate the diverse activities required to reach the firm’s objectives. and efficient manner. Growth necessitates hiring people who
When Macy’s, for example, has a sale, the store manager must work have specialized skills. With more people and greater special-
with the advertising department to make the public aware of the ization, the organization needs to develop a formal structure
sale, with department managers to ensure that extra salespeople are to function efficiently. Imagine the organizational changes
scheduled to handle the increased customer traffic, and with mer- that Nathan’s Famous hot dogs underwent from 1916 when it
chandise buyers to ensure that enough sale merchandise is avail- operated a single Coney Island hot dog shop to a company that
able to meet expected consumer demand. All the people occupying now operates an international chain of fast-food restaurants as
these positions must work together to achieve the store’s objectives. well as selling food products through supermarkets. The com-
pany sells more than 425 million hot dogs a year and generates
The best way to begin to understand how organizational struc-
nearly $51 million in revenue.7 As we shall see, structuring an
ture develops is to consider the evolution of a new business such
organization requires that management assign work tasks to
as a clothing store. At first, the business is a sole proprietorship in
specific individuals and departments and assign responsibility
which the owner does everything—buys, prices, and displays the
for the achievement of specific organizational objectives.
merchandise; does the accounting and tax records; and assists
customers. As the business grows, the owner hires a salesperson
and perhaps a merchandise buyer to help run the store. As the
business continues to grow, the owner hires more salespeople. ASSIGNING TASKS
The growth and success of the business now require the owner For a business to earn profits from the sale of its products, its
to be away from the store frequently, meeting with suppliers, managers must first determine what activities are required
engaging in public relations, and attending trade shows. Thus, to achieve its objectives. At Celestial Seasonings, for example,
FIGURE 7.1
The Evolution of a Clothing Store, Phases 1, 2, and 3
Phase 1 Phase 2 Phase 3
Owner Owner Owner
Sales Merchandise Sales Merchandise

Accountant
Personnel Buyer Manager Buyer
Data
Sales
Processing
Personnel
Analyst

organizational chart specialization departmentaliza-
a visual display of the the division of labor into tion the grouping of jobs
organizational structure, small, specific tasks and the into working units usually
employees must purchase herbs from suppli- lines of authority (chain assignment of employees to called departments, units,
ers, dry the herbs and place them in tea bags, of command), staff do a single task groups, or divisions
package and label the tea, and then ship the relationships, permanent
packages to grocery stores around the country. committee arrangements,
Other necessary activities include negotiating and lines of communication
with supermarkets and other retailers for dis-
play space, developing new products, planning
advertising, managing finances, and managing employees. All dissatisfied and leave. Although some degree of specialization is
these activities must be coordinated, assigned to work groups, necessary for efficiency, because of differences in skills, abilities,
and controlled. Two important aspects of assigning these work and interests, all people are not equally suited for all jobs. We
activities are specialization and departmentalization. examine some strategies to overcome these issues in Chapter 9.
Specialization Departmentalization
After identifying all activities that must be accomplished, man- After assigning specialized tasks to individuals, managers
agers then break down these activities into specific tasks that next organize workers doing similar jobs into groups to make
can be handled by individual employees. This division of labor them easier to manage. Departmentalization is the group-
into small, specific tasks and the assignment of employees to do ing of jobs into working units usually called departments,
a single task is called specialization. units, groups, or divisions. As we shall see, departments are
Specialization means workers do not waste time shifting from one

job to another, and training is easier.
The rationale for specialization is efficiency. People can per-

form more efficiently if they master just one task rather than
all tasks. In The Wealth of Nations, 18th-century economist
Adam Smith discussed specialization, using the manufacture of
straight pins as an example. Individually, workers could pro-
duce 20 pins a day when each employee produced complete
pins. Thus, 10 employees working independently of each other
could produce 200 pins a day. However, when one worker drew
the wire, another straightened it, a third cut it, and a fourth
ground the point, 10 workers could produce 48,000 pins per
day.8 To save money and achieve the benefits of specialization,
some companies outsource and hire temporary workers to pro-
vide key skills. Many highly skilled, diverse, experienced work-
ers are available through temp agencies.
Specialization means workers do not waste time shifting from
one job to another, and training is easier. However, efficiency
is not the only motivation for specialization. Specialization
also occurs when the activities that must be performed within
an organization are too numerous for one person to handle.
Recall the example of the clothing store. When the business was
young and small, the owner could do everything; but when the
business grew, the owner needed help waiting on customers,
keeping the books, and managing other business activities.
Overspecialization can have negative consequences. Employees
may become bored and dissatisfied with their jobs, and the result
of their unhappiness is likely to be poor quality work, more inju- Henry Ford, the founder of Ford Motor Company, revolutionized manu-
ries, and high employee turnover. This is why some manufac- facturing by creating assembly lines like this one to specialize the tasks
turing firms allow job rotation so that employees do not become his workers performed.

commonly organized by function, product, geographic region, depicts the organizational chart for the city of Corpus Christi,
or customer (Figure 7.2). Most companies use more than one Texas, showing these departments.
departmentalization plan to enhance productivity. For instance,
many consumer goods manufacturers have departments for Functional Departmentalization Functional depart-
specific product lines (beverages, frozen dinners, canned goods, mentalization groups jobs that perform similar functional
and so on) as well as departments dealing with legal, purchas- activities, such as finance, manufacturing, marketing, and human
ing, finance, human resources, and other business functions. resources. Each of these functions is managed by an expert in the
For smaller companies, accounting can be set up online, almost work done by the department—an engineer supervises the pro-
as an automated department. Accounting software can handle duction department; a financial executive supervises the finance
electronic transfers so you never have to worry about a late bill. department. This approach is common in small organizations. A
Many city governments also have departments for specific ser- weakness of functional departmentalization is that, because it tends
vices (e.g., police, fire, waste disposal) as well as departments for to emphasize departmental units rather than the organization as a
legal, human resources, and other business functions. Figure 7.3 whole, decision making that involves more than one department
FIGURE 7.2
Departmentalization
Functional Departmentalization
President
Production Marketing Finance Distribution Research and

Department Department Department Department Development
Department
Product Departmentalization
President
Consumer Industrial
Stereo Computer Telecommunications Telecommunications
Equipment Electronics Equipment Equipment
Division Division Division Division
Geographical Departmentalization
President
International
Operation
Pacific Basin European Latin American Middle East

Division Division Division Division
Customer Departmentalization
Product
Manager
Consumer Industrial
Foods Foods

functional depart-
mentalization the
grouping of jobs that
may be slow, and it requires greater coordination. Thus, as busi- than achievement of the organi- perform similar functional
nesses grow, they tend to adopt other approaches to organizing jobs. zation’s overall objectives. How- activities, such as finance,
ever, it simplifies decision making manufacturing, marketing,
Product Departmentalization Product depart- and helps coordinate all activities and human resources
mentalization, as you might guess, organizes jobs around related to a product or product
the products of the firm. Procter & Gamble has global units, group. Campbell Soup Company product departmen-
such as laundry and cleaning products, paper products, and is organized into four segments: talization the organiza-
health care products. Each division develops and imple- (1) U.S. Soup, Sauces and Bever- tion of jobs in relation to the
products of the firm
ments its own product plans, monitors the results, and takes cor- ages, which includes Campbell’s
rective action as necessary. Functional activities—production, soups, Swanson broth, Prego pasta
finance, marketing, and others—are located within each prod- sauce, V8 juice and juice drinks,
uct division. Consequently, organizing by products duplicates Campbell’s tomato juice, and related products; (2) Baking and
functions and resources and emphasizes the product rather Snacking, which includes Pepperidge Farm cookies, crackers,
FIGURE 7.3
An Organizational Chart for the City of Corpus Christi
Municipal
Court City Council City Secretary
Judicial
Assistant
to the City Manager
City Manager
Municipal Public City

Aviation
Libraries Police Attorney
Court Information
Inter-
Economic Education
Fire governmental
Development Director
Affairs
Assistant Assistant Assistant Assistant

City Manager City Manager City Manager City Manager
Convention Municipal Development

Engineering Water Libraries Budget
Facilities Court Services
Storm Water
Human
Gas and Street Health Finance
Relations
Operations
Solid Waste Neighborhood General Human

Operations Wastewater Park & Rec
Services Services Resources
Information
General Environmental Systems and Community
Services Services Museum Customer Development
Service Center
Source: “City of Corpus Christi Organizational Chart,” City of Corpus Christi www.cctexas.com/files/g5/cityorgchart.pdf
(accessed February 11, 2010).

geographical customer depart- delegation of author- responsibility the accountability the
departmentaliza- mentalization the ity giving employees not obligation, placed on principle that employees
tion the grouping of jobs arrangement of jobs around only tasks, but also the power employees through delega- who accept an assignment
according to geographic the needs of various types to make commitments, use tion, to perform assigned and the authority to carry
location, such as state, of customers resources, and take whatever tasks satisfactorily and be it out are answerable to a
region, country, or continent actions are necessary to carry held accountable for the superior for the outcome
out those tasks proper execution of work
bakery and frozen products, and Arnott’s biscuits and salty for either business/frequent travelers or infrequent/vacation-
snacks; (3) International Soup, Sauces and Beverages, which ing customers. Customer departmentalization, like geograph-
includes soup, sauces, and beverages sold outside the United ical departmentalization, does not focus on the organization
States, and (4) North America Foodservice, which includes pre- as a whole and therefore requires a large administrative staff
pared food operations.9 to coordinate the operations of the various groups.
Geographical Departmentalization Geographical

departmentalization groups jobs according to geographic
location, such as a state, region, country, or continent. Frito-Lay, ASSIGNING RESPONSIBILITY
for example, is organized into four regional divisions, allowing After all workers and work groups have been assigned their
the company to get closer to its customers and respond more tasks, they must be given the responsibility to carry them out.
quickly and efficiently to regional competitors. Multinational Management must determine to what extent it will delegate
corporations often use a geographical approach because of responsibility throughout the organization and how many
vast differences between different regions. Coca-Cola, Gen- employees will report to each manager.
eral Motors, and Caterpillar are organized by region. However,
organizing by region requires a large administrative staff and
Delegation of Authority
control system to coordinate operations, and tasks are dupli- Delegation of authority means not only giving tasks to
cated among the different regions. employees but also empowering them to make commitments,
use resources, and take whatever actions are necessary to carry
Customer Departmentalization Customer depart- out those tasks. Let’s say a marketing manager at Nestlé has
mentalization arranges jobs around the needs of various assigned an employee to design a new package that is less
types of customers. Banks, for example, typically have sepa- wasteful (more environmentally responsible) than the current
rate departments for commercial banking activities and for package for one of the company’s frozen dinner lines. To carry
consumer or retail banking. This permits the bank to address out the assignment, the employee needs access to informa-
the unique requirements of each group. Airlines, such as Brit- tion and the authority to make certain decisions on packaging
ish Airways and Delta, provide prices and services customized materials, costs, and so on. Without the authority to carry out
the assigned task, the employee would have to get the approval
of others for every decision and every request for materials.
As a business grows, so do the number and complexity of deci-
sions that must be made; no one manager can handle them all.
Hotels such as Westin Hotels and Resorts and the Ritz-Carlton
give authority to service providers, including front desk person-
nel, to make service decisions such as moving a guest to another
room or providing a discount to guests who experience a problem
at the hotel. Delegation of authority frees a manager to concentrate
on larger issues, such as planning or dealing with problems and
opportunities.
Delegation also gives a responsibility, or obligation, to
employees to carry out assigned tasks satisfactorily and holds
them accountable for the proper execution of their assigned
work. The principle of accountability means that employees
who accept an assignment and the authority to carry it out are
answerable to a superior for the outcome. Returning to the Nestlé
example, if the packaging design prepared by the employee
is unacceptable or late, the employee must accept the blame.
The Campbell Soup Company uses product departmentalization to If the new design is innovative, attractive, and cost-efficient,
organize its company. However, the firm also engages in a type of as well as environmentally responsible, or is completed ahead of
geographical departmentalization for various regions. schedule, the employee will accept the credit.

centralized
organization a struc-
ture in which authority is
The process of delegating authority establishes a pattern Overcentralization can cause seri- concentrated at the top,
of relationships and accountability between a superior and ous problems for a company, in and very little decision-
his or her subordinates. The president of a firm delegates part because it may take longer making authority is del-
responsibility for all marketing activities to the vice president for the organization as a whole egated to lower levels
of marketing. The vice president accepts this responsibil- to implement decisions and to
ity and has the authority to obtain all relevant information, respond to changes and problems decentralized
make certain decisions, and delegate any or all activities to on a regional scale. McDonald’s, for organization an organi-
his or her subordinates. The vice president, in turn, delegates example, was one of the last chains zation in which decision-
making authority is delegated
all advertising activities to the advertising manager, all sales to introduce a chicken sandwich
as far down the chain of
activities to the sales manager, and so on. These managers because of the amount of research, command as possible
then delegate specific tasks to their subordinates. However, development, test marketing, and
the act of delegating authority to a subordinate does not layers of approval the product had
relieve the superior of accountability for the delegated job. to go through.
Even though the vice president of marketing delegates work
to subordinates, he or she is still ultimately accountable to Decentralized Organizations A decentralized orga-
the president for all marketing activities. nization is one in which decision-making authority is delegated
as far down the chain of command as possible. Decentraliza-
Degree of Centralization tion is characteristic of organizations that operate in com-
The extent to which authority is delegated throughout an orga- plex, unpredictable environments. Businesses that face intense
nization determines its degree of centralization. competition often decentralize to improve responsiveness and
enhance creativity. Lower-level managers who interact with the
Centralized Organizations In a centralized external environment often develop a good understanding of it
organization, authority is concentrated at the top, and and thus are able to react quickly to changes.
very little decision-making authority is delegated to lower
Delegating authority to lower levels of managers may increase
levels. Although decision-making authority in centralized
the organization’s productivity. Decentralization requires that
organizations rests with top levels of management, a vast
lower-level managers have strong decision-making skills. In
amount of responsibility for carrying out daily and rou-
recent years the trend has been toward more decentralized
tine procedures is delegated to even the lowest levels of
organizations, and some of the largest and most successful com-
the organization. Many government organizations, includ-
panies, including GE, IBM, Google, Nike, and JCPenney, have
ing the U.S. Army, the U.S. Postal Service, and the IRS, are
decentralized decision-making authority. McDonald’s, realiz-
centralized.
ing most of its growth outside the United States, is becoming
Businesses tend to be more centralized when the decisions increasingly decentralized and “glo-cal,” varying products in
to be made are risky and when low-level managers are not specific markets to better meet consumer demands. This change
highly skilled in decision making. In the banking industry, for in organizational structure for McDonald’s is fostering greater
example, authority to make routine car loans is given to all innovation and local market success. McDonald’s, which was
loan managers, while the authority to make high-risk loans, long known for the homogeneity of its products, has embraced
such as for a large residential development, may be restricted local cuisine on a limited scale. In Italy, McDonald’s introduced
to upper-level loan officers. the McItaly, a burger made with only Italian products. The
FAMILY TEAM MAKES selling his first t-shirts out of the trunk of to score new designs and attend special
his car and the suitcase he used while tour- events. Through it all, John has been sup-
JOHNNY CUPCAKES ing with his band. As business accelerated, ported by his family and friends, who are
A BUSINESS SUCCESS John’s mother and sister began helping him also his co-workers. His mother serves as
fill orders. His parent’s house became his his chief financial officer, his sister runs
warehouse. Along the road to success, John human resources and customer service,
I t might sound like a bakery, but Johnny
Cupcakes is actually the name of a suc-
cessful apparel retailer. Founded in 2001
turned down distribution offers from Nord-
strom, Urban Outfitters, and more. Instead,
his sister’s best friend is training as book-
keeper, and his father assists with various
by John Earle, Johnny Cupcakes sells lim- he opened up his own stores in Hull, Mas- aspects of the business. Although the cre-
ited edition clothing and accessories—all sachusetts (his hometown), Los Angeles, ative inspiration rests with John, Johnny
featuring cupcake designs. John began and Boston. Customers often camp outside Cupcakes is truly a family affair.10

span of management line structure the simplest line-and-staff structure
the number of subordinates who organizational structure in which a structure having a traditional
report to a particular manager direct lines of authority extend line relationship between
from the top manager to the superiors and subordinates and
one another, the manager has few
organizational layers lowest level of the organization also specialized managers— responsibilities other than supervi-
the levels of management in an called staff managers—who are sion, the level of interaction between
organization available to assist line managers superiors and subordinates is low,
few problems arise, subordinates are
highly competent, and a set of spe-
cific operating procedures governs
burger is designed with the red and green Italian flag in mind; the activities of managers and their subordinates, a wide span of
customers can choose from artichoke spread and Asiago cheese management will be more appropriate. Narrow spans of manage-
or onion, lettuce, and pancetta.11 Diversity and decentralization ment are typical in centralized organizations, while wide spans of
seem to be McDonald’s keys to being better, not just bigger. management are more common in decentralized firms.
Nonprofit organizations benefit from decentralization as well.
Organizational Layers
Span of Management Complementing the concept of span of management is
How many subordinates should a manager manage? There is no organizational layers , the levels of management in an
simple answer. Experts generally agree, however, that top man- organization.
agers should not directly supervise more than four to eight peo-
ple, while lower-level managers who supervise routine tasks are A company with many layers of managers is considered
capable of managing a much larger number of subordinates. For tall; in a tall organization, the span of management is nar-
example, the manager of the finance department may supervise row (see Figure 7.4). Because each manager supervises only a
25 employees, whereas the vice president of finance may super- few subordinates, many layers of management are necessary
vise only five managers. Span of management refers to the to carry out the operations of the business. McDonald’s, for
number of subordinates who report to a particular manager. A example, has a tall organization with many layers, including
wide span of management exists when a manager directly superstore managers, district managers, regional managers, and
vises a very large number of employees. A narrow span of man- functional managers (finance, marketing, and so on), as well
agement exists when a manager directly supervises only a few as a chief executive officer and many vice presidents. Because
subordinates (Figure 7.4). At Whole Foods, the best employees there are more managers in tall organizations than in flat
A COMPANY WITH MANY LAYERS OF MANAGERS

IS CONSIDERED TALL.
are recruited and placed in small teams in one of eight depart- organizations, administrative costs are usually higher. Com-
ments. Employees are empowered to discount, give away, and munication is slower because information must pass through
sample products, as well as to assist in creating a respectful work- many layers.
place where goals are achieved, individual employees succeed,
Organizations with few layers are flat and have wide spans of
and customers are core in business decisions. This approach
management. When managers supervise a large number of
allows Whole Foods to offer unique and “local market” expe-
employees, fewer management layers are needed to conduct
riences in each of its stores. This level of
customization is in contrast to more cen-
tralized national supermarket chains such FIGURE 7.4
12 Span of Management: Wide Span and Narrow Span
as Kroger, Safeway, and Publix.
Should the span of management be wide
or narrow? To answer this question, sev- Wide Span: Flat Organization Narrow Span: Tall Organization
eral factors need to be considered. A nar-
row span of management is appropriate
when superiors and subordinates are not
in close proximity, the manager has many
responsibilities in addition to the super-
vision, the interaction between superiors
and subordinates is frequent, and prob-
lems are common. However, when supe-
riors and subordinates are located close to

FIGURE 7.5
Line Structure
Convenience Store
Owner Manager Assistant Manager Hourly Employee
the organization’s activities. Managers in flat organizations immediate supervisor. However, this structure requires that
typically perform more administrative duties than manag- managers possess a wide range of knowledge and skills. They are
ers in tall organizations because there are fewer of them. responsible for a variety of activities and must be knowledge-
They also spend more time supervising and working with able about them all. Line structures are most common in small
subordinates. businesses.
Many of the companies that have decentralized also flattened Line-and-Staff Structure
their structures and widened their spans of management, often
The line-and-staff structure has a traditional line relationship
by eliminating layers of middle management. Many corpora-
between superiors and subordinates, and specialized managers—
tions, including Avon, AT&T, and Ford Motor Company, did
called staff managers—are available to assist line managers
so to reduce costs, speed up decision making, and boost overall
(Figure 7.6). Line managers can focus on their area of expertise
productivity.
in the operation of the business, while staff managers provide
advice and support to line departments on specialized matters
such as finance, engineering, human resources, and the law. In
FORMS OF
FIGURE 7.6
ORGANIZATIONAL Line-and-Staff Structure
STRUCTURE
Along with assigning tasks and the Line relationship
Plant
responsibility for carrying them out, Staff relationship Manager
managers must consider how to struc-
ture their authority relationships—that
is, what structure the organization itself
will have and how it will appear on the
organizational chart. Common forms of
organization include line structure, line- Human
Engineering
and-staff structure, multidivisional struc- Resources
ture, and matrix structure.
Production
Line Structure Manager
The simplest organizational structure,
line structure, has direct lines of
authority that extend from the top man-
ager to employees at the lowest level of the
organization. For example, a convenience
store employee may report to an assistant Supervisor Supervisor Supervisor Supervisor
manager, who reports to the store man-
ager, who reports to a regional manager,
or, in an independent store, directly to the
owner (Figure 7.5). This structure has a
clear chain of command, which enables
managers to make decisions quickly. Employees Employees Employees Employees
A mid-level manager facing a decision
must consult only one person, his or her

multidivisional matrix structure a group two or team a small group
structure a structure that sets up teams more individuals who whose members have
structure that organizes from different departments, communicate with one complementary skills;
the basis of geography,
departments into larger thereby creating two or more another, share a common have a common purpose,
customer, product, or
groups called divisions intersecting lines of author- identity, and have a goals, and approach; and
ity; also called a project- common goal hold themselves mutually a combination of these,
management structure accountable so too divisions can be
formed based on any
of these methods of
organizing. Within each
the city of Corpus Christi (refer back to Figure 7.3), for example,
of these divisions, departments may be organized by product,
assistant city managers are line managers who oversee groups
geographic region, function, or some combination of all three.
of related departments. However, the city attorney, police chief,
Indra Nooyi, CEO of PepsiCo, rearranged the company’s orga-
and fire chief are effectively staff managers who report directly to
nizational structure. Prior to her tenure, PepsiCo was organized
the city manager (the city equivalent of a business chief execu-
geographically. She created new units—PepsiCo Americas Foods
tive officer). Staff managers do not have direct authority over
(PAF), PepsiCo Americas Beverages (PAB), PepsiCo Europe,
line managers or over the line manager’s subordinates, but they
and PepsiCo Asia, Middle East & Africa—that span interna-
do have direct authority over subordinates in their own depart-
tional boundaries and make it easier for employees in different
ments. However, line-and-staff organizations may experience
geographic regions to share business practices.13
problems with overstaffing and ambiguous lines of communi-
cation. Additionally, employees may become frustrated because Multidivisional structures permit delegation of decision-making
they lack the authority to carry out certain decisions. authority, allowing divisional and department managers to
specialize. They allow those closest to the action to make the
Multidivisional Structure decisions that will affect them. Delegation of authority and
divisionalized work also mean that better decisions are made
As companies grow and diversify, traditional line struc-
faster, and they tend to be more innovative. Most importantly,
tures become difficult to coordinate, making communication
by focusing each division on a common region, product, or
difficult and decision making slow. When the weaknesses of
customer, each is more likely to provide products that meet
the structure—the “turf wars,” miscommunication, and work-
the needs of its particular customers. However, the divisional
ing at cross-purposes—exceed the benefits, growing firms
structure inevitably creates work duplication, which makes it
tend to restructure, often into the divisionalized form. A
more difficult to realize the economies of scale that result from
multidivisional structure organizes departments into larger
grouping functions together.
groups called divisions. Just as departments might be formed on
FIGURE 7.7 Matrix Structure

Matrix Structure Another structure that attempts to address
issues that arise with growth, diversifica-
tion, productivity, and competitiveness,
General
is the matrix. A matrix structure, also
Manager called a project management structure,
sets up teams from different departments,
thereby creating two or more intersect-
ing lines of authority (Figure 7.7). The
matrix structure superimposes project-
General
Functional Functional Functional Functional based departments on the more traditional,
Project
Manager Manager Manager Manager function-based departments. Project teams
Manager
bring together specialists from a variety of
Manager areas to work together on a single project,
Project such as developing a new fighter jet. In this
A arrangement, employees are responsible
to two managers—functional managers
Manager and project managers. Matrix structures
Project are usually temporary: Team members
B typically go back to their functional or
line department after a project is finished.
Manager However, more firms are becoming per-
Project manent matrix structures, creating and
C
dissolving project teams as needed to meet
customer needs. The aerospace industry

was one of the first to apply the matrix structure, but today it is teams. Table 7.2 points out some important differences between
used by universities and schools, accounting firms, banks, and them. Work groups emphasize individual work products, indi-
organizations in other industries. vidual accountability, and even individual leadership. Sales-
Matrix structures provide flexibility, enhanced cooperation, people working independently for the same company could be
and creativity, and they enable the company to respond quickly a work group. In contrast, work teams share leadership roles,
to changes in the environment by giving special attention to have both individual and mutual accountability, and create col-
specific projects or problems. However, they are generally lective work products. In other words, a work group’s perfor-
expensive and quite complex, and employees may be confused mance depends on what its members do as individuals, while
as to whose authority has priority—the project manager’s or a team’s performance is based on creating a knowledge center
the immediate supervisor’s. and a competency to work together to accomplish a goal. When
CEO Joe Albanese had to leave his CEO position at Commodore
Builders for active duty in the Army, his team rebalanced his
THE ROLE OF GROUPS AND workload and continued its projects. Albanese had established
teams that focused on collaboration. A core team was prepared
TEAMS IN ORGANIZATIONS to lead the company in his absence. Albanese simply unplugged
himself, leaving the team to perform his duties, including day-
Regardless of how they are organized, most of the essential work
of business occurs in individual work groups and teams, so we’ll to-day leadership. During Albanese’s 10-month deployment to
take a closer look at them now. Although some experts do not the Middle East, the company grew by 40 percent.16
make a distinction between groups and teams, in recent years The type of groups an organization establishes depends on the
there has been a gradual shift toward an emphasis on teams and tasks it needs to accomplish and the situation it faces. Some
managing them to enhance individual and organizational suc- specific kinds of groups and teams include committees, task
cess. Some experts now believe that highest productivity results forces, project teams, product-development teams, quality-
only when groups become teams.14 assurance teams, and self-directed work teams. All of these can
Traditionally, a group has been defined as two or more indi- be virtual teams—employees in different locations who rely on
viduals who communicate with one another, share a common e-mail, audio conferencing, fax, Internet, videoconferencing, or
identity, and have a common goal. A team is a small group other technological tools to accomplish their goals. With more
whose members have complementary skills; have a common than 84 percent of American employees working in a different
purpose, goals, and approach; and hold themselves mutu- location than their supervisors, virtual teams are becoming a
ally accountable.15 All teams are groups, but not all groups are part of everyday business.17
FORD DEVELOPS ALL- group also focuses on reusing damaged release states that in one year the com-
materials, rather than throwing them away. pany has kept almost 30 million pounds of
WOMEN TEAM TO In an industry dominated by men—only plastic out of landfills and saved $4.5 million
GREEN ITS VEHICLES one-fourth of auto employees and one- by utilizing recycled materials. Ford plans
tenth of auto executives are women— to replace fiberglass and plastics with
Ford’s green team feels that it has unique sustainable, eco-friendly alternatives,
F ord is going green with its formation
of its all-women renewable materi-
als research team—also known as Ford’s
skills and insights to contribute. Many
members of the team have children, and
which will lead to a smaller carbon foot-
print and a reduced use of petroleum. It
Green Team. Debbie Mielewski and her five they bring a passion to protect the environ- looks like the Green Team has a winning
female colleagues are all engineers looking ment for future generations to their work. strategy.18
to make Ford cars more eco-friendly. The In addition, the six members find that they
idea for the team started when Mielewski are able to collaborate well. They tend to Discussion Questions
was asked to reshape Ford’s plastics divide into teams, rather than working solo,
1. Why did Ford form an all-women renew-
department. She brought her own green in order to have constant support and feed-
able materials research team to make
concerns to the job and began researching back. The team emphasizes communication
cars more eco-friendly?
how to make Ford’s cars more sustainable. and collective decision making, which they
To date, Mielewski and her team have been feel has been an important factor in their 2. Why is collective decision making a ben-
awarded ten prize patents for innovations achievements. efit to Ford’s Green Team?
such as soy-filled seats and the blending of The green team has already made an 3. Will Ford’s Green Team contribute to
traditional plastics with wheat fibers. The impact on the company. A recent press consumer loyalty and success?

committee a project teams groups product-development quality-assurance self-directed work
permanent, formal group similar to task forces that teams a specific type teams (or quality team (SDWT) a group
that performs a specific task normally run their operation of project team formed circles) small groups of of employees responsible
and have total control of a to devise, design, and workers brought together from for an entire work process
task force a temporary specific work project implement a new product throughout the organization to or segment that delivers
group of employees solve specific quality, produc- a product to an internal or
responsible for bringing tivity, or service problems external customer
about a particular change
T A B L E 7 . 2 Differences between Groups and Teams be formed from individuals outside a company. When Toyota
experienced a major product recall, the president, Akio Toyoda,
Working Group Team
formed and led a Global Quality Task Force to conduct qual-
Has strong, clearly focused Has shared leadership roles ity improvements throughout the worldwide operations of the
leader company. With massive recalls looming, the company focused
Has individual accountability Has individual and group on (1) improving the quality inspection process, (2) enhanc-
accountability ing customer research, (3) establishing an automotive center
Has the same purpose as the Has a specific purpose that of quality excellence, (4) utilizing external industry experts,
broader organizational mission the team itself delivers (5) increasing the frequency of communication with regional
Creates individual work products Creates collective work products authorities, and (6) improving regional autonomy.19
Runs efficient meetings Encourages open-ended
discussion and active Teams
problem-solving meetings Teams are becoming far more common in the U.S. workplace
Measures its effectiveness indirectly Measures performance as businesses strive to enhance productivity and global com-
by its effects on others (e.g., financial directly by assessing collec- petitiveness. In general, teams have the benefit of being able
performance of the business) tive work products to pool members’ knowledge and skills and make greater use
Discusses, decides, and Discusses, decides, and does of them than can individuals working alone. Team building is
delegates real work together becoming increasingly popular in organizations, with around
Source: Robert Gatewood, Robert Taylor, and O. C. Ferrell, Management: half of executives indicating their companies had team-
Comprehension Analysis and Application, 1995, p. 427. Copyright © 1995 building training. Teams require harmony, cooperation,
Richard D. Irwin, a Times Mirror Higher Education Group, Inc., company. synchronized effort, and flexibility to maximize their contri-
Reproduced with permission of the McGraw-Hill Companies.
bution.20 Teams can also create more solutions to problems
Teams are becoming far more common in the U.S.

workplace as businesses strive to enhance productivity
and global competitiveness.
Committees than can individuals. Furthermore, team participation

enhances employee acceptance of, understanding of, and
A committee is usually a permanent, formal group that does
commitment to team goals. Teams motivate workers by pro-
some specific task. For example, many firms have a compensa-
viding internal rewards in the form of an enhanced sense of
tion or finance committee to examine the effectiveness of these
accomplishment for employees as they achieve more, and
areas of operation as well as the need for possible changes. Eth-
external rewards in the form of praise and certain perks.
ics committees are formed to develop and revise codes of eth-
Consequently, they can help get workers more involved.
ics, suggest methods for implementing ethical standards, and
They can help companies be more innovative, and they can
review specific issues and concerns.
boost productivity and cut costs.
Task Forces According to psychologist Ivan Steiner, team productivity peaks
A task force is a temporary group of employees responsible at about five team members. People become less motivated, and
for bringing about a particular change. They typically come group coordination becomes more difficult after this size. Jeff
from across all departments and levels of an organization. Bezos, Amazon.com CEO, says that he has a “two-pizza rule”:
Task force membership is usually based on expertise rather If a team cannot be fed by two pizzas, it is too large. Keep teams
than organizational position. Occasionally, a task force may small enough where everyone gets a piece of the action.21

Project Teams Project teams are
similar to task forces, but normally they run
their operation and have total control of a
specific work project. Like task forces, their
membership is likely to cut across the firm’s
hierarchy and be composed of people from
different functional areas. They are almost
always temporary, although a large project,
such as designing and building a new airplane
at Boeing Corporation, may last for years.
Product-development teams are a spe-
cial type of project team formed to devise,
design, and implement a new product.
Sometimes product-development teams
exist within a functional area—research
and development—but now they more fre-
quently include people from numerous
functional areas and may even include cus-
tomers to help ensure that the end product
meets the customers’ needs. Washington Online sites such as wikis are allowing employee teams to share information and work
State University’s School of Food Science has collaboratively on documents. The most well-known wiki is the online encyclopedia Wikipedia.
several student product-development teams.
Students develop innovative new food prod-
ucts and present them annually at the Institute of Food Technol-
ogists Student Association competition. WSU student projects COMMUNICATING IN
include Tu Mazi, a mango-flavored probiotic milk powder cre-
ated for consumers in developing nations, and Erupt-a-Cake, a ORGANIZATIONS
ready-to-bake dessert featuring gummy dinosaurs.22 Communication within an organization can flow in a variety
of directions and from a number of sources, each using both
Quality-Assurance Teams Quality-assurance teams, oral and written forms of communication. The success of com-
sometimes called quality circles, are fairly small groups of work- munication systems within the organization has a tremendous
ers brought together from throughout the organization to solve effect on the overall success of the firm. Communication mis-
specific quality, productivity, or service problems. Although the takes can lower productivity and morale.
quality circle term is not as popular as it once was,
Alternatives to face-to face communications—such
the concern about quality is stronger than ever.
as meetings—are growing thanks to technology
The use of teams to address quality issues will no
such as voice-mail, e-mail, and online newslet-
doubt continue to increase throughout the busi-
ters. Many companies use internal networks called
ness world.
intranets to share information with employees.
Self-Directed Work Teams A self- Intranets increase communication across different
directed work team (SDWT) is a group of departments and levels of management and help
employees responsible for an entire work process with the flow of everyday business activities. Com-
or segment that delivers a product to an inter- panies can even integrate aspects of social media
23
DID YOU KNOW? into their intranets, allowing employees to post
nal or external customer. SDWTs permit the
flexibility to change rapidly to meet the competi- A survey of managers comments and pictures, participate in polls, and
create group calendars. However, increased access
tion or respond to customer needs. The defining and executives found
characteristic of an SDWT is the extent to which to the Internet at work has also created many prob-
that they feel 28 percent lems, including employee abuse of company mail
it is empowered or given authority to make and
of meetings are a and Internet access.25
implement work decisions. Thus, SDWTs are
designed to give employees a feeling of “owner- waste of time and that
ship” of a whole job. With shared team respon- information could be Formal Communication
sibility for work outcomes, team members often communicated more Formal channels of communication are inten-
have broader job assignments and cross-train to effectively using other tionally defined and designed by the organiza-
master other jobs, thus permitting greater team methods.24 tion. They represent the flow of communication
flexibility. within the formal organizational structure, as

grapevine an
informal channel of
communication, separate
from management’s formal,
shown on organizational charts. With more and more companies downsizing and increas-
official communication Traditionally, formal communi- ing the use of self-managed work teams, many workers are
channels cation patterns were classified as being required to communicate with others in different
vertical and horizontal, but with departments and on different levels to solve problems and
the increased use of teams and coordinate work. When these individuals from different
matrix structures, formal communication may occur in a num- units and organizational levels communicate, it is diagonal
ber of patterns (Figure 7.8). communication. One benefit of companies doing more with
fewer employees is that productivity (output per work hour)
Upward communication flows from lower to higher levels of
increased by 9.5 percent in one year. Increased productivity
the organization and includes information such as progress
allows companies to increase wages and leads to increased
reports, suggestions for improvement, inquiries, and griev-
standards of living.26
ances. Downward communication refers to the traditional flow
of information from upper organizational levels to lower lev-
els. This type of communication typically involves directions, Informal Communication Channels
the assignment of tasks and responsibilities, performance feed- Along with the formal channels of communication shown on an
back, and certain details about the organization’s strategies organizational chart, all firms communicate informally as well.
and goals. Speeches, policy and procedures manuals, employee Communication between friends, for instance, cuts across depart-
handbooks, company leaflets, telecommunications, and job ment, division, and even management-subordinate boundaries.
descriptions are examples of downward Such friendships and other nonwork social
communication. relationships comprise the informal organiza-
tion of a firm, and their impact can be great.
Horizontal communication involves the TEAM EXERCISE
exchange of information among colleagues Assign the responsibility of providing the The most significant informal communi-
and peers on the same organizational organizational structure for a company cation occurs through the grapevine, an
level, such as across or within depart- one of your team members has worked informal channel of communication, sepa-
ments. Horizontal information informs, for. Was your organization centralized rate from management’s formal, official
supports, and coordinates activities both or decentralized in terms of decision communication channels. Grapevines exist
within the department and with other making? Would you consider the span in all organizations. Information passed
departments. At times, the business will of control to be wide or narrow? Were along the grapevine may relate to the job
there any types of teams, committees, or
formally require horizontal communi- or organization, or it may be gossip and
task forces utilized in the organization?
cation among particular organizational Report your work to the class.
rumors unrelated to either. The accuracy
members, as is the case with task forces of grapevine information has been of great
or project teams. concern to managers.
FIGURE 7.8
The Flow of Communication in an Organizational Hierarchy
Key
CEO Upward
Downward
Horizontal
Diagonal
Do
rd wn
wa wa
Up rd
Vice Vice Vice

President President President
Di
al ag
on on
Diag al
Horizontal Horizontal
Manager Manager Manager Manager Manager Manager

Additionally, managers can turn the grapevine to their advan- its use necessary for most companies. Failing to monitor
tage. Using it as a “sounding device” for possible new policies employee’s use of e-mail and the Internet can be costly.
is one example. Managers can obtain valuable information Many companies require that employees sign and follow
from the grapevine that could improve decision making. Some a policy on appropriate Internet use. These agreements
organizations use the grapevine to their advantage by floating often require that employees will use corporate computers
ideas, soliciting feedback, and reacting accordingly. People only for work-related activities. Additionally, several com-
love to gossip, and managers need to be aware that grapevines panies use software programs to monitor employee com-
exist in every organization. Managers who understand how puter usage.27 Instituting practices that show respect for
the grapevine works also can use it to their advantage by feed- employee privacy but do not abdicate employer responsi-
ing it facts to squelch rumors and incorrect information. bility are increasingly necessary in today’s workplace. Sev-
eral websites provide model policies and detailed guidelines
Monitoring Communications for conducting electronic monitoring, including the Model
Technological advances and the increased use of electronic Electronic Privacy Act on the American Civil Liberties
communication in the workplace have made monitoring Union site. ■
SO YOU WANT A JOB // Managing Organizational Culture,

Teamwork, and Communication /
J obs dealing with organizational culture
and structure are usually at the top of
the organization. If you want to be a CEO or
be in communications, human resources,
and positions that assist top organizational
managers.
as the use of e-mail and the Internet have
created new industries. There have to be
internal controls in the organization to make
high-level manager, you will help shape these Teams are becoming more common in sure that the organization does not engage
areas of business. On the other hand, if you the workplace, and it is possible to become in any copyright infringement. If this is an
are an entrepreneur or small-business per- a member of a product-development group or area of interest, there are specific jobs that
son, you will need to make decisions about quality-assurance team. There are also human provide an opportunity to use your techno-
assigning tasks, departmentalization, and resources positions that encourage team- logical skills to assist in maintaining appro-
assigning responsibility. Even managers in work through training activities. The area of priate standards in communicating and using
small organizations have to make decisions corporate communications provides lots of technology.
about decentralization, span of management, opportunities for specific jobs that facilitate If you go to work for a large company with
and forms of organizational structure. While communication systems. Thanks to technol- many divisions, you can expect a number of
these decisions may be part of your job, there ogy, there are job positions to help dissemi- positions dealing with the tasks discussed
are usually no job titles dealing with these nate information through online newsletters, here. If you go to work for a small company,
specific areas. Specific jobs that attempt to intranets, or internal computer networks to you will probably engage in most of these
improve organizational culture could include share information to increase collaboration. tasks as a part of your position. Organiza-
ethics and compliance positions as well as In addition to the many advances using elec- tional flexibility requires individual flexibility,
those who are in charge of communicat- tronic communications, there are technology and those employees willing to take on new
ing memos, manuals, and policies that help concerns that create new job opportunities. domains and challenges will be the employ-
establish the culture. These positions will Monitoring workplace communications such ees who survive and prosper in the future.

GET ONLINE
mhhe.com/FerrellM3e
and video

eight

managing service +
manufacturing options
ll organizations create products— acquiring and managing the resources
introduction A goods, services, or ideas—for

customers. Thus, organizations
as diverse as Toyota, Campbell Soup,
necessary to create goods and services.
Production and operations manage-
ment involves planning and designing
UPS, and a public hospital share a num- the processes that will transform those
ber of similarities relating to how they resources into finished products, man-
transform resources into the products aging the movement of those resources
we consume. Most hospitals use simi- through the transformation process, and
lar admission procedures, while online ensuring that the products are of the
social media companies, like Facebook quality expected by customers.
and Twitter, use their technology and
operating systems to create social net-
working opportunities and sell advertis-
ing. Such similarities are to be expected.
But even organizations in unrelated
industries take similar steps in creat-
LEARNING OBJECTIVES
ing goods or services. The check-in LO1 Define operations management, and
procedures of hotels and commercial differentiate between operations
and manufacturing.
airlines are comparable, for example.
LO2 Explain how operations manage-
The way Subway assembles a sand- ment differs in manufacturing and
service firms.
wich and the way GMC assembles a
LO3 Describe the elements involved in
truck are similar (both use automation planning and designing an opera-
and an assembly line). These similarities tions system.
LO4 Specify some techniques managers
are the result of operations manage- may use to manage the logistics of
ment, the focus of this chapter. transforming inputs into finished
products.
Here, we discuss the role of pro-
LO5 Assess the importance of quality in
duction or operations management in operations management.
CHAPTER 8 | Managing Service and Manufacturing Options 159

operations manufacturing the production the operations the inputs the resources—
management activities and processes activities and processes activities and processes such as labor, money,
(OM) the development used in making tangible used in making tangible used in making both materials, and energy—that
and administration of products; also called products; also called tangible and intangible are converted into outputs
the activities involved in production manufacturing products
transforming resources into outputs the goods,
goods and services services, and ideas that
result from the conversion
of inputs
THE NATURE Today, OM includes a wide range of organizational activities

and situations outside of manufacturing, such as health care,
OF OPERATIONS food service, banking, entertainment, education, transporta-

tion, and charity. Thus, we use the terms manufacturing and
MANAGEMENT production interchangeably to represent the activities and

processes used in making tangible products, whereas we use the
Operations management (OM), the development and broader term operations to describe those processes used in
administration of the activities involved in transforming the making of both tangible and intangible products. Manufac-
resources into goods and services, is of critical importance. turing provides tangible products such as Hewlett-Packard’s lat-
Operations managers oversee the transformation process and est printer, and operations provides intangibles such as a stay at
the planning and designing of operations systems, managing Wyndham Hotels and Resorts.
logistics, quality, and productivity. Quality and productivity
have become fundamental aspects of operations management The Transformation Process
because a company that cannot make products of the quality
At the heart of operations management is the transformation
desired by consumers, using resources efficiently and effec-
process through which inputs (resources such as labor, money,
tively, will not be able to remain in business. OM is the “core”
materials, and energy) are converted into outputs (goods, ser-
of most organizations because it is responsible for the creation
vices, and ideas). The transformation process combines inputs
of the organization’s goods or services.
in predetermined ways using different equipment, administra-
Historically, operations management has been called “productive procedures, and technology to create a product (Figure 8.1).
tion” or “manufacturing” primarily because of the view that To ensure that this process generates quality products efficiently,
it was limited to the manufacture of physical goods. Its focus operations managers control the process by taking measure-
was on methods and techniques required to operate a factory ments (feedback) at various points in the transformation pro-
efficiently. The change from “production” to “operations” rec- cess and comparing them to previously established standards.
ognizes the increasing importance of organizations that provide If there is any deviation between the actual and desired outputs,
services and ideas. Additionally, the term operations represents the manager may take some sort of corrective action. All adjust-
an interest in viewing the operations function as a whole rather ments made to create a satisfying product are a part of the trans-
than simply as an analysis of inputs and outputs. formation process.
Transformation may take place through

FIGURE 8.1 one or more processes. In a business that
The Transformation Process of Operations Management manufactures oak furniture, for exam-
ple, inputs pass through several pro-
cesses before being turned into the final
Inputs Transformation Outputs outputs—furniture that has been designed
land or Conversion goods to meet the desires of customers (Figure
labor procedures services
capital equipment ideas 8.2). The furniture maker must first strip
raw facilities the oak trees of their bark and saw them
materials technology into appropriate sizes—one step in the
time knowledge transformation process. Next, the firm
information dries the strips of oak lumber, a second
energy
form of transformation. Third, the dried
wood is routed into its appropriate shape
and made smooth. Fourth, workers
assemble and treat the wood pieces, then
customer Control
feedback stain or varnish the piece of assembled
standards
furniture. Finally, the completed piece of
furniture is stored until it can be shipped

to customers at the appropriate time.
FIGURE 8.2
Of course, many businesses choose to Inputs, Outputs, and Transformation Processes in the Manufacture of Oak Furniture
eliminate some of these stages by pur-
chasing already processed materials—
lumber, for example—or outsourcing Inputs Transformation Outputs
some tasks to third-party firms with oak trees cutting or oak furniture
greater expertise. labor sawing
information/ routing
knowledge measuring
Operations stain or varnish assembling
router/saw staining/varnishing
Management in warehouse space/ storing
time
Service Businesses
Different types of transformation pro-
cesses take place in organizations that
provide services, such as airlines, col-
leges, and most nonprofit organizations. An airline transforms their objectives. For most organizations, the ultimate objective
inputs such as employees, time, money, and equipment through is for the produced outputs to be worth more than the com-
processes such as booking flights, flying airplanes, maintaining bined costs of the inputs.
equipment, and training crews. The output of these processes
is flying passengers and/or packages to their destinations. In Unlike tangible goods, services are effectively actions or perfor-
a nonprofit organization like Habitat for Humanity, inputs mances that must be directed toward the consumers who use
such as money, materials, information, and volunteer time and them. Thus, there is a significant customer-contact component
labor are used to transform raw materials into homes for needy to most services. Examples of high-contact services include
families. In this setting, transformation processes include health care, real estate, tax preparation, and food service. At
fund-raising and promoting the cause in order to gain new the Inn at Little Washington in Washington, Virginia, for
volunteers and donations of supplies, as well as pouring con- example, food servers are critical to delivering the per-
crete, raising walls, and setting roofs. Transformation processes fect dining experience expected by the most discriminating
occur in all organizations, regardless of what they produce or diners. Wait staff are expected not only to be courteous, but
SHELL USES succeed with Pearl. Lower natural gas of experience. Shell has operated a smaller
prices will likely spur demand, particularly GTL plant in Malaysia since 1993 and
NEW REFINERY as GTL fuel is roughly half the cost of crude has already worked through many of the
TO SUPPORT oil. GTL fuel is also purer than traditional glitches in the GTL process. Finally, Qatar
crude, appealing to more environmentally is rich in labor and energy reserves; if this
SUSTAINABILITY conscious consumers and businesses. partnership proves fruitful, Shell may have
Yet despite the benefits of GTL fuel, access to more profitable relationships
some have criticized the process. For in the future. Creating a more sustainable
R oyal Dutch Shell PLC has partnered with
Qatar (a country in the Middle East) to
create a $19 billion refinery that may bring
instance, the GTL process is extremely
expensive. Critics feel that alternative pro-
future for energy products can be a signifi-
cant contribution to society.1
the company to the forefront of sustainabil- cedures are more cost-effective. In addi-
ity. The plant, Pearl GTL (gas-to-liquids), is tion, the GTL process consumes a great
designed to transform natural gas into odor- deal of energy, calling into question the
free, pollutant-free fuel. The venture, which effectiveness of its environmental sustain- 1. Why is the development of the new trans-
is the largest GTL project to date, has the ability. Others argue that GTL is profitable formation process GTL (gas-to-liquids) so
potential for high returns in a flooded natural only when oil prices are high and that Shell important?
gas market. More importantly, the develop- has an equal chance of winning or losing 2. What are some of the production or
ment of a new transformation process has on the venture. operational barriers that Shell must over-
the potential to create a new natural gas. However, Shell is optimistic. Not only come in order to make GTL successful?
Shell has been working with GTL for does it feel that Pearl will pay itself off in 3. Should Shell continue the GTL project if it
almost four decades and believes it can five years, but it also has the added bonus fails to pay off in five years?

THE ACTUAL PERFORMANCE OF THE SERVICE
TYPICALLY OCCURS AT THE POINT OF CONSUMPTION.
also to demonstrate a detailed knowledge of the restaurant’s Another challenge related to service operations is that the out-
offerings, and even to assess the mood of guests in order to put is generally intangible and even perishable. Few services
respond to diners appropriately.2 Low-contact services, such as can be saved, stored, resold, or returned.4 A seat on an airline
online auction services like eBay, often have a strong high-tech or a table in a restaurant, for example, cannot be sold or used
component. at a later date. Because of the perishability of services, it can be
extremely difficult for service providers to accurately estimate
Regardless of the level of customer contact, service businesses
the demand in order to match the right supply of a service. If an
strive to provide a standardized process, and technology offers
airline overestimates demand, for example, it will still have to
an interface that creates an automatic and structured response.
fly each plane even with empty seats. The flight costs the same
The ideal service provider will be high-tech and high-touch.
regardless of whether it is 50 percent full or 100 percent full,
JetBlue, for example, strives to maintain an excellent website;
but the former will result in much higher costs per passenger. If
friendly, helpful customer contact; and satellite TV service at
the airline underestimates demand, the result can be long lines
every seat on each plane. Thus, service organizations must
of annoyed customers or even the necessity of bumping some
build their operations around good execution, which comes
customers off an overbooked flight.
from hiring and training excellent employees, developing flex-
ible systems, customizing services, and maintaining adjustable Businesses that manufacture tangible goods and those that
capacity to deal with fluctuating demand.3 provide services or ideas are similar yet different. For example,
Although service organizations tend to vary depending on the service provider, businesses strive to standardize operations to ensure a high level of
quality. The wait staff at this hotel wear uniforms and are trained to behave a certain way when interacting with customers.

both types of organizations must make design and operating
decisions. Most goods are manufactured prior to purchase,
but most services are performed after purchase. Flight atten-
dants at Southwest Airlines, hotel service personnel, and even
the New Orleans Saints football team engage in performances
that are a part of the total product. Though manufacturers and
service providers often perform similar activities, they also dif-
fer in several respects. We can classify these differences in five
basic ways.
Nature and Consumption of Output First, manu-

facturers and service providers differ in the nature and con-
sumption of their output. For example, the term manufacturer
implies a firm that makes tangible products. A service provider,
on the other hand, produces more intangible outputs such as
U.S. Postal Service delivery of priority mail or a business stay
in a Hyatt hotel. As mentioned earlier, the very nature of the
service provider’s product requires a higher degree of cus-
tomer contact. Moreover, the actual performance of the ser-
vice typically occurs at the point of consumption. At the Hyatt,
the business traveler may evaluate in-room communications
and the restaurant. Automakers, on the other hand, can sepa-
rate the production of a car from its actual use. Manufactur-
ing, then, can occur in an isolated environment, away from
the customer. On the other hand, service providers, because
of their need for customer contact, are often more limited
than manufacturers in selecting work methods, assigning jobs,
scheduling work, and exercising control over operations. At
FedEx, the Quality Improvement Process (QIP) includes say-
ings such as “Do it right the first time,” and “Make the first
time you do it the only time anyone has to do it.” The quality
of the service experience is often controlled by a service con-
tact employee. However, some hospitals are studying the man-
ufacturing processes and quality control mechanisms applied
in the automotive industry in an effort to improve their service
quality. By analyzing work processes to find unnecessary steps
to eliminate and using teams to identify and address prob-
lems as soon as they occur, these hospitals are slashing patient
waiting times, decreasing inventories of wheelchairs, ready-
ing operating rooms sooner, and generally moving patients Subway’s inputs are sandwich components such as bread, tomatoes,
through their hospital visit more quickly, with fewer errors, and lettuce, while its outputs are customized sandwiches.
and at a lower cost.5
Uniformity of Inputs A second way to classify differ- likely to incorporate your specific desires (customization)
ences between manufacturers and service providers has to do than is the bottle of shampoo.
with the uniformity of inputs. Manufacturers typically have
more control over the amount of variability of the resources Uniformity of Output Manufacturers and service pro-
they use than do service providers. For example, each cus- viders also differ in the uniformity of their output, the final
tomer calling Fidelity Investments is likely to require differ- product. Because of the human element inherent in provid-
ent services due to differing needs, whereas many of the tasks ing services, each service tends to be performed differently.
required to manufacture a Ford Focus are the same across Not all grocery checkers, for example, wait on customers in
each unit of output. Consequently, the products of service the same way. If a barber or stylist performs 15 haircuts in a
organizations tend to be more “customized” than those of day, it is unlikely that any two of them will be exactly the same.
their manufacturing counterparts. Consider, for example, a Consequently, human and technological elements associ-
haircut versus a bottle of shampoo. The haircut is much more ated with a service can result in a different day-to-day or even

hour-to-hour performance of that service. The service experi-
ence can even vary at McDonald’s or Burger King despite the PLANNING AND DESIGNING
fact that the two chains employ very similar procedures and
processes. Moreover, no two customers are exactly alike in OPERATIONS SYSTEMS
their perception of the service experience. Health care offers Before a company can produce any product, it must first decide
another excellent example of this challenge. Every diagnosis, what it will produce and for what group of customers. It must
treatment, and surgery varies because every individual is differ- then determine what processes it will use to make these prod-
ent. In manufacturing, the high degree of automation available ucts as well as the facilities it needs to produce them. These
allows manufacturers to generate uniform outputs and, thus, decisions comprise operations planning. Although planning
the operations are more effective and efficient. For example, we was once the sole realm of the production and operations
would expect every Movado or Rolex watch to maintain very department, today’s successful companies involve all depart-
high standards of quality and performance. ments within an organization, particularly marketing and
research and development, in these decisions.
Labor Required A fourth point of difference is the amount
of labor required to produce an output. Service providers are Planning the Product
generally more labor-intensive (require more labor) because of
Before making any product, a company first must determine
the high level of customer contact, perishability of the output
what consumers want and then design a product to satisfy that
(must be consumed immediately), and high degree of variation
want. Most companies use marketing research (discussed in
of inputs and outputs (customization). For example, Adecco
Chapter 11) to determine the kinds of goods and services to
provides temporary support personnel. Each temporary work-
provide and the features they must possess. Twitter and Face-
er’s performance determines Adecco’s product quality. A manu-
book provide new opportunities for businesses to discover what
facturer, on the other hand, is likely to be more capital-intensive
consumers want, then design the product accordingly. Corda-
because of the machinery and technology used in the mass pro-
rounds.com, a clothing company based in San Francisco, found
duction of highly similar goods. For instance, it would take a
that many people in California bike to work. Based on infor-
considerable investment for Nokia to make a digital phone that
mation gathered on Twitter, the company developed a line of
has a battery with longer life.
bike-ready clothing lined with reflective material. When bike
commuters roll up their pant legs to ride home, the reflective
Measurement of Productivity The final distinction
material helps them stay safe even when they are riding home
between service providers and manufacturers involves the
after dark. Cordarounds also uses Google’s AdWords, another
measurement of productivity for each output produced. For
digital media source, to advertise affordably. Cordarounds
manufacturers, measuring productivity is fairly straightforward
began as a small company and is growing rapidly as more peo-
because of the tangibility of the output and its high degree of
ple become concerned about the environment and choose bik-
uniformity. For the service provider, variations in demand (for
ing over driving.6 Marketing research can also help gauge the
example, higher demand for air travel in some seasons than in
demand for a product and how much consumers are willing to
others), variations in service requirements from job to job, and
pay for it. But when a market’s environment changes, firms have
the intangibility of the product make productivity measure-
to be flexible.
ment more difficult. Consider, for example, how much easier
it is to measure the productivity of employees involved in the Developing a product can be a lengthy, expensive process. For
production of Intel computer processors as opposed to serving example, in the automobile industry, developing the new tech-
the needs of Prudential Securities’ clients. nology for night vision, bumper-mounted sonar systems that
make parking easier, and a satellite service that locates and
It is convenient and simple to think of organizations as being
analyzes car problems has been a lengthy, expensive process.
either manufacturers or service providers as in the preceding
Most companies work to reduce development time and costs.
discussion. In reality, however, most organizations are a com-
For example, through Web collaboration, faucet manufacturer
bination of the two, with both tangible and intangible qualities
Moen reduced the time required to take an idea to a finished
embodied in what they produce. For example, Porsche pro-
product in stores to just 16 months, a drop of 33 percent.7 Once
vides customer services such as toll-free hotlines and warranty
management has developed an idea for a product that custom-
protection, while banks may sell checks and other tangible
ers will buy, it must then plan how to produce the product.
products that complement their primarily intangible product
offering. Thus, we consider “products” to include both tangible Within a company, the engineering or research and develop-
physical goods as well as intangible service offerings. It is the ment department is charged with turning a product idea into a
level of tangibility of its principal product that tends to clas- workable design that can be produced economically. In smaller
sify a company as either a manufacturer or a service provider. companies, a single individual (perhaps the owner) may be
From an OM standpoint, this level of tangibility greatly influ- solely responsible for this crucial activity. Regardless of who is
ences the nature of the company’s operational processes and responsible for product design, planning does not stop with a
procedures. blueprint for a product or a description of a service; it must

standardization the modular design the customization capacity the maximum
making of identical creation of an item in making products to meet a load that an organizational
interchangeable self-contained units, or particular customer’s needs unit can carry or operate
components or products modules, that can be or wants
combined or interchanged
to create different products
also work out efficient production of the product to ensure that of components—CPU case, motherboard, chips, hard drives,
enough is available to satisfy consumer demand. How does a graphics card, and so on—that can be installed in different con-
lawn mower company transform steel, aluminum, and other figurations to meet the customer’s needs. Because many modu-
materials into a mower design that satisfies consumer and envi- lar components are produced as integrated units, the failure of
ronmental requirements? Operations managers must plan for any portion of a modular component usually means replacing
the types and quantities of materials needed to produce the the entire component. Modular design allows products to be
product, the skills and quantity of people needed to make the repaired quickly, thus reducing the cost of labor, but the com-
product, and the actual processes through which the inputs ponent itself is expensive, raising the cost of repair materials.
must pass in their transformation to outputs. Many automobile manufacturers use modular design in the
production process. Manufactured homes are built on a modu-
Designing the Operations lar design and often cost about one-fourth the cost of a conven-
tionally built house.
Processes
Before a firm can begin production, it must first determine the Customization Customization is making products to
appropriate method of transforming resources into the desired meet a particular customer’s needs or wants. Products pro-
product. Often, consumers’ specific needs and desires dictate a duced in this way are generally unique. Such products include
process. Customer needs, for example, require that all 3/4-inch repair services, photocopy services, custom artwork, jewelry,
bolts have the same basic thread size, function, and quality; if and furniture, as well as large-scale products such as bridges,
they did not, engineers and builders could not rely on 3/4-inch ships, and computer software. Custom designs are used in
bolts in their construction projects. A bolt manufacturer, then, communications and service products. A Web-based design
will likely use a standardized process so that every 3/4-inch bolt service, myemma.com, creates a custom template using a com-
produced is like every other one. On the other hand, a bridge pany’s logo and colors to create a unique page for a website. It
often must be customized so that it is appropriate for the site also provides tools for interacting with customers and track-
and expected load; furthermore, the bridge must be constructed ing deliveries.8 Ship design is another industry that uses cus-
on site rather than in a factory. Typically, products are designed tomization. Builders generally design and build each ship to
to be manufactured by one of three processes: standardization, meet the needs of the customer who will use it. Delta Marine
modular design, or customization. Industries, for example, custom-builds each luxury yacht to the
customer’s exact specifications and preferences for things like
Standardization Most firms that manufacture products helicopter garages, golf courses, and swimming pools. Mass
in large quantities for many customers have found that they customization relates to making products that meet the needs
can make them cheaper and faster by standardizing designs. or wants of a large number of individual customers. The cus-
Standardization is making identical, interchangeable com- tomer can select the model, size, color, style, or design of the
ponents or even complete products. With standardization, product. Dell can customize a computer with the exact con-
a customer may not get exactly what he or she wants, but the figuration that fits a customer’s needs. Services such as fitness
product generally costs less than a custom-designed product. programs and travel packages can also be custom designed for
Television sets, ballpoint pens, and tortilla chips are standard- a large number of individual customers. For both goods and
ized products; most are manufactured on an assembly line. services, customers get to make choices and have options to
Standardization speeds up production and quality control and determine the final product.
reduces production costs. And, as in the example of the 3/4-
inch bolts, standardization provides consistency so that cus-
tomers who need certain products to function uniformly all Planning Capacity
the time will get a product that meets their expectations. As a Planning the operational processes for the organization
result of its entry into the World Trade Organization, China involves two important areas: capacity planning and facilities
promoted the standardization of agricultural production across planning. The term capacity basically refers to the maximum
the country, resulting in increased agricultural production. load that an organizational unit can carry or operate. The unit
of measurement may be a worker or machine, a department,
Modular Design Modular design involves building a branch, or even an entire plant. Maximum capacity can be
an item in self-contained units, or modules, that can be com- stated in terms of the inputs or outputs provided. For example,
bined or interchanged to create different products. Personal an electric plant might state plant capacity in terms of the maxi-
computers, for example, are generally composed of a number mum number of kilowatt-hours that can be produced without

fixed-position project process layout a intermittent product layout a
layout a layout that organization a layout that organizes the organizations layout requiring that
brings all resources company using a fixed- transformation process into organizations that deal production be broken down
required to create the position layout because it is departments that group with products of a lesser into relatively simple tasks
product to a central location typically involved in large, related processes magnitude than do project assigned to workers, who
complex projects such as organizations; their products are usually positioned along
construction or exploration are not necessarily unique an assembly line
but possess a significant
number of differences
causing a power outage, while a restaurant might state capac- stakeholder desires will be more expensive in the long run.
ity in terms of the maximum number of customers who can For this reason, utilities companies like PNM in New Mexico
be effectively—comfortably and courteously— have made a commitment to including more
served at any one particular time. renewable energy in their supply mix, comply-
ing with ISO 14001 emissions guidelines for
Efficiently planning the organization’s capac-
power plants, and taking a pro-cap-and-trade
ity needs is an important process for the opera-
stance.10
tions manager. Capacity levels that fall short can
result in unmet demand, and consequently, lost Planning Facilities
customers. On the other hand, when there is
Once a company knows what process it will use
more capacity available than needed, operating
to create its products, it then can design and
costs are driven up needlessly due to unused and
DID YOU KNOW? build an appropriate facility in which to make
often expensive resources. To avoid such situ-
them. Many products are manufactured in
ations, organizations must accurately forecast
demand and then plan capacity based on these
Hershey’s has the factories, but others are produced in stores, at
production capacity home, or where the product ultimately will be
forecasts. Another reason for the importance of
to make more than used. Companies must decide where to locate
efficient capacity planning has to do with long-
their operations facilities, what layout is best for
term commitment of resources. Often, once a 80 million chocolate
producing their particular product, and even
capacity decision—such as factory size—has kisses per day.9 what technology to apply to the transformation
been implemented, it is very difficult to change
process.
the decision without incurring substantial costs.
Large utilities companies have come to realize that although Many firms are developing both a traditional organization
change can be expensive, not adjusting to future demand and for customer contact as well as a virtual organization. Charles
Schwab Corporation, a securities brokerage and investment
company, maintains traditional offices and has developed com-
plete telephone and Internet services for customers. Through
its website, investors can obtain personal investment informa-
tion and trade securities over the Internet without leaving their
home or office.
Facility Location Where to locate a firm’s facilities is a sig-

nificant question because, once the decision has been made and
implemented, the firm must live with it due to the high costs
involved. When a company decides to relocate or open a facility
at a new location, it must pay careful attention to factors such as
proximity to market, availability of raw materials, availability of
transportation, availability of power, climatic influences, avail-
ability of labor, community characteristics (quality of life), and
taxes and inducements. Inducements and tax reductions have
become an increasingly important criterion in recent years.
To increase production and to provide incentives for small
startups, many states are offering tax inducements for solar
companies. State governments are willing to forego some tax
revenue in exchange for job growth, getting in on a burgeoning
Apple stores are designed to make the most efficient use of space. industry as well as the good publicity generated by the com-
The layout of the stores allows customers to test its products before pany. In a very solar-friendly state like Colorado, companies
purchasing. may get tax reductions for starting production, and consumers

continuous
manufacturing
organizations
receive additional rebates for installing solar systems in their products produced on assembly
companies that use
homes and businesses.11 The facility-location decision is com- lines are automobiles, television continuously running
plex because it involves the evaluation of many factors, some of sets, vacuum cleaners, toothpaste, assembly lines, creating
which cannot be measured with precision. Because of the long- and meals from a cafeteria. Contin- products with many similar
term impact of the decision, however, it is one that cannot be uous manufacturing organizations characteristics
taken lightly. using a product layout are charac-
terized by the standardized prod- computer-assisted
Facility Layout Arranging the physical layout of a facility ucts they produce, the large number design (CAD) the
is a complex, highly technical task. Some industrial architects of units produced, and the relatively design of components,
specialize in the design and layout of certain types of busi- low unit cost of production. products, and processes
nesses. There are three basic layouts: fixed-position, process, on computers instead of
Many companies actually use a on paper
and product.
combination of layout designs. For
A company using a fixed-position layout brings all resources example, an automobile manufac- computer-assisted
required to create the product to a central location. The product— manufacturing
turer may rely on an assembly line
perhaps an office building, house, hydroelectric plant, or (CAM) manufacturing
(product layout) but may also use
that employs specialized
bridge—does not move. A company using a fixed-position a process layout to manufacture computer systems to
layout may be called a project organization because it is parts. actually guide and control
typically involved in large, complex projects such as construc- the transformation
tion or exploration. Project organizations generally make a processes
unique product, rely on highly skilled labor, produce very few
Technology Every industry has
a basic, underlying technology that
units, and have high production costs per unit.
dictates the nature of its transfor-
Firms that use a process layout organize the transformation mation process. The steel industry continually tries to improve
process into departments that group related processes. A metal steelmaking techniques. The health care industry performs
fabrication plant, for example, may have a cutting department, research into medical technologies and pharmaceuticals to
a drilling department, and a polishing department. A hospital improve the quality of health care service. Two developments
Every industry has a basic, underlying technology that

dictates the nature of its transformation process.
may have an X-ray unit, an obstetrics unit, and so on. These that have strongly influenced the operations of many businesses
types of organizations are sometimes called intermittent are computers and robotics.
organizations, which deal with products of a lesser magni-
tude than do project organizations, and their products are not Computers have been used for decades and on a relatively large
necessarily unique but possess a significant number of differ- scale since IBM introduced its 650 series in the late 1950s. The
ences. Doctors, makers of custom-made cabinets, commercial operations function makes great use of computers in all phases
printers, and advertising agencies are intermittent organiza- of the transformation process. Computer-assisted design
tions because they tend to create products to customers’ speci- (CAD), for example, helps engineers design components,
fications and produce relatively few units of each product. products, and processes on the computer instead of on paper.
Because of the low level of output, the cost per unit of product Computer-assisted manufacturing (CAM) goes a step
is generally high. further, employing specialized computer systems to actually
guide and control the transformation processes. Such systems
The product layout requires that production be broken down can monitor the transformation process, gathering information
into relatively simple tasks assigned to workers, who are usu- about the equipment used to produce the products and about
ally positioned along an assembly line. Workers remain in one the product itself as it goes from one stage of the transforma-
location, and the product moves from one worker to another. tion process to the next. The computer provides information
Each person in turn performs his or her required tasks or activi- to an operator who may, if necessary, take corrective action. In
ties. Companies that use assembly lines are usually known as some highly automated systems, the computer itself can take
continuous manufacturing organizations, so named corrective action. At Dell’s OptiPlex Plant, electronic instruc-
because once they are set up, they run continuously, creat- tions are sent to double-decker conveyor belts that speed com-
ing products with many similar characteristics. Examples of puter components to assembly stations. Two-member teams

flexible
manufacturing the
direction of machinery
are told by computers which PC some speculate that in the future robots will not be limited to
by computers to adapt to
different versions of similar
or server to build, with initial space programs and production and operations, but will also
operations assembly taking only three to four be able to engage in farming, laboratory research, and even
minutes. Then more electronic household activities. Moreover, robotics are increasingly being
computer- commands move the products used in the medical field. There are an estimated 1 million
integrated (more than 20,000 machines on a robots being used in manufacturing around the world, most
manufacturing typical day) to a finishing area to of them in high-tech industries. They now help doctors per-
(CIM) a complete system be customized, boxed, and sent to form an estimated 86 percent of prostate cancer surgeries in
that designs products, waiting delivery trucks. the United States.13
manages machines and
materials, and controls the Using flexible manufacturing, When all these technologies—CAD/CAM, flexible manu-
operations function computers can direct machinery facturing, robotics, computer systems, and more—are inte-
to adapt to different versions of grated, the result is computer-integrated manufacturing
similar operations. For example, (CIM), a complete system that designs products, manages
with instructions from a computer, one machine can be pro- machines and materials, and controls the operations function.
grammed to carry out its function for several different versions Companies adopt CIM to boost productivity and quality and
of an engine without shutting down the production line for reduce costs. Such technology, and computers in particular,
refitting. will continue to make strong inroads into operations on two
fronts—one dealing with the technology involved in manu-
Robots are also becoming increasingly useful in the trans-
facturing and one dealing with the administrative functions
formation process. These “steel-collar” workers have become
and processes used by operations managers. The operations
particularly important in industries such as nuclear power,
manager must be willing to work with computers and other
hazardous-waste disposal, ocean research, and space construc-
forms of technology and to develop a high degree of computer
tion and maintenance, in which human lives would otherwise
literacy.
be at risk. Robots are used in numerous applications by com-
panies around the world. Many assembly operations—cars,
television sets, telephones, stereo equipment, and numerous
Sustainability and Manufacturing
other products—depend on industrial robots. The Robotic Manufacturing and operations systems are moving quickly to
Industries Association estimates that about 196,000 robots are establish environmental sustainability and minimize negative
now at work in U.S. factories, making the United States one impact on the natural environment. Sustainability deals with
of the two largest users of robotics, second only to Japan.12 reducing the consumption of resources and the long-term
well-being of the planet, including natural entities and the
Researchers continue to make more sophisticated robots, and
interactions of individuals, organizations, and businesses. Sus-
tainability issues are becoming increasingly important to stake-
holders and consumers, as they pertain to the future health of
the planet. Some sustainability issues include pollution of the
land, air, and water, climate change, waste management, defor-
estation, urban sprawl, protection of biodiversity, and geneti-
cally modified foods.
For example, Walmart is working to make its stores and prod-
ucts more environmentally friendly. Walmart has created a
series of broad environmental goals, striving to eventually
create zero waste, to run entirely on renewable energy, and to
sell sustainable products. The company works with suppliers
to reduce cardboard and plastic packaging. Walmart already
increased the efficiency of its truck fleet by 38 percent and
intends to double its efficiency by October 2015. Walmart is
also changing its lighting and other electrical use for maxi-
mum efficiency. All of these initiatives relate to making
operations greener, contributing to environmental sustain-
ability, providing savings, and being a role model for other
businesses.14
The outdoor clothing company Patagonia is always looking for a greener
While Walmart illustrates green initiatives in operations,
way to design, produce, and recycle its products. The company’s mission
statement: Build the best product, cause no unnecessary harm, and use New Belgium Brewing illustrates green initiatives in opera-
business to inspire and implement solutions to the environmental crisis. tions and manufacturing. New Belgium was the first brewery

supply chain
management
connecting and integrating
to adopt 100 percent wind-powered electricity, reducing
carbon emissions by 1,800 metric tons a year. It uses a steam MANAGING all parties or members of
the distribution system in
condenser to capture hot water to be reused for boiling the
next batch of barley and hops. Then the steam is redirected to THE SUPPLY order to satisfy customers
heat the floor tiles and de-ice the loading docks in cold Colo-
rado weather. Used barley and hops are given to local farm- CHAIN purchasing the buying
of all the materials needed
ers to feed cattle. The company is moving to aluminum cans A major function of operations by the organization; also
because they can be recycled an infinite number of times, and is supply chain management, called procurement
recycling one can saves enough electricity to run a television which refers to connecting and
for three hours. The company has won an award from the integrating all parties or members
Environmental Protection Agency and is a role model for of the distribution system in order to satisfy customers.18 Also
other businesses. called logistics, supply chain management includes all the activi-
ties involved in obtaining and managing raw materials and com-
Walmart and New Belgium Brewing demonstrate that reduc- ponent parts, managing finished products, packaging them, and
ing waste, recycling, conserving, and using renewable energy getting them to customers. Sunny Delight had to quickly recreate
not only protect the environment, but can also gain the sup- its supply chain after spinning off from Procter & Gamble. This
port of stakeholders. Green operations and manufacturing can means it had to develop ordering, shipping, and billing, as well as
improve a firm’s reputation along with customer and employee warehouse management systems and transportation, so it could
loyalty, leading to improved profits. focus on growing and managing the Sunny Delight brand.19 The
Much of the movement to green manufacturing and opera- supply chain integrates firms such as raw material suppliers,
tions is the belief that global warming and climate change manufacturers, retailers, and ultimate consumers into a seam-
must decline. The McKinsey Global Institute (MGI) says less flow of information and products.20 Some aspects of logis-
that just by investing in existing technologies, the world’s tics (warehousing, packaging, distributing) are so closely linked
[ “A major function of operations is supply chain management,

which refers to connecting and integrating all parties or members
of the distribution system in order to satisfy customers.” ]
energy use could be reduced by 50 percent by the year 2020. with marketing that we will discuss them in Chapter 12. In this
Just creating green buildings and higher mileage cars could section, we look at purchasing, managing inventory, outsourc-
yield $900 billion in savings per year by 2020.15 Companies ing, and scheduling, which are vital tasks in the transformation
like General Motors are adapting to stakeholder demands of raw materials into finished goods. To illustrate logistics, con-
for greater sustainability by producing smaller and more sider a hypothetical small business—we’ll call it Rushing Water
fuel-efficient cars. For example, the Chevy Volt can run for Canoes Inc.—that manufactures aluminum canoes, which it sells
up to 40 miles on one overnight charge before switching to primarily to sporting goods stores and river-rafting expeditions.
a gas-powered generator. The Volt is also a FlexFuel vehicle, Our company also makes paddles and helmets, but the focus of
which means that it can use either traditional gasoline or E85 the following discussion is the manufacture of the company’s
ethanol, which some people believe is better for the environ- quality canoes as they proceed through the logistics process.
ment.16 Green products produced through green operations
and manufacturing are our future. A report authored by the Purchasing
Center for American Progress cites ways that cities and local Purchasing, also known as procurement, is the buying of
governments can play a role. For example, Los Angeles plans all the materials needed by the organization. The purchas-
to save the city utility costs by retrofitting hundreds of city ing department aims to obtain items of the desired quality in
buildings while creating a green careers training program for the right quantities at the lowest possible cost. Rushing Water
low-income residents. Newark, New Jersey, and Richmond, Canoes, for example, must procure not only aluminum and
California, also have green jobs training programs. Albuquer- other raw materials, and various canoe parts and components,
que, New Mexico, was the first city to sign on to a pledge to but also machines and equipment, manufacturing supplies (oil,
build a green economy as part of its efforts to create green electricity, and so on), and office supplies in order to make its
jobs to stimulate the city’s economy.17 Government initiatives canoes. People in the purchasing department locate and evalu-
provide space for businesses to innovate their green opera- ate suppliers of these items. They must constantly be on the
tions and manufacturing. lookout for new materials or parts that will do a better job or

inventory all raw inventory economic order just-in-time
materials, components, control the process quantity (EOQ) (JIT) inventory
completed or partially of determining how many model a model that management a
completed products, and supplies and goods are identifies the optimum technique using smaller
pieces of equipment a firm needed and keeping track number of items to order quantities of materials that
uses of quantities on hand, to minimize the costs of arrive “just in time” for
where each item is, and managing (ordering, storing, use in the transformation
who is responsible for it and using) them process and therefore
require less storage
space and other inventory
management expense
cost less than those currently being used. The purchasing func- more economically and efficiently than can an outside supplier.
tion can be quite complex and is one area made much easier Coors, for example, manufactures its own cans at a subsidiary
and more efficient by technological advances. plant. On the other hand, firms sometimes find that it is uneco-
nomical to make or purchase an item, and instead arrange to
Not all companies purchase all of the materials needed to create
lease it from another organization. Some airlines, for example,
their products. Oftentimes, they can make some components
lease airplanes rather than buy them. Whether to purchase,
make, or lease a needed item generally depends on
cost, as well as on product availability and supplier
reliability.
Managing Inventory
Once the items needed to create a product have
been procured, some provision has to be made for
storing them until they are needed. Every raw mate-
rial, component, completed or partially completed
product, and piece of equipment a firm uses—its
inventory—must be accounted for, or controlled.
There are three basic types of inventory. Finished-
goods inventory includes those products that are
ready for sale, such as a fully assembled automobile
ready to ship to a dealer. Work-in-process inven-
tory consists of those products that are partly com-
pleted or are in some stage of the transformation
process. At McDonald’s, a cooking hamburger rep-
resents work-in-process inventory because it must
go through several more stages before it can be sold
to a customer. Raw materials inventory includes all
the materials that have been purchased to be used
as inputs for making other products. Nuts and bolts
are raw materials for an automobile manufacturer,
while hamburger patties, vegetables, and buns are
raw materials for the fast-food restaurant. Our fic-
tional Rushing Water Canoes has an inventory of
materials for making canoes, paddles, and helmets,
as well as its inventory of finished products for sale
to consumers. Inventory control is the process
of determining how many supplies and goods are
needed and keeping track of quantities on hand,
where each item is, and who is responsible for it.
Operations management must be closely coordi-
nated with inventory control. The production of
televisions, for example, cannot be planned without
some knowledge of the availability of all the necessary
FAC Food Service Logistics helps manage the supply chain and inventory of food companies materials—the chassis, picture tubes, color guns, and
in the United States so their products—chicken included—arrive on time and unspoiled. so forth. Also, each item held in inventory—any

type of inventory—carries with it a cost. For example, storing
fully assembled televisions in a warehouse to sell to a dealer at a
future date requires not only the use of space, but also the pur-
chase of insurance to cover any losses that might occur due to
fire or other unforeseen events.
Inventory managers spend a great deal of time trying to deter-
mine the proper inventory level for each item. The answer to
the question of how many units to hold in inventory depends
on variables such as the usage rate of the item, the cost of
maintaining the item in inventory, future costs of inventory
and other procedures associated with ordering or making the
item, and the cost of the item itself. For example, the price of
copper has fluctuated between $1.50 and $4 a pound over the
last five years. Firms using copper wiring for construction,
copper pipes for plumbing, and other industries requiring cop-
per have to analyze the trade-offs between inventory costs and
expected changes in the price of copper. Several approaches
may be used to determine how many units of a given item Managing inventory involves finding the right balance between excess
should be procured at one time and when that procurement inventory and not enough inventory. While too much inventory will
should take place. increase storage costs, companies that have an inventory shortage miss
out on additional sales.
The Economic Order Quantity Model To control the
number of items maintained in inventory, managers need to deter- management, which eliminates waste by using smaller quan-
mine how much of any given item they should order. One popu- tities of materials that arrive “just in time” for use in the trans-
lar approach is the economic order quantity (EOQ) model, formation process and therefore require less storage space and
which identifies the optimum number of items to order to mini- other inventory management expense. JIT minimizes inven-
mize the costs of managing (ordering, storing, and using) them. tory by providing an almost continuous flow of items from
suppliers to the production facility. Many U.S. companies,
Just-in-Time Inventory Management An increas- including Hewlett-Packard, IBM, and Harley-Davidson, have
ingly popular technique is just-in-time (JIT) inventory adopted JIT to reduce costs and boost efficiency.
TRADER JOE’S: the typical grocery store. Inventory con- regular on the Ethisphere “World’s Most
trol has been a key advantage to reducing Ethical Companies” list. Trader Joe’s
SECRETS OF SUCCESS costs and focusing on a limited number of has also crafted its distribution process
quality products. While many markets sell to create efficiency and reduce costs. It
F irst founded in 1967 in California, Trader

Joe’s is composed of 344 stores in 25
states plus the District of Columbia. Despite
as many as 50 selections of one food item,
Trader Joe’s sells only a few. With sales of
roughly $8 billion, Trader Joe’s also sets
expands only into areas that can support
this streamlined distribution system. With
its popularity continuing to rise, custom-
its large reach, Trader Joe’s exudes the itself apart with its private label products. ers seem impressed by the way Trader
same neighborhood store atmosphere that Today, 80 percent of company sales come Joe’s is redefining the grocery shopping
it did back in 1967. Trader Joe’s excellent from private label items. experience.21
operations and customer service has gen- Additionally, Trader Joe’s excels at qual-
erated a loyal customer following that has ity and supplier relationships. It employs
made it a success. four product developers who travel the
One of Trader Joe’s biggest assets is world in search of best product/price com- 1. How does inventory control contribute to
uniqueness. In addition to maintaining binations. Suppliers covet contracts with Trader Joe’s success?
a neighborhood store feel, Trader Joe’s Trader Joe’s, which charges less in fees 2. Why do supplier relationships and a focus
maintains smaller facilities and product and is known for on-time payments. Trader on price/quality relations help create loyal
lines than comparable stores—a deliber- Joe’s has vowed to sell only sustainable Trader Joe’s customers?
ate operational move to create its specialty seafood by 2012 and refuses to carry prod- 3. How does being rated as one of the
image. Trader Joe’s stocks about 4,000 ucts containing genetically modified ingre- world’s most ethical companies contrib-
items compared to the 50,000 stocked by dients. Its responsible measures make it a ute to Trader Joe’s success?

material-
requirements
planning (MRP) a
Let’s say that Rushing Water or other tasks to independent companies, often overseas. Many
planning system that
schedules the precise
Canoes uses 20 units of aluminum companies elect to outsource some aspects of their operations to
quantity of materials from a supplier per day. Tradition- companies that can provide these products more efficiently, at a
needed to make the product ally, its inventory manager might lower cost, and with greater customer satisfaction. Globalization
order enough for one month at has put pressure on supply chain managers to improve speed
routing the sequence of a time: 440 units per order (20 and balance resources against competitive pressures. Companies
operations through which units per day times 22 workdays outsourcing to China, in particular, face heavy regulation, high
the product must pass per month). The expense of such transportation costs, inadequate facilities, and unpredictable
a large inventory could be con- supply chain execution. Therefore, suppliers need to provide use-
scheduling the
siderable because of the cost of ful, timely, and accurate information about every aspect of the
assignment of required
tasks to departments or
insurance coverage, recordkeep- quality requirements, schedules, and solutions to dealing with
even specific machines, ing, rented storage space, and so problems. For example, Chinese suppliers took responsibility for
workers, or teams on. The just-in-time approach the lead paint on children’s toys crisis in the United States, but it
would reduce these costs because was an overall management and supply chain system failure that
aluminum would be purchased permitted these toxic toys to be sold in U.S. stores.22
in smaller quantities, perhaps in
Many high-tech firms have outsourced the production of chips,
lot sizes of 20, which the supplier would deliver once a day. Of
computers, and telecom equipment to Asian companies. The
course, for such an approach to be effective, the supplier must be
hourly labor costs in countries such as China, India, and Vietnam
extremely reliable and relatively close to the production facility.
are far less than in the United States, Europe, or even Mexico.
These developing countries have improved their manufactur-
Material-Requirements Planning Another inventory ing capabilities, infrastructure, and technical and business skills,
management technique is material-requirements planning making them more attractive regions for global sourcing. On the
(MRP), a planning system that schedules the precise quantity other hand, the cost of outsourcing halfway around the world
Many executives view outsourcing as an innovative

way to boost productivity and remain competitive
against low-wage offshore factories.
of materials needed to make the product. The basic components must be considered in decisions. While information technol-
of MRP are a master production schedule, a bill of materials, ogy is often outsourced today, transportation, human resources,
and an inventory status file. At Rushing Water Canoes, for services, and even marketing functions can be outsourced. Our
example, the inventory-control manager will look at the pro- hypothetical Rushing Water Canoes might contract with a local
duction schedule to determine how many canoes the company janitorial service to clean its offices and with a local accountant
plans to make. He or she will then prepare a bill of materials—a to handle routine bookkeeping and tax-preparation functions.
list of all the materials needed to make that quantity of canoes.
Outsourcing, once used primarily as a cost-cutting tactic, has
Next, the manager will determine the quantity of these items
increasingly been linked with the development of competitive
that RWC already holds in inventory (to avoid ordering excess
advantage through improved product quality, speeding up
materials) and then develop a schedule for ordering and accept-
the time it takes products to get to the customer, and overall
ing delivery of the right quantity of materials to satisfy the
supply chain efficiencies. Table 8.1 provides the world’s top
firm’s needs. Because of the large number of parts and materials
five outsourcing providers that assist mainly in information
that go into a typical production process, MRP must be done
technology. Outsourcing allows companies to free up time and
on a computer. It can be, and often is, used in conjunction with
resources to focus on what they do best and to create better
just-in-time inventory management.
opportunities to focus on customer satisfaction. Many execu-
tives view outsourcing as an innovative way to boost productiv-
Outsourcing ity and remain competitive against low-wage offshore factories.
Increasingly, outsourcing has become a component of sup- However, outsourcing may create conflict with labor and
ply chain management in operations. As we mentioned in negative public opinion when it results in U.S. workers being
Chapter 3, outsourcing refers to the contracting of manufacturing replaced by lower-cost workers in other countries.

Many athletic shoe manufacturers such as Nike outsource production to China and Vietnam to take advantage of lower labor costs.
T A B L E 8 . 1 The World’s Top Five Outsourcing Providers
Company Services*
Accenture Human resource management; information and communication technology management; financial management
Infosys Technologies Information technology consulting; product engineering; software development; IT solutions
Sodexo Real estate and asset management; facility services; service vouchers and cards
Wipro Technologies Information technology management; business and process solutions
IBM Customer relationship management; human resource management; information technology; strategic consulting
*The services section was provided by the authors.
Sources: “IAOP Announces 2010 Rankings for The World’s Best Outsourcing Providers and Advisors,” International Association of Outsourcing Professionals, https://www.
iaop.org/content/23/196/2043/, (accessed January 12, 2011); “About Us,” Infosys, www.infosys.com/about/what-we-do/pages/index.aspx (accessed January 12, 2011).
Routing and Scheduling the product specifications developed by the engineering depart-
ment of the company.
After all materials have been procured and their use deter-
mined, managers must then consider the routing, or sequence Once management knows the routing, the actual work can be
of operations through which the product must pass. For exam- scheduled. Scheduling assigns the tasks to be done to depart-
ple, before employees at Rushing Water Canoes can form alu- ments or even specific machines, workers, or teams. At Rush-
minum sheets into a canoe, the aluminum must be cut to size. ing Water, cutting aluminum for the company’s canoes might
Likewise, the canoe’s flotation material must be installed before be scheduled to be done by the “cutting and finishing” depart-
workers can secure the wood seats. The sequence depends on ment on machines designed especially for that purpose.

Many approaches to scheduling have been developed, ranging better operational efficiency than larger airlines such as Delta
from simple trial and error to highly sophisticated computer or American.23 Determining quality can be difficult because
programs. One popular method is the Program Evaluation it depends on customers’ perceptions of how well the product
and Review Technique (PERT), which identifies all the major meets or exceeds their expectations. For example, customer sat-
activities or events required to complete a project, arranges isfaction on airlines can vary wildly depending on individual
them in a sequence or path, determines the critical path, customers’ perspectives. However, the airline industry is notori-
and estimates the time required for each event. Producing a ous for its dissatisfied customers. Flight delays are a common
McDonald’s Big Mac, for example, involves removing meat, complaint from airline passengers; 20 percent of all flights arrive
cheese, sauce, and vegetables from the refrigerator; grill- more than 15 minutes late. However, most passengers do not
ing the hamburger patties; assembling the ingredients; plac- select an airline based on how often flights arrive on time.24
ing the completed Big Mac in its package; and serving it to
The fuel economy of an automobile or its reliability (defined in
the customer (Figure 8.3). The cheese, pickles, onions, and
terms of frequency of repairs) can be measured with some degree
sauce cannot be put on before the hamburger patty is com-
of precision. Although automakers rely on their own measures
pletely grilled and placed on the bun. The path that requires
of vehicle quality, they also look to independent sources such as
the longest time from start to finish is called the critical path
the J.D. Power and Associates annual initial quality survey for
because it determines the minimum amount of time in which
confirmation of their quality assessment as well as consumer
the process can be completed. If any of the activities on the
perceptions of quality for the industry, as indicated in Figure 8.4.
critical path for production of the Big Mac fall behind sched-
ule, the sandwich will not be completed on time, causing cus- It is especially difficult to measure quality characteristics when
tomers to wait longer than they usually would. the product is a service. A company has to decide exactly which
quality characteristics it considers important and then define
those characteristics in terms that can be measured. The insepa-
MANAGING QUALITY rability of production and consumption and the level of cus-
tomer contact influence the selection of characteristics of the
Quality, like cost and efficiency, is a critical element of opera-
service that are most important. Employees in high-contact ser-
tions management, for defective products can quickly ruin a
vices such as hairstyling, education, legal services, and even the
firm. Quality reflects the degree to which a good or service meets
barista at Starbucks are an important part of the product.
the demands and requirements of customers. Customers are
increasingly dissatisfied with the quality of service provided by The Malcolm Baldrige National Quality Award is given each
many airlines. Table 8.2 gives the rankings of U.S. airlines in cer- year to companies that meet rigorous standards of quality.
tain operational areas. Smaller carriers are considered to have The Baldrige criteria are (1) leadership, (2) information and
FIGURE 8.3
A Hypothetical PERT Diagram for a McDonald’s Big Mac
Grill beef
patties
(120)
Remove buns, 2
2 beef patties,
cheese,
sauce,
Start lettuce, 1 4 5 6 7 8 E
onions, n
pickle d
(20) Place Top Place Place Serve to
3 cooked with Big Mac in package customer
patties cheese package in heated (5)
on bun and (5) bin
Apply (5) vegetables (5)
sauce (15)
to bun
(10)
5
Critical path Activity Event (185) Time to
complete
event (seconds)

quality control the
processes an organization
uses to maintain its
analysis, (3) strategic planning, (4) human resource develop- Quality is so important that we established quality
ment and management, (5) process management, (6) busi- need to examine it in the context of standards
ness results, and (7) customer focus and satisfaction. The operations management. Quality
criteria have become a worldwide framework for driving control refers to the processes an
business improvement. Seven companies won the award in organization uses to maintain its established quality standards.
2010, representing four different categories: MEDRAD (man- Best Buy’s Geek Squad helps reduce returns of PCs by 40 percent
ufacturing), Nestlé Purina PetCare Co. (manufacturing), when they deliver and set up a computer. This demonstrates that
Freese and Nichols Inc. (small business), K&N Management measuring perceived quality relates to more than just technical
(small business), Studer Group (small business), Advocate defects of a product, but also to other characteristics.26 Quality has
Good Samaritan Hospital (health care), and Montgomery become a major concern in many organizations, particularly in
Country Public Schools (education).25 light of intense foreign competition and increasingly demanding
T A B L E 8 . 2 Rankings of Major U.S. Airlines, Best to Worst
On-Time Cancelled Flights Baggage Handling Bumping Passengers Customer Complaints
1 Alaska Alaska Air Tran JetBlue Southwest

2 United Southwest JetBlue AirTran Alaska
3 AirTran Continental US Airways Delta AirTran
4 US Airways AirTran Continental American JetBlue
5 Continental US Airways Alaska Alaska American
6 Southwest United Southwest United Continental
7 American American United Southwest US Airways
8 Delta JetBlue Delta US Airways United
9 JetBlue Delta American Continental Delta
Source: FlightStats.com for full-year on-time cancellations; DOT Air Travel Consumer Report for 11 months of mishandled bags and complaint data plus nine months
of overbooking data. Information obtained from Scott McCartney, “The Big Guys Finish Last in 2010 Airline Rankings,” USA Today, January 13, 2011, pp. D1, D4.
FIGURE 8.4
J.D. Power and Associates Initial Automobile Quality Study
200
154
147
Problems per 100 cars sold
150
133 133
124 125
119 118 118
108 109
100
50
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Year
Sources: J.D. Power and Associates 2009 Initial Quality Study, http://businesscenter.jdpower.com/news/pressrelease.
aspx?ID=2009108 (accessed February 16, 2010); J.D. Power and Associates 2010 Initial Quality Study, June 17, 2010, http://
businesscenter.jdpower.com/news/pressrelease.aspx?ID=2010099 (accessed January 12, 2011).

total quality statistical process ISO 9000 a series ISO 14000 a
management control a system in of quality-assurance comprehensive set of
(TQM) a philosophy which management collects standards designed by the environmental standards
that uniform commitment and analyzes information International Organization that encourages companies
to quality in all areas of an about the production process for Standardization (ISO) to conduct business in a
organization will promote a to pinpoint quality problems to ensure consistent cleaner, safer, and less
culture that meets customers’ in the production system product quality under many wasteful way. ISO 14000
perceptions of quality conditions provides a uniform set of
standards globally.
STELLA & CHEWY’S: Moody began feeding her other dog, Stella, pathogen-free. Today, Stella & Chewy’s
the same mixture and noticed positive uses hydrostatic high pressure to pasteur-
THE FOOD DOGS results in her as well. Stella & Chewy’s dog ize without removing nutrients and taste.
LOVE food, consisting of fresh meats and organic The company has a third party test each
produce, was born. batch of food. Maintaining quality is critical
Moody began in her apartment kitchen to a raw food diet and for building a prod-
A fter being told that her dog Chewy was
deathly ill, Marie Moody’s only chance
of saving him was to change his diet. She
and later moved to Wisconsin to expand
manufacturing. She developed partner-
uct that consumers trust. Stella & Chewy’s
has flourished, becoming the dog food of
began purchasing organic meat and veg- ships with organic and antibiotic-free meat choice for many pet lovers.27
etables to create her own dog food. Almost producers and hired animal scientists to
immediately, Chewy’s health improved. help create technology to keep the food
customers. To regain a competitive edge, a number of firms have the development of a specific product through the product and
adopted a total quality management approach. Total quality production-facility design processes to the actual manufacture
management (TQM) is a philosophy that uniform commitment of the product. In other words, they view quality control as an
to quality in all areas of the organization will promote a culture element of the product itself, rather than as simply a function
that meets customers’ perceptions of quality. It involves coordinat- of the operations process. When a company makes the prod-
ing efforts to improve customer satisfaction, increasing employee uct correctly from the outset, it eliminates the need to rework
participation, forming and strengthening supplier partnerships, defective products, expedites the transformation process itself,
and facilitating an organizational culture of continuous quality and allows employees to make better use of their time and
improvement. TQM requires constant improvements in all areas of materials. One method through which many companies have
the company as well as employee empowerment. tried to improve quality is statistical process control, a
system in which management collects and analyzes informa-
Continuous improvement of an organization’s goods and ser-
tion about the production process to pinpoint quality problems
vices is built around the notion that quality is free; by contrast,
in the production system.
not having high-quality goods and services can be very expen-
sive, especially in terms of dissatisfied customers.28 A primary
tool of the continuous improvement process is benchmarking,
International Organization
the measuring and evaluating of the quality of the organiza- for Standardization (ISO)
tion’s goods, services, or processes as compared with the quality Regardless of whether a company has a TQM program for qual-
produced by the best-performing companies in the industry.29 ity control, it must first determine what standard of quality it
Benchmarking lets the organization know where it stands com- desires and then assess whether its products meet that standard.
petitively in its industry, thus giving it a goal to aim for over Product specifications and quality standards must be set so the
time. Now that online digital media are becoming more impor- company can create a product that will compete in the mar-
tant in businesses, companies such as Compuware Gomez offer ketplace. Rushing Water Canoes, for example, may specify that
benchmarking tools so companies can monitor and compare each of its canoes has aluminum walls of a specified uniform
the success of their websites. Such tools allow companies to thickness, that the front and back be reinforced with a specified
track traffic to the site versus competitors’ sites. Studies have level of steel, and that each contain a specified amount of flota-
shown a direct link between website performance and online tion material for safety. Production facilities must be designed
sales, meaning this type of benchmarking is important.30 that can produce products with the desired specifications.
Companies employing total quality management (TQM) pro- Quality standards can be incorporated into service businesses
grams know that quality control should be incorporated as well. A hamburger chain, for example, may establish stan-
throughout the transformation process, from the initial plans to dards relating to how long it takes to cook an order and serve

it to customers, how many fries are in each order, how thick
the burgers are, or how many customer complaints might be
acceptable. Once the desired quality characteristics, specifica-
tions, and standards have been stated in measurable terms, the
next step is inspection.
The International Organization for Standardization (ISO) has
created a series of quality management standards—ISO 9000—
designed to ensure that customer’s quality standards are met.
The standards provide a framework for documenting how a cer-
tified business keeps records, trains employees, tests products,
and fixes defects. To obtain ISO 9000 certification, an indepen-
dent auditor must verify that a business’s factory, laboratory, or
office meets the quality standards spelled out by the International
Organization for Standardization. The certification process can
require significant investment, but for many companies, the The ISO 9000 standards are international standards that relate to quality
management. ISO14000 standards relate to environmental management—
process is essential to being able to compete. Thousands of U.S.
managing businesses to minimize harmful effects to the environment.
firms have been certified, and many more are working to meet
the standards. Certification has become a virtual necessity for
doing business in Europe in some high-technology businesses. the inspection of work-in-process is preventive. In other words,
ISO 9002 certification was established for service providers. the purpose of inspection of purchased items and finished
ISO 14000 is a comprehensive set of environmental standards items is to determine what the quality level is. For items that are
that encourages a cleaner and safer world. ISO 14000 is a valu- being worked on—an automobile moving down the assembly
able standard because currently considerable variation exists line or a canoe being assembled—the purpose of the inspection
between the regulations in different nations, and even regions is to find defects before the product is completed so that neces-
within a nation. These variations make it difficult for organiza- sary corrections can be made.
tions committed to sustainability to find acceptable global solu-
tions to problems. The goal of the ISO 14000 standards is to Sampling
promote a more uniform approach to environmental manage- An important question relating to inspection is how many items
ment and to help companies attain and measure improvements should be inspected. Should all canoes produced by Rushing
in their environmental performance. Water be inspected or just some of them? Whether to inspect
100 percent of the output or only part of it is related to the cost
Inspection of the inspection process, the destructiveness of the inspection
Inspection reveals whether a product meets quality standards. process (some tests last until the product fails), and the poten-
Some product characteristics may be discerned by fairly simple tial cost of product flaws in terms of human lives and safety.
inspection techniques—weighing the contents of cereal boxes
Some inspection procedures are quite expensive, use elaborate
or measuring the time it takes for a customer to receive his
testing equipment, destroy products, and/or require a signifi-
or her hamburger. As part of the ongoing quality-assurance
cant number of hours to complete. In such
program at Hershey Foods, all wrapped
cases, it is usually desirable to test only a
Hershey Kisses are checked, and all imper-
sample of the output. If the sample passes
fectly wrapped kisses are rejected. Other
inspection techniques are more elaborate. TEAM EXERCISE inspection, the inspector may assume
Form groups and assign the respon- that all the items in the lot from which
Automobile manufacturers use automated
sibility of finding companies that the sample was drawn would also pass
machines to open and close car doors to outsource their production to other inspection. By using principles of statisti-
test the durability of latches and hinges. The countries. What are the key advantages cal inference, management can employ
food-processing and pharmaceutical indus- of this outsourcing decision? Do you sampling techniques that ensure a rela-
tries use various chemical tests to determine see any drawbacks or weaknesses in tively high probability of reaching the right
the quality of their output. Rushing Water this approach? Why would a company
conclusion—that is, rejecting a lot that does
Canoes might use a special device that can not outsource when such a tactic can
be undertaken to cut manufacturing
not meet standards and accepting a lot that
precisely measure the thickness of each canoe
costs? Report your findings to the class. does. Nevertheless, there will always be a
wall to ensure that it meets the company’s
risk of making an incorrect conclusion—
specifications.
accepting a population that does not meet
Organizations normally inspect purchased standards (because the sample was satis-
items, work-in-process, and finished items. The inspection of factory) or rejecting a population that does meet standards
purchased items and finished items takes place after the fact; (because the sample contained too many defective items).

SO YOU WANT A JOB // in Operations Management /
W hile you might not have been familiar
with terms such as supply chain or
logistics or total quality management before
purchasing, production, transportation, stor-
age and distribution, customer service, and
more. Their performance helps organizations
an interface that provides an automatic qual-
ity performance. Consider jobs in health care,
the travel industry, fast food, and entertain-
taking this course, careers abound in the oper- control expenses, boost sales, and maximize ment. Think of any job or task that is a part
ations management field. You will find these profits. of the final product in these industries. Even
careers in a wide variety of organizations— Warehouse managers are a vital part of an online retailer such as Amazon.com has
manufacturers, retailers, transportation com- manufacturing operations. A typical ware- a transformation process that includes infor-
panies, third-party logistics firms, government house manager’s duties include overseeing mation technology and human activities that
agencies, and service firms. Approximately and recording deliveries and pickups, main- facilitate a transaction. These services have
$1.3 trillion is spent on transportation, inven- taining inventory records and the product a standardized process and can be evalu-
tory, and related logistics activities, and logis- tracking system, and adjusting inventory ated based on their level of achieved service
tics alone accounts for more than 9.5 percent levels to reflect receipts and disbursements. quality.
of U.S. gross domestic product.31 Closely Warehouse managers also have to keep in Total quality management is becoming
managing how a company’s inputs and out- mind customer service and employee issues. a key attribute for companies to ensure that
puts flow from raw materials to the end con- Warehouse managers can earn up to $60,000 quality pervades all aspects of the organiza-
sumer is vital to a firm’s success. Successful in some cases. tion. Quality-assurance managers may make
companies also need to ensure that quality is Operations management is also required salaries in the $55,000 to $65,000 range. These
measured and actively managed at each step. in service businesses. With more than 80 managers monitor and advise on how a com-
Supply chain managers have a tremendous percent of the U.S. economy in services, jobs pany’s quality management system is perform-
impact on the success of an organization. exist for services operations. Many service ing and publish data and reports regarding
These managers are engaged in every facet contact operations require standardized pro- company performance in both manufacturing
of the business process, including planning, cesses that often use technology to provide and service industries.
Sampling is likely to be used when inspection tests are destruc- drawn. However, human life and safety often depend on the
tive. Determining the life expectancy of lightbulbs by turning proper functioning of specific items, such as the navigational
them on and recording how long they last would be foolish: systems installed in commercial airliners. For such items, even
There is no market for burned-out lightbulbs. Instead, a gener- though the inspection process is costly, the potential cost of
alization based on the quality of a sample would be applied to flawed systems—in human lives and safety—is too great not to
the entire population of lightbulbs from which the sample was inspect 100 percent of the output. ■

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nine
180 PART 4 | Creating the Human Resource Advantage

motivating
the workforce
their employees can help them reach
introduction
ecause employees do the
B actual work of the business

and influence whether the firm
achieves its objectives, most top man-
higher levels of productivity and thus
contribute to the achievement of orga-
nizational goals.
agers agree that employees are an
organization’s most valuable resource.
To achieve organizational objectives,
employees must have the motiva-
LEARNING OBJECTIVES
tion, ability (appropriate knowledge
LO1 Define human relations, and
and skills), and tools (proper training determine why its study is
important.
and equipment) to perform their jobs.
LO2 Summarize early studies that laid
Chapter 10 covers topics related to the groundwork for understanding
managing human resources, such employee motivation.
LO3 Compare and contrast the human-
as those listed earlier. This chapter
relations theories of Abraham
focuses on how to motivate employees. Maslow and Frederick Herzberg.
We examine employees’ needs LO4 Investigate various theories of
motivation, including theories
and motivation, managers’ views X, Y, and Z; equity theory; and
of workers, and several strategies expectancy theory.
LO5 Describe some of the strategies
for motivating employees. Manag-
that managers use to motivate
ers who understand the needs of employees.
CHAPTER 9 | Motivating the Workforce 181

human relations the
study of the behavior of
individuals and groups in
organizational settings NATURE the need and achieve a goal (Figure 9.1). Consider a per-
son who takes a job as a salesperson. If his or her perfor-
motivation an inner
drive that directs a person’s
OF HUMAN mance is far below other salespeople’s, he or she will likely
recognize a need to increase sales. To satisfy that need and
behavior toward goals
RELATIONS achieve success, the person may try to acquire new insights
from successful salespeople or obtain additional training to
What motivates employees to per- improve sales skills. In addition, a sales manager might try
form on the job is the focus of human relations, the study different means to motivate the salesperson to work harder
of the behavior of individuals and groups in organizational and improve his or her skills. Human relations is concerned
settings. In business, human relations involves motivating with the needs of employees, their goals and how they try to
employees to achieve organizational objectives efficiently and achieve them, and the impact of those needs and goals on
effectively. The field of human relations has become increasingly job performance.
important over the years as businesses strive to understand how
to boost workplace morale, maximize employees’ productivity Effectively motivating employees helps keep them engaged
and creativity, and motivate their ever more diverse employees in their work. Engagement involves emotional involvement
to be more effective. and commitment. Being engaged results in carrying out the
expectations and obligations of employment. Many employees
Motivation is an inner drive that directs a person’s behav- are actively engaged in their jobs, while others are not. Some
ior toward goals. A goal is the satisfaction of some need, employees do the minimum amount of work required to get
and a need is the difference between a desired state and an by, and some employees are completely disengaged. Motivating
actual state. Both needs and goals can
be motivating. Motivation explains
why people behave as they do; simi- FIGURE 9.1
larly, a lack of motivation explains, at T h e M o t i v a t i o n Process
times, why people avoid doing what
they should do. Motivating employ-
ees to do the wrong things or for the Need
wrong reasons can be problematic,
however. Encouraging employees
to take excessive risks through high
compensation, for example, is not
a good idea and can lead to ethical Goal-Directed
misconduct disasters for a corpora- Behavior
tion. The most recent financial cri-
sis resulted from firms allowing or
encouraging excessive risk taking in
order to achieve financial rewards. A
Need Satisfaction
person who recognizes or feels a need
is motivated to take action to satisfy
FULL YIELD SEEKS to revolutionize the health care industry by The program costs $750 per person annu-
teaching employees how to improve their ally for education and support on shifting to a
TO REVOLUTIONIZE health with wiser food choices. It seems sim- whole food diet. Insurance company Harvard
EMPLOYEE HEALTH ple enough. Research shows that many dis- Pilgrim Health has already signed up 350 of its
eases that contribute to high health care costs employees for the program, and Finch Totten
stem from poor diet. Better employee health, has the support of major organizations like
H ow do businesses lower employee
health care costs while supporting
healthier, motivated employees? Entrepre-
therefore, translates into lower health insur-
ance costs. Big businesses are taking note,
Danone and the City of Boston. Although the
road ahead will be challenging, the success of
neur Zoe Finch Totten feels she has the with 60 percent promoting employee wellness Full Yield could contribute to healthier, happier
answer. Her company, The Full Yield, plans via benefits. The Full Yield is there to help. employees—and businesses as well!1

morale an employee’s
attitude toward his or
her job, employer, and
employees to stay engaged is a key responsibility of manage- gourmet meals and snacks; and colleagues
ment. For example, to test if his onsite production managers the “20% a week” rule, which
were fully engaged in their jobs, former Van Halen frontman allows engineers to work on what- intrinsic rewards
David Lee Roth placed a line in the band’s rider asking for a ever project they want for one day the personal satisfaction
bowl of M&Ms with the brown ones removed. It was a means each week.3 and enjoyment that you feel
for the band to test local stage production crews’ attention to after attaining a goal
Employees are motivated by
detail. Because their shows were highly technical, Lee Roth
their perceptions of extrinsic and extrinsic
would demand a complete recheck of everything if he found
intrinsic rewards. An intrinsic rewards benefits and/
brown M&Ms in the bowl.2
reward is the personal satisfac- or recognition received
One prominent aspect of human relations is morale—an tion and enjoyment that you feel from someone else
employee’s attitude toward his or her job, employer, and col- from attaining a goal. For example,
leagues. High morale contributes to high levels of productivity, in this class you may feel personal
high returns to stakeholders, and employee loyalty. Conversely, enjoyment in learning how busi-
low morale may cause high rates of absenteeism and turnover ness works and aspire to have a career in business or to operate
(when employees quit or are fired and must be replaced by new your own business one day. Extrinsic rewards are benefits
employees). Google recognizes the value of happy, committed and/or recognition that you receive from someone else. In this
employees and strives to engage in practices that will minimize class, your grade is extrinsic recognition of your efforts and
turnover. Employees have the opportunity to have a massage success in the class. In business, praise and recognition, pay
every other week; onsite laundry service; free all-you-can-eat increases, and bonuses are extrinsic rewards. If you believe that
Many companies offer onsite day care as a benefit for employees who have children. Company benefits such as these tend to increase employee
satisfaction and motivation.

classical theory of
motivation theory
suggesting that money
your job provides More comprehensive benefits include employee
is the sole motivator for
an opportunity to discounts on Nike products, scholarships for chil-
workers
contribute to society dren of employees, employee assistance plans,
or the environment, tuition assistance, group legal plans, and matching
then that aspect would represent an intrinsic gift programs. At the Beaverton, Oregon, world
reward. Both intrinsic and extrinsic rewards con- headquarters, Nike employees may take advantage
tribute to motivation that stimulates employees to of onsite day care and fitness centers, onsite cafés
do their best in contributing to business goals. and restaurants, an onsite hair and nail salon, dis-
counted annual TriMet transit passes ($25 annual
Respect, involvement, appreciation, adequate com- DID YOU KNOW? fee versus $600), and several other work-life
pensation, promotions, a pleasant work environ-
Absenteeism can cost resources.5 Many companies offer a diverse array
ment, and a positive organizational culture are all
a company as much as of benefits designed to improve the quality of
morale boosters. Table 9.1 lists some ways to retain
employees’ lives and increase their morale and
good employees. Nike seeks to provide a compre- 36 percent of payroll.4 satisfaction. Some of the best companies to work
hensive compensation and benefits package, which
for offer onsite day care, concierge services (e.g.,
includes traditional elements such as medical, den-
dry cleaning, shoe repair, prescription renewal),
tal, vision, life and disability insurance, paid holidays and time off,
domestic partner benefits to same-sex couples, and fully paid
sabbaticals, and team as well as individual compensation plans.
sabbaticals. Table 9.2 offers suggestions as to how leaders can
motivate employees on a daily basis.
HISTORICAL
PERSPECTIVES ON
EMPLOYEE MOTIVATION
Throughout the 20th century, researchers have conducted
numerous studies to try to identify ways to motivate workers and
increase productivity. From these studies have come theories that
have been applied to workers with varying degrees of success. A
brief discussion of two of these theories—the classical theory of
motivation and the Hawthorne studies—provides a background
for understanding the present state of human relations.
Classical Theory of Motivation

The birth of the study of human relations can be traced to
time and motion studies conducted at the turn of the century
Even small symbols of recognition, such as an “Employee of the by Frederick W. Taylor and Frank and Lillian Gilbreth. Their
Month” parking space, can serve as strong motivators for employees. studies analyzed how workers perform specific work tasks in an
T A B L E 9 . 1 Top 10 Ways to Retain Great Employees
1. Satisfied employees know clearly what is expected from them every day at work.
2. The quality of the supervision an employee receives is critical to employee retention.
3. The ability of the employee to speak his or her mind freely within the organization is another key factor in employee retention.
4. Talent and skill utilization is another environmental factor your key employees seek in your workplace.
5. The perception of fairness and equitable treatment is important in employee retention.
6. Employees must have the tools, time, and training necessary to do their jobs well—or they will move to an employer who provides them.
7. The best employees, those employees you want to retain, seek frequent opportunities to learn and grow in their careers, knowledge, and skill.
8. Take time to meet with new employees to learn about their talents, abilities, and skills. Meet with each employee periodically.
9. No matter the circumstances, never, never, ever threaten an employee’s job or income.
10. Staff members must feel rewarded, recognized, and appreciated.
Source: Susan M. Heathfield, “Top Ten Ways to Retain Your Great Employees,” About.com, http://humanresources.about.com/od/retention/a/more_retention.htm

T A B L E 9 . 2 You Can Make Their Day: Tips for the Leader
about Employee Motivation
1. Use simple, powerful words.

2. Make sure people know what you expect.
3. Provide regular feedback.
4. People need positive and not so positive consequences.
5. It’s about discipline, not magic.
6. Continue learning and trying out new ideas for employee motivation.
7. Make time for people.
8. Focus on the development of people.
9. Share the goals and the context: communicate.
Source: Susan M. Heathfield, “You Can Make Their Day: Ten Tips for the Leader
About Employee Motivation,” About.com, http://humanresources.about.com/od/
motivationsucces3/a/lead_motivation.htm (accessed February 18, 2010).
Working conditions are important. However, the Hawthorne studies,
which were carried out at the electric company shown here beginning in
effort to improve the employees’ productivity. These efforts led the 1920s, found that the workers became more productive because of
to the application of scientific principles to management. the attention they received—regardless of their working conditions.
According to the classical theory of motivation, money is the
sole motivator for workers. Taylor suggested that workers who were corporate boards of directors have taken steps to link executive
paid more would produce more, an idea that would benefit both compensation more closely to corporate performance. Despite
companies and workers. To improve productivity, Taylor thought these changes, many top executives still receive large com-
that managers should break down each job into its component pensation packages. H. Lawrence Culp, Jr., CEO of Danaher
tasks (specialization), determine the best way to perform each task, Corporation, is the highest paid executive, with a total compen-
and specify the output to be achieved by a worker performing the sation of $141.36 million.6
task. Taylor also believed that incentives would motivate employ-
Like most managers of the early 20th century, Taylor believed
ees to be more productive. Thus, he suggested that managers link
that satisfactory pay and job security would motivate employ-
workers’ pay directly to their output. He developed the piece-rate
ees to work hard. However, later studies showed that other fac-
system, under which employees were paid a certain amount for
tors are also important in motivating workers.
each unit they produced; those who exceeded their quota were
paid a higher rate per unit for all the units they produced.
The Hawthorne Studies
We can still see Taylor’s ideas in practice today in the use of finan- Elton Mayo and a team of researchers from Harvard Uni-
cial incentives for productivity. Moreover, companies are increas- versity wanted to determine what physical conditions in the
ingly striving to relate pay to performance at both the hourly and workplace—such as light and noise levels—would stimulate
managerial level. Incentive planners choose an individual incen- employees to be most productive. From 1924 to 1932, they
tive to motivate and reward their employees. In contrast, team studied a group of workers at the Hawthorne Works Plant of
incentives are used to generate partnership and collaboration to the Western Electric Company and measured their productiv-
accomplish organizational goals. Boeing develops sales teams for ity under various physical conditions.
most of its products, including commercial airplanes. The team
dedicated to each product shares in the sales incentive program. What the researchers discovered was quite unexpected and
very puzzling: Productivity increased regardless of the physi-
More and more corporations are tying pay to performance in cal conditions. This phenomenon has been labeled the Haw-
order to motivate—even up to the CEO level. The topic of exec- thorne effect. When questioned about their behavior, the
utive pay has become controversial in recent years, and many employees expressed satisfaction because their co-workers in
Taylor believed that satisfactory pay and job security would

motivate employees to work hard. However, later studies showed
that other factors are also important in motivating workers.

Maslow’s hierarchy physiological security needs the social needs the need esteem needs the
a theory that arranges needs the most basic need to protect oneself from for love, companionship, need for respect—both
the five basic needs of human needs to be physical and economic harm and friendship—the desire self-respect and respect
people—physiological, satisfied—water, food, for acceptance by others from others
security, social, esteem, and shelter, and clothing
self-actualization—into the
order in which people strive
to satisfy them
the experiments were friendly and, more importantly, because

their supervisors had asked for their help and cooperation THEORIES OF EMPLOYEE
in the study. In other words, they were responding to the
attention they received, not the changing physical work con- MOTIVATION
ditions. The researchers concluded that social and psycholog- The research of Taylor, Mayo, and many others has led to the
ical factors could significantly affect productivity and morale. development of a number of theories that attempt to describe
Medtronic, often called the “Microsoft of the medical-device what motivates employees to perform. In this section, we will
industry,” has a built-in psychological factor that influences discuss some of the most important of these theories. The suc-
employee morale. The company makes life-saving medical cessful implementation of ideas based on these theories will
devices, such as pacemakers, neurostimulators, and stents. vary, of course, depending on the company, its management,
New hires at Medtronic receive medallions inscribed with a and its employees. It should be noted, too, that what worked
portion of the firm’s mission statement, “alleviate pain, restore in the past may no longer work today. Good managers must
health, and extend life.” There is an annual party where peo- have the ability to adapt their ideas to an ever-changing, diverse
ple whose bodies function thanks to Medtronic devices give group of employees.
testimonials. Obviously, Medtronic employees feel a sense
of satisfaction in their jobs. Figure 9.2 indicates what execu- Maslow’s Hierarchy of Needs
tives consider to be most valuable in maintaining an effective Psychologist Abraham Maslow theorized that people have five
work-life balance. basic needs: physiological, security, social, esteem, and self-
actualization. Maslow’s hierarchy arranges these needs into
The Hawthorne experiments marked the beginning of a con-
the order in which people strive to satisfy them (Figure 9.3).
cern for human relations in the workplace. They revealed
that human factors do influence workers’ behavior and that Physiological needs, the most basic and first needs to be
managers who understand the needs, beliefs, and expecta- satisfied, are the essentials for living—water, food, shelter, and
tions of people have the greatest success in motivating their clothing. According to Maslow, humans devote all their efforts
workers. to satisfying physiological needs until they are met. Only when
these needs are met can people focus their attention on satisfy-
ing the next level of needs—security.
FIGURE 9.2 Security needs relate to protecting yourself from physi-
Value of Employer Work-Life Concessions cal and economic harm. Actions that may be taken to achieve
security include reporting a dangerous workplace condition
Highly Valuable Somewhat Valuable Not Valuable to management, maintaining safety equipment, and purchas-
ing insurance with income protection in the event you become
70% unable to work. Once security needs have been satisfied, people
60% may strive for social goals.
50%
40% Social needs are the need for love, companionship, and
friendship—the desire for acceptance by others. To fulfill social
30%
needs, a person may try many things: making friends with a
20% co-worker, joining a group, volunteering at a hospital, throw-
10% ing a party. Once their social needs have been satisfied, people
0% attempt to satisfy their need for esteem.
s
ut g/
ed ily
e”
Esteem needs relate to respect—both self-respect and respect

or ib el
al
m in
Sa le
ch da
v
tim
g
ic
tra
m rk
in
at
from others. One aspect of esteem needs is competition—the

k s le
co o
p
bb
d
le e w
om
ite
need to feel that you can do something better than anyone else.
w Flex
“C
Te om
Lim
Competition often motivates people to increase their produc-

H
tivity. Esteem needs are not as easily satisfied as the needs at

Source: “BlueSteps 2010 Executive Work-Life Balance Survey,” http://viewswire. lower levels in Maslow’s hierarchy because they do not always
eiu.com/report_dl.asp?mode=fi&fi=757215260.PDF (accessed January 13, 2011). provide tangible evidence of success. However, these needs can

self-actualization
needs the need to be
be realized through rewards and increased involvement in orga- the best one can be; at the
she or he is living life to its fullest
top of Maslow’s hierarchy
nizational activities. Until esteem needs are met, people focus in every way. For Stephen King,
their attention on achieving respect. When they feel they have self-actualization might mean
achieved some measure of respect, self-actualization becomes the being praised as the best fiction writer in the world; for actress
major goal of life. Halle Berry, it might mean winning an Oscar.
Self-actualization needs, at the top of Maslow’s hierarchy, Maslow’s theory maintains that the more basic needs at the bot-
mean being the best you can be. Self-actualization involves tom of the hierarchy must be satisfied before higher-level goals
maximizing your potential. A self-actualized person feels that can be pursued. Thus, people who are hungry and homeless are
not concerned with obtaining respect
FIGURE 9.3 from their colleagues. Only when physi-
ological, security, and social needs have
Maslow’s Hierarchy of Needs
been more or less satisfied do people
seek esteem. Maslow’s theory also sug-
gests that if a low-level need is suddenly
reactivated, the individual will try to sat-
isfy that need rather than higher-level
needs. Many laid off workers probably
shift their focus from high-level esteem
Self-
needs to the need for security. When U.S.
Actualization unemployment reached 10 percent dur-
Needs ing the last recession and the job market
appeared increasingly insecure, many
employees, particularly those in manu-
facturing, banking, and finance, felt they
Esteem Needs
had to shift their focus back to secu-
rity needs. Managers should learn from
Maslow’s hierarchy that employees will
be motivated to contribute to organiza-
tional goals only if they are able to first
Social Needs
satisfy their physiological, security, and
social needs through their work.
Herzberg’s Two-
Security Needs Factor Theory
In the 1950s psychologist Frederick Her-
zberg proposed a theory of motivation
that focuses on the job and on the envi-
Physiological Needs
ronment where work is done. Herzberg
studied various factors relating to the
job and their relation to employee moti-
vation and concluded that they can be
Source: Adapted from Abraham H. Maslow, “A Theory of Human Motivation,” Psychology Review 50 (1943), divided into hygiene factors and motiva-
pp. 370–396. American Psychology Association. tional factors (Table 9.3).
Maslow’s theory maintains that the more basic needs

at the bottom of the hierarchy must be satisfied
before higher-level goals can be pursued.

REWARDING global travel deal website), Bluewolf, Inc. Points of Light Foundation claims that
(an IT consulting firm), and Patagonia. At over 80 percent of companies feel that
PERFORMERS WITH Bluewolf, emphasis is placed on outcome volunteering raises profits. This may
TIME OFF rather than time spent at a desk, enabling be due to the fact that consumers are
its 175 employees to take unlimited time off increasingly doing business with socially
to travel, volunteer, and more. Travelzoo responsible companies. Employees also
D uring the most recent recession, sev-
eral organizations decided to decrease
employee incentives (perks) due to the
offers its employees of more than one year
an annual $1,500–$32,000 with three extra
become committed to companies that
give back to communities and appreciate
difficult financial environment. Although vacation days and the chance to snatch up their efforts.7
incentives are rising again, there are still a deal listed on its site. In return, employees
fewer employee perks than there were pre- are merely required to submit pictures and Discussion Questions
recession. However, some employers are brief write-ups to the company’s subscriber 1. Do you think providing time off is an
taking an unusual approach by offering more newsletter. After one year of employment, incentive that will increase employee
time off as a reward—even for part-time Patagonia covers up to 60 days’ worth of performance?
workers. Indeed, a survey of companies in an employee’s salary to allow the employee 2. Could giving employees additional
the Washington, DC/Baltimore area revealed to volunteer with a grassroots organiza- time off diminish the performance of
that 73 percent of surveyed employers now tion. Like those at Travelzoo, employ- other employees who do not get the
offer paid time off to part-time workers rather ees are asked to report back about their reward?
than creating full-time positions, which come experiences.
3. Would you rather have time off as a
with their own share of costs. Studies have suggested that these
reward for good performance or a finan-
Three companies that reward employ- types of incentives boost bottom-line cial reward?
ees with extra time off include Travelzoo (a profits and enhance employee retention.
T A B L E 9 . 3 Herzberg’s Hygiene and Motivational Factors not result in dissatisfaction, but their presence is likely to motivate
employees to excel. Many companies are beginning to employ
Hygiene Factors Motivational Factors
methods to give employees more responsibility and control and to
Company policies Achievement involve them more in their work, which serves to motivate them to
Supervision Recognition higher levels of productivity and quality. L.L.Bean employees have
Working conditions Work itself tremendous latitude to satisfy customer’s needs. One employee
drove 500 miles from Maine to New York to deliver a canoe to
Relationships with peers, Responsibility
supervisors, and subordinates a customer who was leaving on a trip. L.L.Bean is one of the top
25 companies on Bloomberg Businessweek’s list of “Customer Ser-
Salary Advancement
vice Champs.” L.L.Bean also ranks high in employee satisfaction.
Security Personal growth When the company decided to close down a call center, L.L.Bean
allowed the call-center employees to act as home-based agents
rather than laying them off and outsourcing the work. Besides
Hygiene factors, which relate to the work setting and not to empowering employees, the company has strict service training,
the content of the work, include adequate wages, comfortable and answering every call within 20 seconds.8
safe working conditions, fair company policies, and job security.
Herzberg’s motivational factors and Maslow’s esteem and
These factors do not necessarily motivate employees to excel, but
self-actualization needs are similar. Workers’ low-level needs
their absence may be a potential source of dissatisfaction and high
(physiological and security) have largely been satisfied by
turnover. Employee safety and comfort are clearly hygiene factors.
minimum-wage laws and occupational-safety standards set by
Many people feel that a good salary is one of the most impor- various government agencies and are therefore not motivators.
tant job factors, even more important than job security and Consequently, to improve productivity, management should
the chance to use one’s mind and abilities. Salary and secu- focus on satisfying workers’ higher-level needs (motivational
rity, two of the hygiene factors identified by Herzberg, make it factors) by providing opportunities for achievement, involve-
possible for employees to satisfy the physiological and security ment, and advancement and by recognizing good performance.
needs identified by Maslow. However, the presence of hygiene
factors is unlikely to motivate employees to work harder. McGregor’s Theory X and Theory Y
Motivational factors, which relate to the content of the work In The Human Side of Enterprise, Douglas McGregor
itself, include achievement, recognition, involvement, responsi- related Maslow’s ideas about personal needs to manage-
bility, and advancement. The absence of motivational factors may ment. McGregor contrasted two views of management—the

hygiene factors motivational Theory X McGregor’s traditional Theory Y McGregor’s
aspects of Herzberg’s theory of factors aspects of Herzberg’s view of management whereby it humanistic view of management
motivation that focus on the work theory of motivation that focus is assumed that workers generally whereby it is assumed that workers
setting and not the content of on the content of the work itself; dislike work and must be forced to like to work and that under proper
the work; these aspects include these aspects include achievement, do their jobs conditions employees will seek
adequate wages, comfortable recognition, involvement, out responsibility in an attempt to
and safe working conditions, fair responsibility, and advancement satisfy their social, esteem, and self-
company policies, and job security actualization needs
The Dirty Jobs television series recognizes individuals who take on society’s undesirable, but essential, jobs.
traditional view, which he called Theory X, and a humanistic Managers who subscribe to the Theory X view maintain tight
view, which he called Theory Y. control over workers, provide almost constant supervision, try
to motivate through fear, and make decisions in an autocratic
According to McGregor, managers adopting Theory X assume fashion, eliciting little or no input from their subordinates. The
that workers generally dislike work and must be forced to do their Theory X style of management focuses on physiological and
jobs. They believe that the following statements are true of workers: security needs and virtually ignores the higher needs discussed
1. The average person naturally dislikes work and will avoid it by Maslow.
when possible.
The Theory X view of management does not take into account
2. Most workers must be coerced, controlled, directed, or people’s needs for companionship, esteem, and personal growth,
threatened with punishment to get them to work toward the whereas Theory Y, the contrasting view of management, does.
achievement of organizational objectives. Managers subscribing to the Theory Y view assume that work-
3. The average worker prefers to be directed and to avoid respon- ers like to work and that under proper conditions employ-
sibility, has relatively little ambition, and wants security.9 ees will seek out responsibility in an attempt to satisfy their

Theory Z a
management philosophy
that stresses employee
social, esteem, and self-actualization Y managers address the high-level needs in Maslow’s hierarchy
participation in all aspects of
company decision making needs. McGregor describes the as well as physiological and security needs. Today, Theory Y
assumptions behind Theory Y in enjoys widespread support and may have displaced Theory X.
the following way:
1. The expenditure of physical and mental effort in work is as Theory Z
natural as play or rest. Theory Z is a management philosophy that stresses employee
2. People will exercise self-direction and self-control to achieve participation in all aspects of company decision making. It was
objectives to which they are committed. first described by William Ouchi in his book Theory Z—How
American Business Can Meet the Japanese Challenge. Theory
3. People will commit to objectives when they realize that the
Z incorporates many elements associated with the Japanese
achievement of those goals will bring them personal reward.
approach to management, such as trust and intimacy, but Japa-
4. The average person will accept and seek responsibility. nese ideas have been adapted for use in the United States. In a
5. Imagination, ingenuity, and creativity can help solve organi- Theory Z organization, managers and workers share responsi-
zational problems, but most organizations do not make ade- bilities; the management style is participative; and employment
quate use of these characteristics in their employees. is long term and often lifelong. Japan has faced a significant
period of slowing economic progress and competition from
6. Organizations today do not make full use of workers’ intellec-
China and other Asian nations. This has led to experts ques-
tual potential.10
tioning Theory Z, particularly at firms such as Sony and Toyota.
Obviously, managers subscribing to the Theory Y philoso- Theory Z results in employees feeling organizational owner-
phy have a management style very different from managers ship. Research has found that such feelings of ownership may
subscribing to the Theory X philosophy. Theory Y managers produce positive attitudinal and behavioral effects for employ-
maintain less control and supervision, do not use fear as the ees.11 In a Theory Y organization, managers focus on assump-
primary motivator, and are more democratic in decision mak- tions about the nature of the worker. The two theories can be
ing, allowing subordinates to participate in the process. Theory seen as complementary. Table 9.4 compares the traditional
Theory Y managers maintain less control and

supervision, do not use fear as the primary motivator,
and are more democratic in decision making.
T A B L E 9 . 4 Comparison of American, Japanese, and Theory Z Management Styles
American Japanese Theory Z
Duration of Relatively short term; workers subject Lifelong; no layoffs Long term; layoffs rare
employment to layoffs when business slows
Rate of promotion Rapid Slow Slow
Amount of Considerable; worker develops Minimal; worker develops expertise Moderate; worker learns all aspects
specialization expertise in one area only in all aspects of the organization of the organization
Decision making Individual Consensual; input from all Consensual; emphasis on quality
concerned parties is considered
Responsibility Assigned to the individual Shared by the group Assigned to the individual
Control Explicit and formal Less explicit and less formal Informal but with explicit
performance measures
Concern for workers Focus is on work only Focus extends to worker’s whole life Focus includes worker’s life and
family
Source: Adapted from William Ouchi, Theory Z—How American Business Can Meet the Japanese Challenge, p. 58. © 1981 by Addison-Wesley Publishing Company,
Inc. Reprinted by permission of Perseus Books Publishers, a member of Perseus Books, L.L.C.

equity theory an
assumption that how
much people are willing
American management style, the Japanese management style, feel that you are being treated
to contribute to an
and Theory Z (the modified Japanese management style). unfairly and be motivated to seek organization depends on
change. Or if you learn that your their assessment of the
Variations on Theory Z co-worker who makes $35,000 fairness, or equity, of the
Theory Z has been adapted and modified for use in a number of has only a high-school diploma, rewards they will receive in
U.S. companies. One adaptation involves workers in decisions you may feel cheated by your exchange
through quality circles. Quality circles (also called quality- employer. To achieve equity, you
assurance teams) are small, usually having five to eight mem- could try to increase your outputs expectancy
bers who discuss ways to reduce waste, eliminate problems, by asking for a raise or promotion. theory the assumption
You could also try to have your co- that motivation depends not
and improve quality, communication, and work satisfaction.
only on how much a person
Such quality teams are a common technique for harnessing the worker’s inputs increased or his or
wants something but also
knowledge and creativity of hourly employees to solve prob- her outputs decreased. Failing to
on how likely he or she is
lems in companies. As Theory Z has questioned the use of qual- achieve equity, you may be moti- to get it
ity circles, their prevalence has declined. Quality circles have vated to look for a job at a differ-
been replaced with quality methods. ent company.
Quality circles are often modified and operate under names Because almost all the issues involved in equity theory are sub-
such as participative management, employee involvement, jective, they can be problematic. Author David Callahan has
or self-directed work teams. Regardless of the term used to argued that feelings of inequity may underlie some unethical
describe such programs, they strive to give employees more or illegal behavior in business. For example, due to employee
control over their jobs while making them more responsible theft and shoplifting, Walmart experiences billions in inventory
for the outcome of their efforts. Such programs often orga- losses every year. Some employees may take company resources
nize employees into work teams of 5 to 15 members who are to restore what they perceive to be equity. Theft of company
responsible for producing an entire product item. Team mem- resources is the number one ethical issue, based on a survey by
bers are cross-trained and can therefore move from job to the Ethics Resource Center.12 Callahan believes that employees
job within the team. Each team essentially manages itself and who do not feel they are being treated equitably may be moti-
is responsible for its quality, scheduling, ordering and use of vated to equalize the situation by lying, cheating, or otherwise
materials, and problem solving. Many firms have successfully “improving” their pay, perhaps by stealing.13 Managers should
employed work teams to boost morale, productivity, quality, try to avoid equity problems by ensuring that rewards are dis-
and competitiveness. tributed on the basis of performance and that all employees
clearly understand the basis for their pay and benefits.
Equity Theory
According to equity theory, how much people are willing Expectancy Theory
to contribute to an organization depends on their assess- Psychologist Victor Vroom described expectancy theory,
ment of the fairness, or equity, of the rewards they will which states that motivation depends not only on how much a
receive in exchange. In a fair situation, a person receives person wants something but also on the person’s perception of
rewards proportional to the contribution he or she makes how likely he or she is to get it. A person who wants something
to the organization. However, in practice, equity is a sub- and has reason to be optimistic will be strongly motivated. For
jective notion. Each worker regularly develops a personal example, say you really want a promotion. And let’s say because
input-output ratio by taking stock of his or her contribution you have taken some night classes to improve your skills, and
(inputs) to the organization in time, effort, skills, and experi- moreover, have just made a large, significant sale, you feel con-
ence and assessing the rewards (outputs) offered by the orga- fident that you are qualified and able to handle the new position.
nization in pay, benefits, recognition, and promotions. The Therefore, you are motivated to try to get the promotion. In con-
worker compares his or her ratio to the input-output ratio trast, if you do not believe you are likely to get what you want,
of some other person—a “comparison other,” who may be a you may not be motivated to try to get it, even though you really
co-worker, a friend working in another organization, or an want it.
“average” of several people working in the organization. If
the two ratios are close, the individual will feel that he or she
is being treated equitably.
Let’s say you have a high-school education and earn $25,000
STRATEGIES FOR
a year. When you compare your input-output ratio with that
of a co-worker who has a college degree and makes $35,000 a
MOTIVATING EMPLOYEES
year, you will probably feel that you are being paid fairly. How- Based on the various theories that attempt to explain what
ever, if you perceive that your personal input-output ratio is motivates employees, businesses have developed several
lower than that of your college-educated co-worker, you may strategies for motivating their employees and boosting

behavior modification job rotation job enlargement the job enrichment the
changing behavior and encouraging movement of employees from one addition of more tasks to a job incorporation of motivational factors,
appropriate actions by relating the job to another in an effort to relieve instead of treating each task as such as opportunity for achievement,
consequences of behavior to the the boredom often associated with separate recognition, responsibility, and
behavior itself job specialization advancement, into a job
morale and productivity. Some of these techniques include Job Design

behavior modification and job design, as well as the already
Herzberg identified the job itself as a motivational factor.
described employee involvement programs and work teams.
Managers have several strategies that they can use to design
jobs to help improve employee motivation. These include job
Behavior Modification rotation, job enlargement, job enrichment, and flexible sched-
Behavior modification involves changing behavior and uling strategies.
encouraging appropriate actions by relating the consequences
of behavior to the behavior itself. The concept of behavior Job Rotation Job rotation allows employees to move
modification was developed by psychologist B. F. Skinner, who from one job to another in an effort to relieve the boredom
showed that there are two types of consequences that can modify that is often associated with job specialization. Businesses
behavior—reward and punishment. Skinner found that behavior often turn to specialization in hopes of increasing productiv-
that is rewarded will tend to be repeated, while behavior that is ity, but there is a negative side effect to this type of job design:
punished will tend to be eliminated. For example, employees who Employees become bored and dissatisfied, and productiv-
know that they will receive a bonus such as an expensive restau- ity declines. Job rotation reduces this boredom by allowing
rant meal for making a sale over $2,000 may be more motivated workers to undertake a greater variety of tasks and by giving
to make sales. Workers who know they will be punished for being them the opportunity to learn new skills. With job rotation,
tardy are likely to make a greater effort to get to work on time. an employee spends a specified amount of time performing
one job and then moves on to another, different job. The
However, the two strategies may not be equally effective.
worker eventually returns to the initial job and begins the
Punishing unacceptable behavior may provide quick results
cycle again.
but may lead to undesirable long-term side effects, such as
employee dissatisfaction and increased turnover. In general, Job rotation is a good idea, but it has one major drawback.
rewarding appropriate behavior is a more effective way to Because employees may eventually become bored with all the
modify behavior. jobs in the cycle, job rotation does not totally eliminate the
URSULA BURNS promoted, finally becoming president in 2007. to use the downturn as a time to encour-
Thanks to her no-nonsense management age her employees worldwide to become
MOTIVATES style, Burns helped Xerox find success by more independent and self-managing.
EMPLOYEES improving efficiency and customer service. Her goal is to establish trust between
According to her peers, Burns has all herself and her workers, empowering
the skills necessary to successfully lead them to make the right decisions on their
I n 2009 Ursula Burns became the first black
female CEO of a Fortune 500 corporation
when she took over the top position at
Xerox as the company’s top manager: tech-
nical expertise and conceptual, analytical,
own. Burns’s shared commitment to both
employees and innovation may be just
Xerox. Burns credits her rise from intern and human relations skills. Burns will need what Xerox needs to point the company in
to CEO to hard work. While she admits these skills in coming years. During the last a new direction.14
that Xerox’s support of diversity probably economic recession, Xerox faced losses
helped her at the beginning of her career, as customers purchased less and product Discussion Questions
Burns’s straightforward style and strong prices fell. People and businesses are also 1. Why do you think Ursula Burns is so
work ethic helped her rise to the top. beginning to use less paper as they move successful?
Raised in poverty by a single mother from copies to e-mail to share information. 2. What kind of skills do you think are most
who worked hard so that her children could However, Burns has a strong history of inno- useful to Ursula Burns as CEO of Xerox?
attend private school, Burns learned the vation and is making plans to expand Xerox’s
3. How do you think Ursula Burns’s early
value of hard work at an early age. She first capabilities.
life prepared her for her current position
went to work at Xerox as an intern in 1980 and One of her strategies is to adjust the
at Xerox?
never left the company. Burns was quickly company’s corporate culture. She hopes

flextime a program
that allows employees to
choose their starting and
problem of boredom. Job rotation is extremely useful, however, responsibility and provide oppor-
ending times, provided that
in situations where a person is being trained for a position that tunities for growth and advance- they are at work during a
requires an understanding of various units in an organization. ment when the worker is able to specified core period
Eli Lilly is a strong believer in the benefits of job rotation. The take on the more challenging
company leaves employees in their current jobs and asks them tasks. Hyatt Hotels Corporation
to take on short-term assignments outside their field of exper- and General Foods use job enrichment to improve the qual-
tise or interest. The results of the process have been positive, ity of work life for their employees. The potential benefits of
and Nokia is trying the same process with similar outcomes.15 job enrichment are great, but it requires careful planning and
Many executive training programs require trainees to spend execution.
time learning a variety of specialized jobs. Job rotation is also
used to cross-train today’s self-directed work teams. Flexible Scheduling Strategies Many U.S. workers
work a traditional 40-hour workweek consisting of five 8-hour
Job Enlargement Job enlargement adds more tasks days with fixed starting and ending times. Facing problems of
to a job instead of treating each task as separate. Like job rota- poor morale and high absenteeism as well as a diverse work-
tion, job enlargement was developed to overcome the bore- force with changing needs, many managers have turned to flex-
dom associated with specialization. The rationale behind this ible scheduling strategies such as flextime,
strategy is that jobs are more satisfying as compressed workweeks, job sharing, part-
the number of tasks performed by an indi- time work, and telecommuting. A survey
vidual increases. Employees sometimes by CareerBuilder.com showed that 40 per-
enlarge, or craft, their jobs by noticing
Flextime cent of working fathers were offered flexible
what needs to be done and then chang- provides many work schedules versus 53 percent of work-
ing tasks and relationship boundaries to ing mothers.16
adjust. Individual orientation and motiva- benefits, including Flextime is a program that allows employ-
tion shape opportunities to craft new jobs
and job relationships. Job enlargement improved ability to ees to choose their starting and ending
strategies have been more successful in times, as long as they are at work during a
increasing job satisfaction than have job
recruit and retain specified core period (Figure 9.4). It does
not reduce the total number of hours that
rotation strategies. IBM, AT&T, and May- workers who wish employees work; instead, it gives employ-
tag are among the many companies that
have used job enlargement to motivate to balance work and ees more flexibility in choosing which hours
employees. they work. A firm may specify that employ-
home life. ees must be present from 10:00 a.m. to 3:00
Job Enrichment Job enrichment p.m. One employee may choose to come in
incorporates motivational factors such at 7:00 a.m. and leave at the end of the core
as opportunity for achievement, recognition, responsibility, time, perhaps to attend classes at a nearby college after work.
and advancement into a job. It gives workers not only more Another employee, a mother who lives in the suburbs, may come
tasks within the job, but more control and authority over the in at 9:00 a.m. in order to have time to drop off her children at
job. Job enrichment programs enhance a worker’s feeling of a day-care center and commute by public transportation to her
job. Flextime provides many benefits,
including improved ability to recruit and
FIGURE 9.4 retain workers who wish to balance work
Flextime, Showing Core and Flexible Hours and home life. Customers can be better
served by allowing more coverage of cus-
tomers over longer hours, workstations
12 and facilities can be better utilized by
11 1
staggering employee use, and rush hour
10 Core 2 traffic may be reduced. In addition, flex-
Time ible schedules have been associated with
an increase in healthy behaviors on the
9 3
Start End part of employees. More flexible sched-
Time Time ules are associated with healthier lifestyle
8 4 choices such as increased physical activ-
7 5 ity and healthier sleep habits.17
6
Related to flextime are the scheduling strat-
egies of the compressed workweek and job

compressed
workweek a four-day
(or shorter) period during
sharing. The compressed work- their batteries.” When the employees return to full-time work,
which an employee works
40 hours
week is a four-day (or shorter) they are usually given a position comparable to their original
period in which an employee works full-time position. Other firms are allowing employees to tele-
job sharing 40 hours. Under such a plan, commute or telework (work at home a few days of the week),
performance of one full- employees typically work 10 hours staying connected via computers, modems, and telephones.
time job by two people on per day for four days and have Today, 33.7 million Americans are teleworkers, working most
part-time hours a three-day weekend. The com- often from home, a customer’s business, or from their cars.19
pressed workweek reduces the
Although many employees ask for the option of working at
company’s operating expenses
home to ease the responsibilities of caring for family members,
because its actual hours of operation are reduced. It is also
some have discovered that they are more productive at home
sometimes used by parents who want to have more days off to
without the distractions of the workplace. An assessment of 12
spend with their families. The U.S. Bureau of Labor Statistics
company telecommuting programs, including Apple, AT&T,
notes that the following career options provide greater flexibil-
and the state of California, found that positive productivity
ity in scheduling: medical transcriptionist, financial manager,
changes occurred. Traveler’s Insurance Company reports its
nurse, database administrator, accountant, soft-
telecommuters to be 20 percent more produc-
ware developer, physical therapist assistant,
tive than its traditional employees.20 Other
paralegal, graphic designer, and private
employees, however, have discovered that
investigator.18 TEAM EXERCISE they are not suited for working at home.
Job sharing occurs when two people Form groups and outline a compensation Many chief financial officers, for example,
package that you would consider ideal believe that telecommuting is not conducive
do one job. One person may work from
in motivating an employee, recognizing to their jobs. A survey of finance executives
8:00 a.m. to 12:30 p.m.; the second person performance, and assisting the company
comes in at 12:30 p.m. and works until revealed that only 18.3 percent of finance
in attaining its cost-to-performance
5:00 p.m. Job sharing gives both people the departments allow their employees to work
objectives. Think about the impact of
opportunity to work as well as time to ful- intrinsic and extrinsic motivation and from home on a regular basis as part of
fill other obligations, such as parenting or recognition. How can flexible scheduling their flexible working arrangements.21 Still,
school. With job sharing, the company has strategies be used effectively to moti- work-at-home programs do help reduce
the benefit of the skills of two people for vate employees? Report your compen- overhead costs for businesses. For example,
one job, often at a lower total cost for sala- sation package to the class. some companies used to maintain a surplus
ries and benefits than one person working of office space but have reduced the surplus
eight hours a day would be paid. through employee telecommuting, “hotel-
ing” (being assigned to a desk through a res-
Two other flexible scheduling strategies attaining wider use ervation system), and “hot-desking” (several people using the
include allowing full-time workers to work part time for a cer- same desk but at different times).
tain period and allowing workers to work at home either full or
part time. Employees at some firms may be permitted to work Companies are turning to flexible work schedules to provide
part time for several months in order to care for a new baby or an more options to employees who are trying to juggle their
elderly parent or just to slow down for a little while to “recharge work duties with other responsibilities and needs. Prelimi-
nary results indicate that flexible scheduling plans increase
job satisfaction, which, in turn, leads to increases in produc-
tivity. Some recent research, however, has indicated there are
potential problems with telecommuting. Some managers are
reluctant to adopt the practice because the pace of change in
today’s workplace is faster than ever, and telecommuters may
be left behind or actually cause managers more work in help-
ing them stay abreast of changes. Some employers also worry
that telecommuting workers create a security risk by creat-
ing more opportunities for computer hackers or equipment
thieves. Some employees have found that working outside the
office may hurt career advancement opportunities, and some
report that instead of helping them balance work and family
responsibilities, telecommuting increases the strain by blur-
ring the barriers between the office and home. Co-workers call
REI, the outdoor-sporting company, encourages its workers to have a at all hours, and telecommuters are apt to continue to work
healthy work-life balance. Among other benefits, employees get paid to when they are not supposed to (after regular business hours or
take a sabbatical after a number of years of service. during vacation time).

Importance of Motivational
Strategies
Motivation is more than a tool that managers can use to foster
employee loyalty and boost productivity. It is a process that
affects all the relationships within an organization and influ-
ences many areas such as pay, promotion, job design, train-
ing opportunities, and reporting relationships. Employees are
motivated by the nature of the relationships they have with
their supervisors, by the nature of their jobs, and by charac-
teristics of the organization. Table 9.5 shows the top 10 com-
panies in the Fortune 100 Best Companies to Work For, along
with the types of strategies they use to motivate employees.
Even the economic environment can change an employee’s
Businesses have come up with different ways to motivate employees, motivation. In a slow growth or recession economy, sales can
including rewards such as trophies and plaques to show the company’s flatten or decrease and morale can drop because of the need
appreciation. to cut jobs. In the most recent recession, many workers feared
SO YOU THINK // You May Be Good at Motivating a Workforce /

I f you are good at mediation, can smooth
over conflict, and have a good understand-
ing of motivation and human relations theo-
to be more group oriented, and therefore
anything that singles out individuals would
not be an effective way of rewarding and
especially as firms become more global and
more diverse.
Another important part of motivation is
ries, then you might be a good leader, human motivating. American workers, on the other enjoying where you work and your career
resource manager, or training expert. Most hand, are very individualistic, and a raise opportunities. Here is a list of the best places
organizations, especially as they grow, will and public praise might be more effective. to do business and start careers in the
need to implement human relations programs. However, what might motivate a younger United States, according to Forbes maga-
These are necessary to teach employees employee (bonuses, raises, and perks) may zine. Chances are, workers who live in these
about sensitivity to other cultures, religions, not be the same as what motivates a more places have encountered fewer frustrations
and beliefs, as well as for teaching the work- seasoned, experienced, and financially suc- than those places at the bottom of the list and,
force about the organization so that they cessful employee (recognition, opportunity therefore, would probably be more content
understand how they fit in the larger pic- for greater influence, and increased training). with where they work. 22
ture. Employees need to appreciate the ben- Motivation is not an easy thing to understand,
efits of working together to make the firm run
smoothly, and they also need to understand Best Places for Business and Careers
how their contributions help the firm. To stay
motivated, most employees need to feel like Job Growth Projected Metro Area Population
Rank Metro Area Rank (in thousands)
what they do each day contributes something
of value to the firm. Disclosing information 1. Des Moines, IA 10 563
and including employees in decision-making 2. Provo, UT 29 556
processes will also help employees feel valu- 3. Raleigh, NC 14 1,126
able and wanted within the firm.
4. Fort Collins, CO 21 298
There are many different ways employ-
ers can reward and encourage employees. 5. Lincoln, NE 72 298
However, employers must be careful when 6. Denver, CO 49 2,552
considering what kinds of incentives to 7. Omaha, NE 54 850
use. Different cultures value different kinds 8. Huntsville, AL 2 406
of incentives more highly than others. For
9. Lexington, KY 32 471
example, a Japanese worker would prob-
ably not like it if she were singled out from 10. Austin, TX 12 1,705
the group and given a large cash bonus as Source: Kurt Badenhausen, “The Best Places for Business and Careers,” Forbes, April 14, 2010, www.forbes
reward for her work. Japanese workers tend .com/2010/04/13/best-places-for-business=beltway-business-places-10_lander.html, accessed April 13, 2011.

T A B L E 9 . 5 Best Companies to Work For
Rank Companies Motivational Strategies
1. SAS Employee benefits such as on-site health care, kids summer camp, and salon
2. Boston Consulting Group Good pay, dedication to social work
3. Wegmans Food Markets Emphasizes employee well-being through exercise and healthy eating
4. Google 10 percent pay hike, ability to award one another “spot bonuses”
5. Netapp Generous pay and bonuses
6. Zappos.com Fun corporate culture, free lunches, a life coach on hand
7. Camden Property Trust Allows employees to rent furnished apartments for personal vacations at $20 a night
8. Nugget Market Holds employee rallies where awards are delivered and employees are given a chance to win
bonuses
9. Recreational Equipment (REI) Four-week sabbaticals after 15 years of service, steep discounts on clothes
10. Dreamworks Animation SKG Movie screenings, afternoon yoga, art classes, monthly parties
Source: “The 100 Best Companies to Work For,” Fortune, February 7, 2011, pp. 91–101.
losing their jobs and increased the amount they were saving. Motivation tools, then, must be varied as well. Managers
The firm may have to work harder to keep good employees can further nurture motivation by being honest, supportive,
and to motivate all employees to work to overcome obstacles. empathetic, accessible, fair, and open. Motivating employees
In good economic times, employees may be more demanding to increase satisfaction and productivity is an important con-
and be on the lookout for better opportunities. New rewards cern for organizations seeking to remain competitive in the
or incentives may help motivate workers in such economies. global marketplace. ■

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and video

ten
managing
human resources
f a business is to achieve success, way, we’ll also consider the challenges
introduction
I it must have sufficient numbers of

employees who are qualified and
motivated to perform the required
of managing unionized employees and
workplace diversity.
LEARNING OBJECTIVES
duties. Thus, managing the quan-
LO1 Define human resources manage-
tity (from hiring to firing) and qual- ment, and explain its significance.
ity (through training, compensating, LO2 Summarize the processes of recruit-
ing and selecting human resources
and so on) of employees is an impor-
for a company.
tant business function. Meeting the LO3 Discuss how workers are trained and
challenge of managing increasingly their performance appraised.
diverse human resources effectively LO4 Identify the types of turnover com-
panies may experience, and explain
can give a company a competitive why turnover is an important issue.
edge in a global marketplace. LO5 Specify the various ways a worker
may be compensated.
This chapter focuses on the quantity
LO6 Discuss some of the issues associ-
and quality of human resources. First ated with unionized employees,
we look at how human resources including collective bargaining and
dispute resolution.
managers plan for, recruit, and select
LO7 Describe the importance of diversity
qualified employees. Next we look in the workforce.
at training, appraising, and compen-
sating employees, aspects of human
resources management designed to
retain valued employees. Along the
CHAPTER 10 | Managing Human Resources 199

human resources job analysis the job description a job specification a recruiting forming a
management determination, through formal, written explanation description of the pool of qualified applicants
(HRM) all the activities observation and study, of of a specific job, usually qualifications necessary from which management
involved in determining pertinent information about including job title, tasks, for a specific job, in terms can select employees
an organization’s human a job—including specific relationship with other of education, experience,
resources needs, as well tasks and necessary jobs, physical and mental and personal and physical
as acquiring, training, and abilities, knowledge, and skills required, duties, characteristics
compensating people to fill skills responsibilities, and
those needs working conditions
THE NATURE OF older workers and workers with disabilities. Human resources
managers must be aware of these changes and leverage them
HUMAN RESOURCES to increase the productivity of their employees. Every manager

practices some of the functions of human resources manage-
MANAGEMENT ment at all times.
Chapter 1 defined human resources as labor, the physical and

mental abilities that people use to produce goods and services.
Human resources management (HRM) refers to all the
PLANNING FOR HUMAN
activities involved in determining an organization’s human
resources needs, as well as acquiring, training, and compensating
RESOURCES NEEDS
When planning and developing strategies for reaching the
people to fill those needs. Human resources managers are con- organization’s overall objectives, a company must consider
cerned with maximizing the satisfaction of employees and moti- whether it will have the human resources necessary to carry
vating them to meet organizational objectives productively. In out its plans. After determining how many employees and
some companies, this function is called personnel management. what skills are needed to satisfy the overall plans, the human
HRM has increased in importance over the last few decades, in resources department (which may range from the owner in a
part because managers have developed a better understanding small business to hundreds of people in a large corporation)
of human relations through the work of Maslow, Herzberg, and ascertains how many employees the company currently has and
others. Moreover, the human resources themselves are chang- how many will be retiring or otherwise leaving the organization
ing. Employees today are concerned not only about how much a during the planning period. With this information, the human
job pays; they are concerned also with job satisfaction, personal resources manager can then forecast how many more employ-
performance, recreation, benefits, the work environment, and ees the company will need to hire and what qualifications they
their opportunities for advancement. Once dominated by white must have, or determine if layoffs are required to meet demand
men, today’s workforce includes significantly more women, more efficiently. HRM planning also requires forecasting the
African Americans, Hispanics, and other minorities, as well as availability of people in the workforce who will have the neces-
sary qualifications to meet the organization’s future needs. The
human resources manager then develops a strategy for satisfy-
ing the organization’s human resources needs. As organizations
strive to increase efficiency through outsourcing, automation,
or learning to effectively use temporary workers, hiring needs
can change dramatically.
Next, managers analyze the jobs within the organization so that
they can match the human resources to the available assign-
ments. Job analysis determines, through observation and
study, pertinent information about a job—the specific tasks
that comprise it; the knowledge, skills, and abilities necessary to
perform it; and the environment in which it will be performed.
Managers use the information obtained through a job analysis
to develop job descriptions and job specifications.
A job description is a formal, written explanation of a spe-
cific job that usually includes job title, tasks to be performed
(for instance, waiting on customers), relationship with other
jobs, physical and mental skills required (such as lifting heavy
boxes or calculating data), duties, responsibilities, and working
Today’s organizations are more diverse, with a greater range of women, conditions. A job specification describes the qualifications
minorities, and older workers. necessary for a specific job, in terms of education (some jobs

TheLadders.com is a website that targets job seekers looking for jobs with an annual pay of $100,000 or more.
require a college degree), experience, personal characteristics Recruiting

(ads frequently request outgoing, hardworking persons), and
Recruiting means forming a pool of qualified applicants
physical characteristics. Both the job description and job speci-
from which management can select employees. There are two
fication are used to develop recruiting materials such as news-
sources from which to develop this pool of applicants—internal
papers, trade publications, and online advertisements.
and external.
Internal sources of applicants include the organization’s current
RECRUITING AND employees. Many firms have a policy of giving first consider-
ation to their own employees—or promoting from within. The
SELECTING NEW cost of hiring current employees to fill job openings is inex-
pensive when compared with the cost of hiring from external
EMPLOYEES sources, and it is good for employee morale. However, hiring
from within creates another job vacancy to be filled.
After forecasting the firm’s human resources needs and com-
paring them to existing human resources, the human resources External sources consist of advertisements in newspapers and
manager should have a general idea of how many new employ- professional journals, employment agencies, colleges, vocational
ees the firm needs to hire. With the aid of job analyses, manage- schools, recommendations from current employees, competing
ment can then recruit and select employees who are qualified to firms, unsolicited applications, and online services. Internships
fill specific job openings. are also a good way to solicit for potential employees. Many

ABILITY AND PERFORMANCE TESTS ARE USED TO
DETERMINE WHETHER AN APPLICANT HAS THE SKILLS
NECESSARY FOR THE JOB.
companies hire college students or recent graduates to low- post job openings and job seekers can post their résumés, includ-
paying internships that give them the opportunity to get hands- ing Monster.com and CareerBuilder.com. TheLadders.com
on experience on the job. If the intern proves to be a good fit, is a website that focuses on jobs starting at $100,000 a year. It
an organization may then hire the intern as a full-time worker. seeks higher educated and more experienced individuals for
Figure 10.1 illustrates some of the top benefits of becoming an high-paying positions. Employers looking for employees for
intern. There are also hundreds of websites where employers can specialized jobs can use more focused sites such as comput-
erwork.com. Increasingly, companies can turn
to their own websites for potential candidates:
FIGURE 10.1 Nearly all of the Fortune 500 firms provide career
Benefits of an Internship websites where they recruit, provide employment
information, and take applications. Employers can
also use social networking sites such as LinkedIn
Making industry contacts
to post jobs and search for candidates. Figure 10.2
12%
indicates that many consumers believe social net-
working sites may eventually supplant traditional
Acquiring technical skills 22% résumés. Using external sources of applicants is
generally more expensive than hiring from within,
Improving soft skills like presentation skills 24% but it may be necessary if there are no current
employees who meet the job specifications or there
Experiencing different work environments 31% are better-qualified people outside of the organi-
zation. Recruiting for entry-level managerial and
professional positions is often carried out on col-
0 5 10 15 20 25 30 35
lege and university campuses. For managerial or
Percent professional positions above the entry level, com-
panies sometimes depend on employment agen-
Source: Creative Group Survey of 125 Advertising Executives and 125 Senior Marketing
Executives, “‘What I did this summer . . . ’,” April 15, 2009, http://creativegroup.mediaroom.com/ cies or executive search firms, sometimes called
index.php?s=43&item=91 (accessed October 11, 2011). headhunters, which specialize in luring qualified
people away from other companies.
FIGURE 10.2 Selection
Will profiles on networking sites replace traditional résumés?
Selection is the process of collecting information about appli-
1% cants and using that information to decide which ones to hire.
It includes the application itself, as well as interviewing, test-
ing, and reference checking. This process can be quite lengthy
and expensive. Procter & Gamble, for example, offers online
applications for jobs in 80 countries. The first round of evalua-
tions involves assessment, and if this stage goes well, the candi-
No date interviews in the region or country to which the applicant
36%
Yes applied.1 Such rigorous scrutiny is necessary to find those appli-
63%
cants who can do the work expected and fit into the firm’s struc-
Don’t Know
ture and culture. If an organization finds the “right” employees
through its recruiting and selection process, it will not have to
spend as much money later in recruiting, selecting, and training
replacement employees.
The Application In the first stage of the selection process,

the individual fills out an application form and perhaps has a
Source: OfficeTeam survey of 500 human resources managers. Reprinted in brief interview. The application form asks for the applicant’s
USA Today, March 16, 2011. name, address, telephone number, education, and previous work

selection the process
of collecting information
about applicants and using
experience. The goal of this stage of the selection process is to personality tests may be used to that information to make
get acquainted with the applicants and to weed out those who assess an applicant’s potential for a hiring decisions
are obviously not qualified for the job. For employees with work certain kind of work and his or her
experience, most companies ask for the following information ability to fit into the organization’s
before contacting a potential candidate: current salary, reason for culture. One of the most commonly used tests is the Myers-
seeking a new job, years of experience, availability, and level of Briggs Type Indicator. Myers-Briggs Type Indicator Test is used
interest in the position. In addition to identifying obvious quali-
fications, the application can provide subtle clues about whether
T A B L E 1 0 . 1 Interviewing Tips
a person is appropriate for a particular job. For instance, an appli-
cant who gives unusually creative answers may be perfect for a 1. Evaluate the work environment. Do employees seem to get
position at an advertising agency; a person who turns in a sloppy, along and work well in teams?
hurriedly scrawled application probably would not be appropri- 2. Evaluate the attitude of employees. Are employees happy,
ate for a technical job requiring precise adjustments. Many com- tense, or overworked?
panies now accept online applications. The online application for 3. Are employees enthusiastic and excited about their work?
Target is designed not only to collect biographical data on the 4. What is the organizational culture, and would you feel
applicant, but also to create a picture of the applicant and how comfortable working there?
that person might contribute to the company. The completion of
Source: Adapted from “What to Look for During Office Visits,” http://
the survey takes about 45 minutes, depending on the position.
careercenter.tamu.edu/guides/interviews/lookforinoffice.cfm?sn5parents
To get a better view of the fit between the applicant and the com- (accessed April 13, 2011).
pany, the online application contains a questionnaire that asks
applicants more specific questions, from how they might react
in a certain situation to personality attributes like self-esteem or T A B L E 1 0 . 2 Most Common Questions Asked during the
Interview
ability to interact with people.
1. Tell me about yourself.
The Interview The next phase of the selection process involves
2. Why should I hire you?
interviewing applicants. Table 10.1 provides some insights on
finding the right work environment. Interviews allow manage- 3. Please tell me about your future objectives.
ment to obtain detailed information about the applicant’s expe- 4. Has your education prepared you for your career?
rience and skills, reasons for changing jobs, attitudes toward the 5. Have you been a team player?
job, and an idea of whether the person would fit in with the com- 6. Did you encounter any conflict with your previous professors
pany. Table 10.2 lists some of the most common questions asked or employer? What are the steps that you have taken to
by interviewers, while Table 10.3 reveals some common mistakes resolve this issue?
candidates make in interviewing. Furthermore, the interviewer 7. What is your biggest weakness?
can answer the applicant’s questions about the requirements for
8. How would your professors describe you?
the job, compensation, working conditions, company policies,
organizational culture, and so on. A potential employee’s ques- 9. What are the qualities that a manager should possess?
tions may be just as revealing as his or her answers. 10. If you could turn back time, what would you change?
Source: “Job Interview Skills Training: Top Ten Interview Questions for
Testing Another step in the selection process is testing. Abil- College Graduates,” February 17, 2010, www.articlesbase.com/business-
ity and performance tests are used to determine whether an articles/job-interview-skills-training-top-ten-interview-questions-for-college-
applicant has the skills necessary for the job. Aptitude, IQ, or graduates-1871741.html (accessed April 13, 2011).
BURGERVILLE: Propstra, there are currently 39 locations issue, and Burgerville responded. Today, the
found throughout Washington and Oregon. company sees less turnover and higher pro-
FAST FOOD THAT The company is dedicated to fresh, local, ductivity. Burgerville has received the Com-
EMPLOYEES CAN and sustainable concepts, so much so that Psych Corporation “Health at Work Award”
it began offering compostable cups, straws, Silver Award for committing to affordable
LOVE and lids. However, what really makes this health care and the YMCA “Spirit of Health
chain unique is its employee health care Award” for employee health care benefits
I f you’re looking for a unique spin on fast

food and a business committed to cor-
porate social responsibility, check out
plan. Burgerville pays 90 percent of premi-
ums for employees working at least 20 hours
and its commitment to sustainable business
practices. The company motto is “serve with
weekly—a rarity in fast food. An employee love,” and this is certainly easier to do when
Burgerville. Founded in 1961 by George survey revealed health care as a primary your company loves you back!2

T A B L E 1 0 . 3 Mistakes Made in Interviewing
1. Not taking the interview seriously.

2. Not dressing appropriately (dressing down).
3. Not appropriately discussing experience, abilities, and education.
4. Being too modest about your accomplishments.
5. Talking too much.
6. Too much concern about compensation.
7. Speaking negatively of a former employer.
8. Not asking enough or appropriate questions.
9. Not showing the proper enthusiasm level.
10. Not engaging in appropriate follow-up to the interview.
Source: “Avoid the Top 10 Job Interview Mistakes,” All Business,
www.allbusiness.com/human-resources/careers-job-interview/1611-1.html
(April 13, 2011).
worldwide by millions of people each year. Although polygraph

(“lie detector”) tests were once a common technique for evaluat-
ing the honesty of applicants, in 1988 their use was restricted to
specific government jobs and those involving security or access
to drugs. Applicants may also undergo physical examinations
to determine their suitability for some jobs, and many compa-
nies require applicants to be screened for illegal drug use. Illegal
Some jobs require potential hires to undergo physical examinations
drug use and alcoholism can be particularly damaging to busi-
such as drug tests.
nesses. There are more than 11 million heavy drinkers and 16
million illegal drug users in the United States. Of this group, 75
percent are employed full time and around half work for small
businesses. On average in small businesses, 1 out of 10 employ-
ees are either alcohol or drug abusers. Small businesses may
have a higher percentage of these employees because they do not
engage in systematic drug testing. If you employ a drug or alco-
hol abuser, you can expect a 33 percent loss in productivity from
this employee, which costs employers roughly $7,000 annually.
Overall, substance abuse costs American employers $160 billion
each year through high employee turnover and absenteeism,
workplace accidents, higher workers’ compensation costs, higher
medical costs, and workplace theft and violence.3
Because computer knowledge is a requirement for many jobs
today, certain companies also require an applicant to take a
typing test or tests to determine their knowledge of MS Word,
Excel, PowerPoint, and/or other necessary programs. Like the
application form and the interview, testing serves to eliminate
those who do not meet the job specifications.
Reference Checking Before making a job offer, the com-

pany should always check an applicant’s references. Reference
checking usually involves verifying educational background
and previous work experience. Background checking is impor-
tant because applicants may misrepresent themselves on their
applications or résumés. The star of Dinner: Impossible on the
Food Network fabricated portions of his résumé, including
Background checks are important for detecting past misconduct or the claim that he cooked for Britain’s royal family. The Food
criminal activities committed by job applicants. Network, upon learning of these errors, did not renew Robert

Title VII of the Civil
Rights Act prohibits
discrimination in
T A B L E 1 0 . 4 Top 10 Résumé Lies charges made up 36 percent of the
employment and created
total, while sexual discrimination the Equal Employment
1. Stretching dates of employment 6
charges consisted of 29 percent. Opportunity Commission
2. Inflating past accomplishments and skills The Civil Rights Act of 1964 also
3. Enhancing job titles and responsibilities outlaws the use of discrimina-
4. Education exaggeration and fabricating degrees tory tests for applicants. Aptitude tests and other indirect tests
must be validated; in other words, employers must be able to
5. Unexplained gaps and periods of “self employment”
demonstrate that scores on such tests are related to job perfor-
6. Omitting past employment mance, so that no one race has an advantage in taking the tests
7. Faking credentials or is alternatively discriminated against. Although many hope
8. Fabricating reasons for leaving previous job for improvements in organizational diversity, in a survey of 357
9. Providing fraudulent references global senior executives, 76 percent have one or no minorities
among their top executives. Minorities make up 17 percent of
10. Misrepresenting military record
the U.S. workforce, and that number should hit 20 percent by
Source: Christopher T. Marquet and Lisa J. B. Peterson, “Résumé Fraud: The 2016. In spite of a lack of diversity, many of these companies
Top 10 Lies,” www.marquetinternational.com/pdf/Resume%20Fraud-Top%20 indicate an initiative to support workplace diversity.7
Ten%20Lies.pdf (accessed April 13, 2011).
Other laws affecting HRM include the Americans with Disabili-
ties Act (ADA), which prevents discrimination against persons
Irvine’s contract, indicating that viewers place trust in the net-
with disabilities. It also classifies people with AIDS as disabled
work and the accuracy of information that it provides and that
and, consequently, prohibits using a positive AIDS test as rea-
Irvine “challenged that trust.”4 Irvine had to work for months
son to deny an applicant employment. The Age Discrimination
to apologize and set the record straight about his chef creden-
in Employment Act specifically outlaws discrimination based
tials. Food Network ultimately did rehire him to host Dinner:
on age. Its focus is banning hiring practices that discriminate
Impossible. As Table 10.4 illustrates, some of the most common
against people between the ages of 40 and 69, but it also out-
types of résumé lies include the faking of credentials, overstate-
laws policies that require employees to retire before the age of
ments of skills or accomplishments, lies concerning education/
70. Generally, when companies need employees, recruiters head
degrees, omissions of past employment, and the falsification
to college campuses, and when downsizing is necessary, many
of references.5 Reference checking is a vital, albeit often over-
older workers are offered early retirement. For instance, roughly
looked, stage in the selection process. Managers charged with
9 percent of retirees said they were forced to retire.8 However,
hiring should be aware, however, that many organizations will
the last few years have seen a new trend of older people work-
confirm only that an applicant is a former employee, perhaps
ing more. Approximately 28 million people 55 or older held jobs
with beginning and ending work dates, and will not release
in 2010, the highest level yet for this age range. Conversely, the
details about the quality of the employee’s work.
number of people in the workforce between the ages of 16 and
Legal Issues in Recruiting 24 hit its lowest level during the same period.9 Figure 10.3 shows
the changes within these two age groups. Indeed there are many
and Selecting benefits that companies are realizing in hiring older workers.
Legal constraints and regulations are present in almost every Some of these benefits include the fact that they are more dedi-
phase of the recruitment and selection process, and a violation cated, punctual, honest, and detail-oriented; are good listeners;
of these regulations can result in lawsuits and fines. Therefore, take pride in their work; exhibit good organizational skills; are
managers should be aware of these restrictions to avoid legal efficient and confident; are mature; can be seen as role models;
problems. Some of the laws affecting human resources man- have good communication skills; and offer an opportunity for a
agement are discussed below. reduced labor cost because of already having insurance plans.10
Because one law pervades all areas of human resources manage- The Equal Pay Act mandates that men and women who do equal
ment, we’ll take a quick look at it now. Title VII of the Civil work must receive the same wage. Wage differences are accept-
Rights Act of 1964 prohibits discrimination in employment. It able only if they are attributed to seniority, performance, or
also created the Equal Employment Opportunity Commission qualifications. In the United States, the typical full-time female
(EEOC), a federal agency dedicated to increasing job opportu- employee earns 19 percent less than the average full-time male
nities for women and minorities and eliminating job discrimi- employee. In a study by PayScale, some of the biggest gender pay
nation based on race, religion, color, sex, national origin, or gaps can be found in positions such as chief executive (women
disability. As a result of Title VII, employers must not impose earn 71 percent of what men earn), hospital administrator
sex distinctions in job specifications, job descriptions, or news- (women earn 77 percent of what men earn), and chief operating
paper advertisements. In 2010 workplace discrimination charges officer (women earn 80 percent of what men earn). Performance
filed with the EEOC totaled 99,922. Monetary compensation for quality in these jobs is relatively subjective. Jobs like engineers,
victims reached more than $404 million. Race discrimination actuaries, or electricians, where the performance evaluation is

FIGURE 10.3 FIGURE 10.4
U.S. Population Employed within Two Age Groups (in Thousands) Women Leaders at Fortune 500 Companies
30,000 16%
14%
25,000
12%
20,000
10%
15,000 8%
6%
10,000
4%
5,000 2%
0%
0 F500 F500 F500 F500
16–24 55+ CEOs CFOs board executive
2007 2010 sets officers
Source: U.S. Department of Labor, Bureau of Labor Statistics, labor force Sources: “U.S. Women in Business,” Catalyst, December 2010, www.
statistics from the Current Population Survey, http://data.bls.gov:8080/PDQ/ catalyst.org/publication/132/us-women-in-business; Alix Stuart, “Women
outside.jsp?survey5ln (accessed January 31, 2011). CFOs Holding Steady,” July 14, 2010, www.cfo.com/article.cfm/14510069/
c_14511151?f5home_todayinfinance; “Women CEOs,” CNNMoney.com, http://
money.cnn.com/magazines/fortune/fortune500/2010/womenceos/ (accessed
January 13, 2011).
more objective, result in greater salary parity between men and so they can begin to be productive members of the workforce.
women.11 However, despite the wage inequalities that still exist, Orientation familiarizes the newly hired employees with fel-
women in the workplace are becoming increasingly accepted low workers, company procedures, and the physical properties
among both genders. The working mother is no longer a nov- of the company. It generally includes a tour of the building;
elty; in fact, many working mothers seek the same amount of introductions to supervisors, co-workers, and subordinates;
achievement as working men and women who are not mothers. and the distribution of organizational manuals describing the
One survey revealed that 69 percent of young working mothers organization’s policy on vacations, absenteeism, lunch breaks,
reported that they want to move up in their careers compared company benefits, and so on. Orientation also involves social-
to 48 percent in 2002. Also, more and more men believe that izing the new employee into the ethics and culture of the new
a woman can be a good mother and still maintain a successful company. Many larger companies now show videotapes of pro-
career. About 67 percent of the male respondents believe that cedures, facilities, and key personnel in the organization to help
working women can still be good mothers compared to 49 per- speed the adjustment process.
cent in 1977. Figure 10.4 shows the percentage of women who
hold some of the country’s top leadership positions.12 Training and Development
Although recruiting and selection are designed to find employees
who have the knowledge, skills, and abilities the company needs,
DEVELOPING THE new employees still must undergo training to learn how to do
their specific job tasks. On-the-job training allows workers to learn
WORKFORCE by actually performing the tasks of the job, while classroom train-
Once the most qualified applicants have been selected, have ing teaches employees with lectures, conferences, videotapes,
been offered positions, and have accepted their offers, they case studies, and Web-based training. For instance, McDonald’s
must be formally introduced to the organization and trained trains those interested in company operations and leadership

orientation
familiarizing newly hired
employees with fellow
development at the Fred L. Turner Training Center, otherwise he typically produces in one day workers, company
known as Hamburger University. Hamburger University employs or by how many of his boards have procedures, and the physical
full-time professors to train students in a variety of topics, includ- defects. A Century 21 real estate properties of the company
ing crew development, restaurant management, middle manage- agent might be judged by the num-
ment, and executive development. Training includes classroom ber of houses she has shown or the training teaching
instruction, hands-on instruction, and computer e-learning, with number of sales she has closed. employees to do specific
instruction available in 28 different languages.13 Development is A company can also use tests as job tasks through either
training that augments the skills and knowledge of managers and an objective method of assess- classroom development or
professionals. Training and development are also used to improve ment. Whatever method they use, on-the-job experience
the skills of employees in their present positions and to prepare managers must take into account development training
them for increased responsibility and job promotions. Training the work environment when they that augments the
is therefore a vital function of human resources management. appraise performance objectively. skills and knowledge of
Companies are engaging in more experiential and involvement- managers and professionals
oriented training exercises for employees. Use of role-plays, simu- When jobs do not lend themselves
lations, and online training methods are becoming increasingly to objective appraisal, the manager
popular in employee training. must relate the employee’s performance to some other standard.
One popular tool used in subjective assessment is the ranking
Assessing Performance system, which lists various performance factors on which the
manager ranks employees against each other. Although used
Assessing an employee’s performance—his or her strengths
by many large companies, ranking systems are unpopular with
and weaknesses on the job—is one of the most difficult tasks for
many employees. Qualitative criteria, such as teamwork and
managers. However, performance appraisal is crucial because it
communication skills, used to evaluate employees are generally
gives employees feedback on how they are doing and what they
hard to gauge. Such grading systems have triggered employee
need to do to improve. It also provides a basis for determin-
lawsuits that allege discrimination in grade/ranking assignments.
ing how to compensate and reward employees, and it generates
For example, one manager may grade a company’s employees
information about the quality of the firm’s selection, training,
one way, while another manager grades a group more harshly
and development activities. Table 10.5 identifies 16 characteris-
depending on the managers’ grading style. If layoffs occur, then
tics that may be assessed in a performance review.
employees graded by the second manager may be more likely
Performance appraisals may be objective or subjective. An to lose their jobs. Other criticisms of grading systems include
objective assessment is quantifiable. For example, a Westing- unclear wording or inappropriate words that a manager may
house employee might be judged by how many circuit boards unintentionally write in a performance evaluation, like young or
T A B L E 1 0 . 5 Performance Characteristics
• Productivity—rate at which work is regularly produced

• Quality—accuracy, professionalism, and deliverability of produced work
• Job knowledge—understanding of the objectives, practices, and standards of work
• Problem solving—ability to identify and correct problems effectively
• Communication—effectiveness in written and verbal exchanges
• Initiative—willingness to identify and address opportunities for improvement
• Adaptability—ability to become comfortable with change
• Planning and organization skills—reflected through the ability to schedule projects, set goals, and maintain organizational systems
• Teamwork and cooperation—effectiveness of collaborations with co-workers
• Judgment—ability to determine appropriate actions in a timely manner
• Dependability—responsiveness, reliability, and conscientiousness demonstrated on the job
• Creativity—extent to which resourceful ideas, solutions, and methods for task completion are proposed
• Sales—demonstrated through success in selling products, services, yourself, and your company
• Customer service—ability to communicate effectively with customers, address problems, and offer solutions that meet or exceed their
expectations
• Leadership—tendency and ability to serve as a doer, guide, decision maker, and role model
• Financial management—appropriateness of cost controls and financial planning within the scope defined by the position
Source: “Performance Characteristics,” Performance Review from www.salary.com/Careerresources/docs/related_performance_review_part2_popup.html
(accessed June 12, 2001). Used with permission.

For multinational corporations such as McDonald’s, employee training and performance assessments might need to be slightly adapted for different cultures.
pretty to describe an employee’s appearance. These liabilities can from a panel that typically includes superiors, peers, and sub-
all be fodder for lawsuits should employees allege that they were ordinates. Because of the tensions it may cause, peer appraisal
treated unfairly. It is therefore crucial that managers use clear appears to be difficult for many. However, companies that have
language in performance evaluations and be consistent with all success with 360-degree feedback tend to be open to learning
employees. Several employee grading computer packages have and willing to experiment and are led by executives who are
been developed to make performance evaluations easier for direct about the expected benefits as well as the challenges.15
managers and clearer for employees.14 Managers and leaders with a high emotional intelligence (sensi-
tivity to their own as well as others’ emotions) assess and reflect
Another performance appraisal method used by many compa-
upon their interactions with colleagues on a daily basis. In addi-
nies is the 360-degree feedback system, which provides feedback
tion, they conduct follow-up analysis on their projects, asking
the right questions and listening carefully to responses without
getting defensive of their actions.16
Whether the assessment is objective or subjective, it is vital that
the manager discuss the results with the employee, so that the
employee knows how well he or she is doing the job. The results
of a performance appraisal become useful only when they are
communicated, tactfully, to the employee and presented as a
tool to allow the employee to grow and improve in his or her
position and beyond. Performance appraisals are also used to
determine whether an employee should be promoted, trans-
ferred, or terminated from the organization.
Turnover
Turnover, which occurs when employees quit or are fired and
must be replaced by new employees, results in lost productiv-
ity from the vacancy, costs to recruit replacement employees,
and management time devoted to interviewing, training, and
socialization expenses for new employees. Clarkston Consult-
Some companies are choosing to incorporate training opportunities into ing in Durham, North Carolina, was going through a phase
virtual worlds such as Second Life. where employees were dissatisfied. They were working more

turnover occurs when
employees quit or are fired
and must be replaced by
than the industry norm of 56 hours per week (not including should be carefully explained to all new employees
travel), and turnover was increasing. The company engaged in employees and should be set forth
intense training to improve skills and understand competitive in employee handbooks. Table 10.6 promotion an
and best practices, and it introduced a truncated travel sched- illustrates what not to do when you advancement to a higher-
ule. The travel program allowed employees to leave home on are terminated. level job with increased
Monday, stay in a hotel and work at the client’s site for four days, authority, responsibility,
Many companies have downsized and pay
and return to work at home on Friday. Removing large amounts
in recent years, laying off tens of
of travel from evenings and weekends significantly improved
thousands of employees in their transfer a move to
morale, productivity, and satisfaction.17 Part of the reason for
effort to become more productive another job within the
turnover may be overworked employees as a result of downsiz- company at essentially the
and competitive. Chrysler under-
ing and a lack of training and advancement opportunities.18 Of same level and wage
went a restructuring plan that
course, turnover is not always an unhappy occasion when its
cut 3,000 jobs and three models,
takes the form of a promotion or transfer. separations
including the PT Cruiser, Dodge
employment changes
A promotion is an advancement to a higher-level job with Durango, and Chrysler Aspen. involving resignation,
increased authority, responsibility, and pay. In some companies The company also rejected hun- retirement, termination,
and most labor unions, seniority—the length of time a person dreds of car dealership agreements, or layoff
has been with the company or at a particular job classification— resulting in significant job losses.19
The results of a performance appraisal become useful only

when they are communicated, tactfully, to the employee and
presented as a tool to allow the employee to grow and improve
in his or her position and beyond.
is the key issue in determining who should be promoted. Most Layoffs are sometimes temporary; employees may be brought
managers base promotions on seniority only when they have back when business conditions improve. For instance, after the
candidates with equal qualifications: Managers prefer to base most recent recession Chrysler began to rehire some of the
promotions on merit. workers it had been forced to lay off.20 When layoffs are to be
A transfer is a move to another job within the company at permanent, employers often help employees find other jobs and
essentially the same level and wage. Transfers allow workers to may extend benefits while the employees search for new employ-
obtain new skills or to find a new position within an organi- ment. Such actions help lessen the trauma of the layoffs. Fortu-
zation when their old position has been eliminated because of nately, there are several business areas that are choosing not to
automation or downsizing. downsize. Table 10.7 shows some industries that are planning to
hire in the near future.
Separations occur when employees resign, retire, are termi-
nated, or are laid off. Employees may be terminated, or fired,
for poor performance, violation of work rules, absenteeism, and T A B L E 1 0 . 6 What You Should Not Do When You Are
so on. Businesses have traditionally been able to fire employees Terminated
at will, that is, for any reason other than for race, religion, sex,
1. Do not tell off your boss and co-workers, even if you think they
or age, or because an employee is a union organizer. However, deserve it.
recent legislation and court decisions now require that compa-
2. Do not damage company property or steal something.
nies fire employees fairly, for just cause only. Managers must
take care, then, to warn employees when their performance is 3. Do not forget to ask for a reference.
unacceptable and may lead to dismissal, elevating the impor- 4. Do not badmouth your employer or any of your co-workers to
tance of performance evaluations. They should also document your replacement.
all problems and warnings in employees’ work records. To 5. Do not badmouth your employer to a prospective employer
avoid the possibility of lawsuits from individuals who may feel when you go on a job interview.
they have been fired unfairly, employers should provide clear, Source: Dawn Rosenberg McKay, “Five Things Not to Do When You Leave
business-related reasons for any firing, supported by written Your Job,” http://careerplanning.about.com/od/jobseparation/a/leave_
documentation if possible. Employee disciplinary procedures mistakes.htm (accessed April 13, 2011).

wage/salary survey wages financial rewards commission an
a study that tells a company based on the number of incentive system that
how much compensation hours the employee works pays a fixed amount
that a high turnover rate in a company may
comparable firms are or the level of output or a percentage of the
signal problems either with the selection and
paying for specific jobs that achieved employee’s sales
the firms have in common training process, the compensation program,
or even the type of company. To help reduce
turnover, companies have tried a number of
strategies, including giving employees more
A well-organized human resources department strives to interesting job responsibilities (job enrichment), allowing
minimize losses due to separations and transfers because for increased job flexibility, and providing more employee
recruiting and training new employees is very expensive. Note benefits.
T A B L E 1 0 . 7 Job Areas for Which Employers Plan to Hire Recent Graduates
All Job Areas Entry Level Middle Level Senior Level Executive Level Total
Accounting 24% 64% 65% 22% 15% 100%

Consulting 27 51 72 20 12 100
Business development 31 47 73 28 16 100
Investment banking 16 57 66 22 15 100
Finance other than investment banking 42 55 71 20 11 100
General management 29 48 72 32 19 100
HR or organization management 17 58 71 29 19 100
Information technology or MIS 15 61 75 26 17 100
Marketing or sales 45 50 70 22 11 100
Operations and logistics 25 53 73 27 13 100
Other job areas 17 56 69 25 13 100
Source: “Corporate Recruiters Survey: 2010 General Data Report,” Graduate Management Admission Council®, www.gmac.com/NR/rdonlyres/8C83F765-646D-44AC-
AF8C-D76687593C7B/0/2010CRS_GeneralDataReport.pdf (accessed January 13, 2011).
KING ARTHUR bakeries and grocery stores, runs a retail improved environmental and economic per-
store in Vermont, and excels in public rela- formance) and Green Up Day, and it is a
FLOUR: AN tions and marketing. Employees throughout certified Founding B Corporation (meaning
EMPLOYEE-CENTERED the business are honored as valuable mem- it has met rigorous social and environmen-
bers of a team. All employees are offered tal performance standards).
CORPORATE training and development opportunities Overall, King Arthur appears to be a fun
CULTURE such as baking/cooking workshops, along place to work—where those who love cook-
with free products and store discounts. ing, baking, and sustainability can come
The company has won awards based on together in partnership to run their own
Y ou might think flour is boring, but at King
Arthur Flour employees love the stuff!
The company was founded in 1790—the year
its structure: number six on Best Places
to Work in Vermont and part of The Wall
company.21
after George Washington was elected presi- Street Journal’s Top Small Workplaces. Discussion Questions
dent. It has grown slowly from five employees Employees at King Arthur are also dedi- 1. King Arthur Flour is 100 percent employee
in 1990 to over 160 today. What makes these cated to sustainability and the environment. owned. How does this change how the
employees so passionate about flour? They The company advocates sustainable liv- business operates, and how is it run ver-
own the business. Although King Arthur Flour ing by recycling, composting, decreasing sus other organizational models?
operated as a family-owned business for five energy consumption, and reducing its use 2. What are some of the perks of working at
decades, it is now 100 percent employee of toxic products. King Arthur does not use King Arthur Flour?
owned. Therefore, employees control their chemical additives in its flour, nor does it
3. Why is King Arthur Flour such a great
fate and have a true stake in their flour. use genetically modified wheat. The com-
place to work? Would you like to work
In 1990 King Arthur was essentially pany is a member of the Vermont Busi-
there?
a mail-order business. Today it sells to ness Environmental Partnership (promoting

per hour in 2009 for covered nonexempt workers.22 Many states
also mandate minimum wages; in the case where the two wages
are in conflict, the higher of the two wages prevails. There may
even be differences between city and state minimum wages. In
New Mexico, the minimum wage is $7.50, whereas in the state
capital of Santa Fe, the minimum wage is $9.85, due to a higher
cost of living.23 Table 10.8 compares wage and other informa-
tion for Costco and Walmart, two well-known discount chains.
Time wages are appropriate when employees are continually
interrupted and when quality is more important than quantity.
Assembly-line workers, clerks, and maintenance personnel are
commonly paid on a time-wage basis. The advantage of time
wages is the ease of computation. The disadvantage is that time
wages provide no incentive to increase productivity. In fact, time
wages may encourage employees to be less productive.
To overcome these disadvantages, many companies pay on

an incentive system, using piece wages or commissions. Piece
wages are based on the level of output achieved. A major
COMPENSATING THE advantage of piece wages is that they motivate employees to
supervise their own activities and to increase output. Skilled
WORKFORCE craftworkers are often paid on a piece-wage basis.
People generally don’t work for free, and how much they are
paid for their work is a complicated issue. Also, designing a The other incentive system, commission, pays a fixed amount
fair compensation plan is an important task because pay and or a percentage of the employee’s sales. Kele & Co Jewelers in
benefits represent a substantial portion of an organization’s Plainfield, Illinois, makes sterling silver jewelry and offers semi-
expenses. Wages that are too high may result in the company’s precious stones and gemstones at affordable prices. Its hand-
products being priced too high, making them uncompetitive crafted jewelry is sold through the Internet (www.keleonline.
in the market. Wages that are too low may damage employee com) and through independent sales representatives (ISRs) all
morale and result in costly turnover. Remember that compen- over the country. The unique aspect of Kele’s sales process is
sation is one of the hygiene factors identified by Herzberg. its innovative sales and commission structure. ISRs have no
minimum sales quotas, sales are shared among team mem-
Designing a fair compensation plan is a difficult task because bers during training and after being promoted, and there is no
it involves evaluating the relative worth of all jobs within the requirement to purchase inventory as jewelry is shipped from
business while allowing for individual efforts. Compensation Kele headquarters. ISRs receive a 30 percent commission on
for a specific job is typically determined through a wage/ sales. Kele also pays for the design, development, and main-
salary survey, which tells the company how much compen- tenance of a website to support ISRs. The goal is to increase
sation comparable firms are paying for specific jobs that the the profit margin and earning potential of the salespeople. The
firms have in common. Compensation for individuals within company’s goal is to become the largest direct sales company
a specific job category depends on both the compensation for in the industry.24 This method motivates employees to sell as
that job and the individual’s produc-
tivity. Therefore, two employees with T A B L E 1 0 . 8 Costco versus Walmart
identical jobs may not receive exactly
Costco Walmart
the same pay because of individual
differences in performance. Number of employees 147,000 2,100,0001
Revenues $71.4 billion $405 billion
Financial Average hourly wage $19 $11.75 full time
Compensation World’s most admired ranking 21 9
Financial compensation falls into two
general categories—wages and salaries. Strengths Management quality; Management quality;
financial soundness; people financial soundness; global
Wages are financial rewards based management competitiveness
on the number of hours the employee
Sources: “Fortune Global 500,” CNN Money.com, http://money.cnn.com/magazines/fortune/global500/2010/
works or the level of output achieved.
full_list/; “World’s Most Admired Companies,” CNNMoney.com, http://money.cnn.com/magazines/fortune/
Wages based on the number of hours mostadmired/2010/full_list/; Edward Teach, “Because It’s the Right Thing to Do,” CFO Magazine, March 1, 2010,
worked are called time wages. The fed- www.cfo.com/article.cfm/14476783/1/c_14477052?f5insidecfo; “Walmart,” updated May 8, 2010, nyjobsource.
eral minimum wage increased to $7.25 com, http://nyjobsource.com/walmart.html (accessed January 14, 2011).

salary a financial reward bonuses monetary profit sharing a form benefits nonfinancial
calculated on a weekly, rewards offered by of compensation whereby forms of compensation
monthly, or annual basis companies for exceptional a percentage of company provided to employees, such
performance as incentives profits is distributed to the as pension plans, health
to further increase employees whose work insurance, paid vacation and
productivity helped generate them holidays, and the like
CHALLENGES OF will grow annually by roughly 350,000 for relaxed atmosphere than a normal work
the next few years. The situation has led environment; one of these “work spaces,”
WORKING AT HOME experts to recommend methods to help for instance, is located in a Victorian home
work-at-home employees. in Brooklyn. Other work-at-home entrepre-
W orking from home may sound like a

dream. Yet when that dream comes
true, employees find some downsides that
First, employees working at home
should have a clear work space, even if it is
only a desk on which work materials reside.
neurs opt to form weekly work gatherings,
where individuals can work on their laptops
while being able to socialize with others.
they did not expect. Perhaps the great- Maintaining a schedule of strict hours For many self-motivated individuals, the
est challenge is the balancing of work and devoted to work and then communicating rewards of working away from the office
home life. In a traditional job setting, work these hours to family and friends is impor- overcome the sacrifices.25
occurs in the office while leisure occurs at tant. Additionally, for some workers who
home. However, those who work at home crave socialization, working alone might
lack this clear boundary. Lack of office be difficult. However, thanks to technology,
space, family distractions, and sticking to employees can often work in social settings 1. Why is working at home a challenge to
set schedules are additional challenges like coffee shops or libraries. many employees?
work-at-home employees face. Those who can’t get past these chal- 2. How does one create a boundary between
These challenges are not going away lenges have pursued other creative alterna- work and home life when working at
anytime soon. According to Interactive tives. Some freelancers and entrepreneurs home?
Data Corporation, over 18.4 million U.S. have begun renting office space at work 3. Would you be more productive working
workers set up home-based businesses. areas designed to accommodate the self- at home or renting space at an out-of-
Interactive Data predicts this number employed. These spaces have a more home work area?
The most common counseling services offered include drug-

and alcohol-abuse treatment programs, fitness programs,
smoking cessation clinics, stress-management clinics, financial
counseling, family counseling, and career counseling.
much as they can. Some companies also combine payment incentive to continue working hard. Many owners and manag-
based on commission with time wages or salaries. ers are recognizing that simple bonuses and perks foster hap-
pier employees and reduce turnover.
A salary is a financial reward calculated on a weekly, monthly,
or annual basis. Salaries are associated with white-collar workers Another form of compensation is profit sharing, which dis-
such as office personnel, executives, and professional employ- tributes a percentage of company profits to the employees whose
ees. Although a salary provides a stable stream of income, work helped generate those profits. Some profit-sharing plans
salaried workers may be required to work beyond usual hours involve distributing shares of company stock to employees. Usu-
without additional financial compensation. ally referred to as ESOPs—employee stock ownership plans—
they have been gaining popularity in recent years. One reason for
In addition to the basic wages or salaries paid to employees, the popularity of ESOPs is the sense of partnership that they cre-
a company may offer bonuses for exceptional performance ate between the organization and employees. Profit sharing can
as an incentive to increase productivity further. Many work- also motivate employees to work hard, because increased produc-
ers receive a bonus as a “thank you” for good work and an tivity and sales mean that the profits or the stock dividends will

increase. Many organizations offer employees a T A B L E 1 0 . 9 Google’s Employee Benefits
stake in the company through stock purchase
• Health insurance:
plans, ESOPs, or stock investments through
401(k) plans. Employees below senior manage- – Employee medical insurance (spouse and domestic-partner insurance also
available)
ment levels rarely received stock options, until
recently. Companies are adopting broad-based – Dental insurance
stock option plans to build a stronger link – Vision insurance
between employees’ interests and the organiza- • Vacation (15 days per year for one–three years’ employment; 20 days off for four–five
tion’s interests. ESOPs have met with enormous years’ employment; 25 days for more than six years’ employment)
success over the years, and employee-owned • Twelve paid holidays/year
stock has even outperformed the stock market
• Savings plans
during certain periods. Many businesses have
found employee stock options a great way to – 401(k) retirement plan, matched by Google
boost productivity and increase morale. As a – Flexible spending accounts
result, approximately 12,000 companies have • Disability and life insurance
adopted ESOPs within the United States.26 • Employee Assistance Program
• Free lunches and snacks
Benefits • Massages, gym membership, hair stylist, fitness class, and bike repair
Benefits are nonfinancial forms of compen-
• Weekly activities
sation provided to employees, such as pen-
sion plans for retirement; health, disability, • Maternity leave
and life insurance; holidays and paid days off • Adoption assistance
for vacation or illness; credit union member- • Tuition reimbursement
ship; health programs; child care; elder care; • Employee referral plan
assistance with adoption; and more. Accord-
• On-site doctor
ing to the Bureau of Labor Statistics, employer
costs for employee compensation for civilian • Backup child care
workers in the United States average $27.42 • Holiday parties, health fair, credit union, roller hockey, outdoor volleyball court,
per hour worked. Wages and salaries account discounts for local attractions
for approximately 70.8 percent of those costs, Source: “Google Benefits,” www.google.com/intl/en/jobs/lifeatgoogle/benefits (accessed April 13,
while benefits account for 29.2 percent of the 2011).
cost. Legally required benefits (Social Secu-
rity, Medicare, federal and state employment
insurance, and workers’ compensation) account for 7.7 percent
of total compensation.27 Such benefits increase employee secu-
rity and, to a certain extent, their morale and motivation.
Table 10.9 lists some of the benefits Internet search engine
Google offers its employees. Although health insurance is a
common benefit for full-time employees, rising health care
costs have forced a growing number of employers to trim this
benefit. Even government workers, whose wages and benefits
used to be virtually guaranteed safe, have seen reductions in
health care and other benefits. For example, the City Council of
Pensacola, Florida, voted to sharply reduce city workers’ ben-
efits and wages in order to deal with a budget shortfall after the
most recent recession left the city struggling financially.28
A benefit increasingly offered is the employee assistance pro-
gram (EAP). Each company’s EAP is different, but most offer
counseling for and assistance with those employees’ per-
sonal problems that might hurt their job performance if not
addressed. The most common counseling services offered
include drug- and alcohol-abuse treatment programs, fit-
ness programs, smoking cessation clinics, stress-management Larger companies such as Google will sometimes offer onsite gyms or
clinics, financial counseling, family counseling, and career workout facilities as an employee benefit.

labor collective labor contract the
unions employee bargaining the formal, written document
organizations formed to negotiation process through that spells out the
deal with employers for
achieving better pay, hours,
which management and
unions reach an agreement
relationship between the
union and management for
MANAGING
and working conditions about compensation,
working hours, and
a specified period of time—
usually two or three years
UNIONIZED
working conditions for the
bargaining unit
EMPLOYEES
Employees who are dissatisfied with their
working conditions or compensation have to
counseling. EAPs help reduce costs associated with poor pro- negotiate with management to bring about
ductivity, absenteeism, and other workplace issues by help- change. Dealing with management on an individual basis is
ing employees deal with personal problems that contribute to not always effective, however, so employees may organize
these issues. For example, exercise and fitness programs reduce themselves into labor unions to deal with employers and to
health insurance costs by helping employees stay healthy. Fam- achieve better pay, hours, and working conditions. Organized
ily counseling may help workers trying to cope with a divorce employees are backed by the power of a large group that can
or other personal problems to better focus on their jobs. hire specialists to represent the entire union in its dealings with
management. Union workers make significantly more than
Companies try to provide the benefits they believe their employ- nonunion employees. The United States has a roughly 13.6
ees want, but diverse people may want different things. In recent percent unionization rate. Figure 10.5 displays unionization
years, some single workers have felt that co-workers with spouses rates by state. On average, unionized workers have 15 percent
and children seem to get “special breaks” and extra time off to higher hourly wages than nonunionized employees in similar
deal with family issues. Some companies use flexible benefit pro- positions.29
grams to allow employees to choose the benefits they would like,
up to a specified amount.
FIGURE 10.5
Fringe benefits include sick leave,
Union Membership Rates by State
vacation pay, pension plans, health
plans, and any other extra com- New England
Mountain West North Central East
pensation. Soft benefits include
Wash. North Central
perks that help balance life and Middle
Atlantic Maine
work. They include onsite child N.D.
Mont. Minn.
M. N.H.
care, spas, food service, and even Wts.
Ore. S.D. N.Y. Mass.
laundry services and hair salons.
Idaho. Mkh.
These soft benefits motivate Wyo. Pa. Conn. R.l.
Iowa.
employees and give them more Neb.
Ohio.
N.J.
Nev. II. Ind.
time to focus on their jobs.
Utah. Colo. Kan. Mo. W.Va. Md.
Cafeteria benefit plans provide a Calt. Ky. Ya.
financial amount to employees so
N.C.
that they can select the specific ben- Tenn.
Ariz. N.M. Okla. S.C.
efits that fit their needs. The key Ark. South
is making benefits flexible, rather Miss. Ala. Qa. Atlantic
than giving employees identical Texas La.
Pacific
benefits. As firms go global, the West
need for cafeteria or flexible benefit South Central Fla
East
plans becomes even more impor- South Central
tant. For some employees, benefits
are a greater motivator and differen-
Union Membership Rate
tiator in jobs than wages. For many (U.S. rate = 12.3%)
Starbucks employees who receive
Alaska 17.0% or more
health insurance when working
13.0%–16.9%
part time, this benefit could be the
most important compensation. 9.0%–12.9%
Hawaii
5.0%–8.9%
Over the last two decades, the list
of fringe benefits has grown dra- 4.9% or less
matically, and new benefits are
being added every year. Source: U.S. Department of Labor, Bureau of Labor Statistics, January 21, 2011.

However, union growth has slowed in recent years, and prospects Many labor contracts contain a cost-of-living escalator (or
for growth do not look good. One reason is that most blue-collar adjustment) (COLA) clause, which calls for automatic wage
workers, the traditional members of unions, have already been increases during periods of inflation to protect the “real”
organized. Factories have become more automated and need income of the employees. During tough economic times,
fewer blue-collar workers. The United States has shifted from a unions may be forced to accept givebacks—wage and benefit
manufacturing to a service economy, further reducing the demand concessions made to employers to allow them to remain com-
for blue-collar workers. Moreover, in response to foreign competitive or, in some cases, to survive and continue to provide
petition, U.S. companies are scrambling to find ways to become jobs for union workers.
more productive and cost efficient. Job enrichment programs and
participative management have blurred the line between manage-
ment and workers. Because workers’ say in the way plants are run
Resolving Disputes
Sometimes, management and labor simply cannot agree on a
is increasing, their need for union protection is decreasing.
contract. Most labor disputes are handled through collective
Nonetheless, labor unions have been successful in organizing bargaining or through grievance procedures. When these pro-
blue-collar manufacturing, government, and health care work- cesses break down, however, either side may resort to more
ers, as well as smaller percentages of employees in other indus- drastic measures to achieve its objectives.
tries. Consequently, significant aspects
of HRM, particularly compensation, are
dictated to a large degree by union con-
tracts at many companies. Therefore, FIGURE 10.6
The Collective Bargaining Process
we’ll take a brief look at collective bar-
gaining and dispute resolution in this
section. Union prepares list of Management prepares list of
demands and concessions: demands and concessions:
Collective Bargaining Pay raises Scheduling
Overtime rates Hiring and firing
Collective bargaining is the negotia- Benefits Pay cuts
tion process through which management Security Production standards
and unions reach an agreement about Seniority Discipline
compensation, working hours, and work-
ing conditions for the bargaining unit
(Figure 10.6). The objective of negotia-
tions is to reach agreement about a labor Negotiation teams establish
contract, the formal, written document rules and schedule meetings
that spells out the relationship between
the union and management for a speci-
fied period of time, usually two or three
Negotiation and compromise
years.
In collective bargaining, each side tries
to negotiate an agreement that meets its
demands; compromise is frequently nec-
essary. Management tries to negotiate a Ratification of contract Rejection of contract
labor contract that permits the company
to retain control over things like work
schedules; the hiring and firing of work-
ers; production standards; promotions,
transfers, and separations; the span of Union tactics:
management in each department; and Union represents Strikes Management tactics:
workers at Boycotts Lockouts
discipline. Unions tend to focus on con- that work facility Strikebreakers
Picketing
tract issues such as magnitude of wages;
better pay rates for overtime, holidays,
and undesirable shifts; scheduling of
pay increases; and benefits. These issues
will be spelled out in the labor contract,
which union members will vote to either Renegotiation of contract
accept (and abide by) or reject.

picketing a public protest strikes employee boycott an attempt to lockout management’s strikebreakers
against management practices walkouts; one of the most keep people from purchasing version of a strike, wherein people hired by management
that involves union members effective weapons of labor the products of a company a work site is closed so that to replace striking employees;
marching and carrying unions employees cannot go to work called “scabs” by striking
antimanagement signs at the union members
employer’s plant or work site
Labor Tactics Picketing is a public protest against man- employees cannot go to work. Lockouts are used, as a general
agement practices and involves union members marching (often rule, only when a union strike has partially shut down a plant
waving antimanagement signs and placards) at the employer’s and it seems less expensive for the plant to close completely.
plant or work site. Picketing workers hope that their signs will For instance, National Football League team owners locked out
arouse sympathy for their demands from the public and from players after a dispute over revenues and a failure to accept a
other unions. Picketing may occur as a protest or in conjunction new collective bargaining agreement. The lockout placed the
with a strike. 2011 NFL season in jeopardy as neither side seemed willing to
capitulate.31
Strikes (employee walkouts) are one of the most effective
weapons labor has. By striking, a union makes carrying out the Strikebreakers, called “scabs” by striking union members,
normal operations of a business difficult at best and impossible are people hired by management to replace striking employees.
at worst. Strikes receive widespread publicity, but they remain Managers hire strikebreakers to continue operations and reduce
a weapon of last resort. For example, after the French gov- the losses associated with strikes—and to show the unions that
ernment announced plans to overhaul pensions and raise the they will not bow to their demands. Strikebreaking is generally a
retirement age from 60 to 62, citizens engaged in a nationwide last-resort measure for management because it does great dam-
strike to protest the changes. The strikes shut down schools and age to the relationship between management and labor.
delayed rail and flight services.30 The threat of a strike is often
enough to get management to back down. In fact, the number Outside Resolution Management and union members
of worker-days actually lost to strikes is less than the amount normally reach mutually agreeable decisions without outside
lost to the common cold. assistance. Sometimes though, even after lengthy negotiations,
strikes, lockouts, and other tactics, management and labor still
A boycott is an attempt to keep people from purchasing the cannot resolve a contract dispute. In such cases, they have three
products of a company. In a boycott, union members are asked choices: conciliation, mediation, and arbitration. Conciliation
not to do business with the boycotted organization. Some unions brings in a neutral third party to keep labor and management
may even impose fines on members who ignore the boycott. talking. The conciliator has no formal power over union repre-
To gain further support for their objectives, a union involved sentatives or over management. The conciliator’s goal is to get
in a boycott may also ask the public—through picketing and both parties to focus on the issues and to prevent negotiations
advertising—not to purchase the products of the picketed firm. from breaking down. Like conciliation, mediation involves
bringing in a neutral third party, but the mediator’s role is to sug-
Management Tactics Management’s version of a strike gest or propose a solution to the problem. Mediators have no for-
is the lockout; management actually closes a work site so that mal power over either labor or management. With arbitration,
a neutral third party is brought in to settle the dispute, but the
arbitrator’s solution is legally binding and enforceable. Gener-
ally, arbitration takes place on a voluntary basis—management
and labor must agree to it, and they usually split the cost (the
arbitrator’s fee and expenses) between them. Occasionally, man-
agement and labor submit to compulsory arbitration, in which an
outside party (usually the federal government) requests arbitra-
tion as a means of eliminating a prolonged strike that threatens
to disrupt the economy.
THE IMPORTANCE OF
WORKFORCE DIVERSITY
Customers, employees, suppliers—all the participants in the
Workers at a GE Aircraft Engines facility went on strike to protest the world of business—come in different ages, genders, races, eth-
company’s decision to outsource jobs overseas. nicities, nationalities, and abilities, a truth that business has

conciliation a method of mediation a method of outside arbitration settlement of a diversity the participation of
outside resolution of labor and resolution of labor and management labor/management dispute by a different ages, genders, races,
management differences in which a differences in which the third party’s third party whose solution is legally ethnicities, nationalities, and abilities
third party is brought in to keep the role is to suggest or propose a binding and enforceable in the workplace
two sides talking solution to the problem
come to label diversity. Understand- FIGURE 10.7

ing this diversity means recognizing Characteristics of Diversity
and accepting differences as well as
valuing the unique perspectives such
differences can bring to the workplace. Secondary
Characteristics
• Education
The Characteristics of • Work Background
Diversity • Income
• Marital Status
When managers speak of diverse work- • Parental Status
forces, they typically mean differences in • Military Experience
gender and race. While gender and race • Religious Beliefs
are important characteristics of diver- • Geographic Location
sity, others are also important. We can
divide these differences into primary
and secondary characteristics of diver-
sity. In the lower segment of Figure 10.7, Primary Characteristics
age, gender, race, ethnicity, abilities,
and sexual orientation represent pri- • Sexual
mary characteristics of diversity which • Age • Gender
Orientation
are inborn and cannot be changed.
In the upper section of Figure 10.7
are eight secondary characteristics of
diversity—work background, income,
• Race • Ethnicity • Abilities
marital status, military experience, reli-
gious beliefs, geographic location, paren-
tal status, and education—which can
be changed. We acquire, change, and Source: Marilyn Loden and Judy B. Rosener, Workforce America! Managing Employee Diversity as a Vital
discard them as we progress through Resource, 1991, p. 20. Used with permission. Copyright © 1991 The McGraw-Hill Companies.
our lives.
Defining characteristics of diversity as either primary or sec-
ondary enhances our understanding, but we must remember Why Is Diversity Important?
that each person is defined by the interrelation of all charac- The U.S. workforce is becoming increasingly diverse. Once
teristics. In dealing with diversity in the workforce, managers dominated by white men, today’s workforce includes sig-
must consider the complete person—not one or a few of a per- nificantly more women, African Americans, Hispanics, and
son’s differences. other minorities, as well as older workers and workers with
Once dominated by white men, today’s

workforce includes significantly more women, African
Americans, Hispanics, and other minorities, as well as
older workers and workers with disabilities.

Some of the major benefits of diversity include a wider range of employee perspectives, greater innovation and creativity, and the ability to target a
diverse customer base more effectively.
T A B L E 1 0 . 1 0 Population by Race disabilities. Table 10.10 presents some of the population data
from the Census Bureau. It is estimated that within the next
Ethnic Group Percentage Total ($ millions)
50 years, Hispanics will represent 24 percent of the popula-
Total population 100% $308.7 tion, while African Americans and Asians/Pacific Islanders
White 72% 223.6 will comprise 15 percent and 9 percent, respectively.32 These
groups have traditionally faced discrimination and higher
Black 13% 38.9
unemployment rates and have been denied opportunities to
Asian 5% 14.7 assume leadership roles in corporate America. Consequently,
American Indian or 0.9% 2.9 more and more companies are trying to improve HRM pro-
Alaska Native grams to recruit, develop, and retain more diverse employees to
Hawaiian or Pacific 0.2% 0.5 better serve their diverse customers. Some firms are providing
Islander special programs such as sponsored affinity groups, mentor-
Other race 6% 19.1 ing programs, and special career development opportunities.
Two or more races 3% 9.0 Sodexo has implemented a diversity scorecard index that uses
both quantitative and qualitative measurements to measure the
Hispanic 16% 50.5
company’s progress in the recruitment, retaining, and promo-
*The U.S. Census Bureau does not include a separate listing for tion of women and minority employees. Sodexo held managers
Hispanic origin. The 16 percent who are classified as Hispanic are responsible for diversity by creating a link between scorecard
included in the given segments (they may be classified as white,
results and management bonuses. The result was a 23 per-
black, etc., depending on origins). This is why the percentages will
come out greater than 100 percent. cent increase of minority employees in the company since the
Source: “2010 Census Shows America’s Diversity,” U.S. Census Bureau, implementation of the scorecard and an 11 percent increase in
March 24, 2011, www.census.gov/newsroom/releases/archives/2010 census/ female employees.33 Table 10.11 shows the top 20 companies
cbll -cn 125.html (accessed April 13, 2011). for minorities according to a study by Diversity, Inc. Effectively

affirmative action
programs legally
mandated plans that
managing diversity in the workforce involves cultivating and Companies that do not value their
try to increase job
valuing its benefits and minimizing its problems. diverse employees are likely to opportunities for minority
experience greater conflict, as well groups by analyzing the
The Benefits of as prejudice and discrimination. current pool of workers,
Workforce Diversity Among individual employees, for identifying areas where
example, racial slurs and gestures, women and minorities are
There are a number of benefits to fostering and valuing work- sexist comments, and other behav- underrepresented, and
force diversity, including the following: iors by co-workers harm the indi- establishing specific hiring
1. More productive use of a company’s human resources. viduals at whom such behavior and promotion goals, with
is directed. The victims of such target dates, for addressing
2. Reduced conflict among employees of different ethnicities, the discrepancy
races, religions, and sexual orientations as they learn to behavior may feel hurt, depressed,
respect each other’s differences. or even threatened and suffer from
lowered self-esteem, all of which
3. More productive working relationships among diverse employ- harm their productivity and morale. In such cases, women and
ees as they learn more about and accept each other.
minority employees may simply leave the firm, wasting the time,
4. Increased commitment to and sharing of organizational goals money, and other resources spent on hiring and training them.
among diverse employees at all organizational levels. When discrimination comes from a supervisor, employees may
5. Increased innovation and creativity as diverse employees bring also fear for their jobs. A discriminatory atmosphere not only
new, unique perspectives to decision-making and problem- can harm productivity and increase turnover, but it may also
solving tasks. subject a firm to costly lawsuits and negative publicity.
6. Increased ability to serve the needs of an increasingly diverse Astute businesses recognize that they need to modify their
customer base.34 human resources management programs to target the needs of
T A B L E 1 0 . 1 1 The DiversityInc Top 50 Companies for Diversity

1. Sodexo 26. Cummins
2. Johnson & Johnson 27. HSBC–North America
3. AT&T 28. Monsanto Co.
4. Kaiser Permanente 29. General Mills
5. Ernst & Young 30. Aetna
6. PricewaterhouseCoopers 31. Capital One
7. Marriot International 32. Prudential Financial
8. IBM Corp. 33. The Walt Disney Co.
9. Bank of America 34. JPMorgan Chase
10. Abbott 35. Kraft Foods
11. Verizon Communications 36. Toyota Motor North America
12. American Express Co. 37. Cisco Systems
13. Merck & Co. 38. Blue Cross Blue Shield of Florida
14. Colgate-Palmolive 39. Time Warner
15. KPMG 40. Target Corp.
16. Novartis Pharmaceuticals Corp 41. SC Johnson
17. The Coca-Cola Co. 42. MetLife
18. Procter & Gamble 43. Wells Fargo & Co.
19. Starwood Hotels & Resorts Worldwide 44. Ford Motor Co.
20. Health Care Service Corp. 45. Comerica
21. Cox Communications 46. JCPenney
22. Accenture 47. Northrop Grumman Corp.
23. Time Warner Cable 48. Xerox Corp.
24. MGM Mirage 49. Automatic Data Processing
25. Deloitte 50. WellPoint
Source: “The 2010 DiversityInc Top 50 List,” DiversityInc, April 5, 2010, www.diversityincbestpractices.com/content/1934/article/7378/ (accessed January 14, 2011).

all their diverse employees as well as the needs the discrepancy. Affirmative action began in
of the firm itself. They realize that the bene- 1965 as Lyndon B. Johnson issued the first
fits of diversity are long term in nature and of a series of presidential directives. It was
come only to those organizations willing to TEAM EXERCISE designed to make up for past hiring and
make the commitment. Most importantly, Form groups and go to monster.com promotion prejudices, to overcome work-
as workforce diversity becomes a valued and look up job descriptions for posi- place discrimination, and to provide equal
organizational asset, companies spend less tions in business (account executive employment opportunities for blacks and
in advertising, marketing manager,
time managing conflict and more time whites. Since then, minorities have made
human resources director, produc-
accomplishing tasks and satisfying cus- solid gains.
tion supervisor, financial analyst,
tomers, which is, after all, the purpose of bank teller, etc). What are the key Legislation passed in 1991 reinforces affir-
business. requirements for the position that you mative action but prohibits organizations
have been assigned (education, work from setting hiring quotas that might result
Affirmative Action experience, language/computer skills,
in reverse discrimination. Reverse dis-
etc.)? Does the position announcement
Many companies strive to improve their crimination occurs when a company’s poli-
provide a thorough understanding of
working environment through affirmative cies force it to consider only minorities or
the job? Was any key information that
action programs, legally mandated you would have expected omitted? women instead of concentrating on hiring
plans that try to increase job opportuni- Report your findings to the class. the person who is best qualified. More com-
ties for minority groups by analyzing the panies are arguing that affirmative action
current pool of workers, identifying areas stifles their ability to hire the best employ-
where women and minorities are under- ees, regardless of their minority status.
represented, and establishing specific hiring and promotion Because of these problems, affirmative action became politi-
goals along with target dates for meeting those goals to resolve cally questionable. ■
SO YOU WANT TO WORK // in Human Resources /

M anaging human resources is a chal-
lenging and creative facet of a busi-
ness. It is the department that handles the
and turbulent; thus, it is imperative that all
employees are carefully selected, trained,
and motivated so that they will remain com-
Diversity is an asset and can help a company
from having blindspots or harmony in thought,
background, and perspective, which stifles
recruiting, hiring, training, and firing of mitted and loyal to the company. This is not an good team decisions. However, a diverse
employees. Because of the diligence and easy task, but it is one of the responsibilities workforce can present some management
detail required in hiring and the sensitivity of the human resources manager. Because challenges. Human resources management is
required in firing, human resources manag- even with references, a résumé, background often responsible for managing diversity train-
ers have a broad skill set. Human resources, checks, and an interview, it can be hard to tell ing and compliance to make sure employees
therefore, is vital to the overall functioning of how a person will fit in the organization—the do not violate the ethical culture of the orga-
the business because without the right staff HR manager needs to have skills to be able to nization or break the law. Different people
a firm will not be able to effectively carry out anticipate how every individual will “fit in.” have different goals, motivations, and ways
its plans. Like in basketball, a team is only Human resources jobs include compensation, of thinking about issues that are informed by
as strong as its individual players, and those labor relations, benefits, training, ethics, and their culture, religion, and the people clos-
players must be able to work together and compliance managers. All of the tasks associ- est to them. No one way of thinking is more
to enhance strengths and downplay weak- ated with the interface with hiring, developing, right or more wrong than others, and they are
nesses. In addition, a good human resources and maintaining employee motivation come all valuable. A human resources manager’s
manager can anticipate upcoming needs and into play in human resources management. job can become very complicated, however,
changes in the business, hiring in line with the Jobs are diverse and salaries will depend on because of diversity. To be good at human
dynamics of the market and organization. responsibilities, education, and experience. resources, you should be aware of the value
Once a good workforce is in place, One of the major considerations for an of differences, strive to be culturally sensitive,
human resources managers must ensure that HR manager is workforce diversity. A mul- and ideally should have a strong understand-
employees are properly trained and oriented ticultural, multiethnic workforce consisting ing and appreciation of different cultures and
and that they clearly understand some ele- of men and women will help bring a variety religions. Human resources managers’ ability
ments of what the organization expects. Hir- of viewpoints and improve the quality and to manage diversity and those differences will
ing new people is expensive, time-consuming, creativity of organizational decision making. affect their overall career success.

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and video

222 PART 5 | Marketing: Developing Relationships
introduction
eleven
arketing involves planning
M and executing the develop-

ment, pricing, promotion, and
distribution of ideas, goods, and ser-
customer-driven
vices to create exchanges that satisfy
individual and organizational goals.
marketing
These activities ensure that the prod-
ucts consumers want to buy are avail-
able at a price they are willing to pay LEARNING OBJECTIVES
and that consumers are provided with LO1 Define marketing, and describe
the exchange process.
information about product features
LO2 Specify the functions of marketing.
and availability. Organizations of all LO3 Explain the marketing concept
sizes and objectives engage in these and its implications for developing
marketing strategies.
activities.
LO4 Examine the development
In this chapter, we focus on the of a marketing strategy, including
market segmentation and
basic principles of marketing. First
marketing mix.
we define and examine the nature LO5 Investigate how marketers conduct
of marketing. Then we look at how marketing research and study
buying behavior.
marketers develop marketing strate-
LO6 Summarize the environmental
gies to satisfy the needs and wants of forces that influence marketing
decisions.
their customers. Next we discuss buy-
ing behavior and how marketers use
research to determine what consum-
ers want to buy and why. Finally, we
explore the impact of the environment
on marketing activities.
CHAPTER 11 | Customer-Driven Marketing 223

marketing a group
of activities designed to
expedite transactions
by creating, distributing, NATURE OF The Exchange Relationship
pricing, and promoting At the heart of all business is the exchange, the act of giv-
goods, services, and ideas
MARKETING ing up one thing (money, credit, labor, goods) in return for
something else (goods, services, or ideas). Businesses exchange
exchange the act of A vital part of any business under-
their goods, services, or ideas for money or credit supplied by
giving up one thing (money, taking, marketing is a group
credit, labor, goods) in customers in a voluntary exchange relationship, illustrated in
of activities designed to expedite
return for something else Figure 11.1. The buyer must feel good about the purchase, or
transactions by creating, distrib-
(goods, services, or ideas) the exchange will not continue. If your cell phone service works
uting, pricing, and promoting
everywhere, you will probably feel good about using its ser-
goods, services, and ideas. These
vices. But if you have a lot of dropped calls, you will probably
activities create value by allowing
use another phone service next time.
individuals and organizations to obtain what they need and
want. A business cannot achieve its objectives unless it provides For an exchange to occur, certain conditions are required. As indi-
something that customers value. But just creating an innovative cated by the arrows in Figure 11.1, buyers and sellers must be able
product that meets many users’ needs isn’t sufficient in today’s to communicate about the “something of value” available to each.
volatile global marketplace. Products must be conveniently An exchange does not necessarily take place just because buyers
available, competitively priced, and uniquely promoted. and sellers have something of value to exchange. Each participant
Marketing is an important part of a firm’s overall strategy. Other must be willing to give up his or her respective “something of
functional areas of the business—such as operations, finance, and value” to receive the “something” held by the other. You are willing
all areas of management—must be coordinated with marketing to exchange your “something of value”—your money or credit—
decisions. Businesses try to respond to consumer wants and needs for soft drinks, football tickets, or new shoes because you consider
and to anticipate changes in the environment. Unfortunately, it is those products more valuable or more important than holding on
difficult to understand and predict what con- to your cash or credit potential.
sumers want: Motives are often unclear; few When you think of marketing products, you
principles can be applied consistently; and may think of tangible things—cars, MP3 play-
markets tend to fragment, each desiring cus- ers, or books, for example. What most con-
tomized products, new value, or better service.
A business sumers want, however, is a way to get a job
It is important to note what marketing is cannot achieve its done, solve a problem, or gain some enjoy-
not: It is not manipulating consumers to get ment. You may purchase a Hoover vacuum
them to buy products they do not want. It objectives unless it cleaner not because you want a vacuum
is not just selling and advertising; it is a sys- cleaner but because you want clean carpets.
tematic approach to satisfying consumers.
provides something Starbucks serves coffee drinks at a premium
Marketing focuses on the many activities— that customers price, providing convenience, quality, and an
planning, pricing, promoting, and distrib- inviting environment. Therefore, the tangible
uting products—that foster exchanges. value. product itself may not be as important as the
image or the benefits associated with the prod-
uct. This intangible “something of value” may
F I G U R E 1 1 . 1 The Exchange Process: Giving Up One Thing in Return for Another be capability gained from using a product or the
image evoked by it, or even the brand name. Good
examples of brand names that are easy to remem-
ething of Va
Som redit, labo lue ber include Avon’s Skin So Soft, Tide detergent,
, c r, go and the Ford Mustang. The label or brand name
oney od
s
(m may also offer the added bonus of being a con-
)
versation piece in a social environment, such as

Dancing Bull or Smoking Loon wine.
Buyer Seller
Functions of Marketing
Marketing focuses on a complex set of activities
that must be performed to accomplish objectives
and generate exchanges. These activities include
buying, selling, transporting, storing, grading,
financing, marketing research, and risk taking.
So
m ue
( g o e t h i n g o f V a l s) Buying Everyone who shops for products
o d s, a
s ervi c e s, id e
(consumers, stores, businesses, governments)
decides whether and what to buy. A marketer
value a customer’s
subjective assessment
of benefits relative to costs
that consumers clearly understand
in determining the worth
their nature and quality. Many of a product
products, such as meat, steel, and
fruit, are graded according to a set
of standards that often are established by the state or federal
government.
Financing For many products, especially large items such

as automobiles, refrigerators, and new homes, the marketer
arranges credit to expedite the purchase.
Marketing Research Through research, marketers ascer-

tain the need for new goods and services. By gathering informa-
tion regularly, marketers can detect new trends and changes in
consumer tastes.
Risk Taking Risk is the chance of loss associated with mar-

keting decisions. Developing a new product creates a chance
of loss if consumers do not like it enough to buy it. Spending
money to hire a sales force or to conduct marketing research
also involves risk. The implication of risk is that most market-
ing decisions result in either success or failure.
Creating Value with Marketing1

Value is an important element of managing long-term cus-
tomer relationships and implementing the marking concept.
We view value as a customer’s subjective assessment of ben-
efits relative to costs in determining the worth of a product
Many companies use celebrities to promote their products, as Nikon (customer value = customer benefits − customer costs).
does with actor Ashton Kutcher. Companies hope that celebrity
promotion will create additional value for consumers by extending their
Customer benefits include anything a buyer receives in an
positive perceptions of the celebrity to the products. exchange. Hotels and motels, for example, basically provide a
room with a bed and bathroom, but each firm provides a differ-
ent level of service, amenities, and atmosphere to satisfy its guests.
must understand buyers’ needs and desires to determine what Hampton Inn offers the minimum services necessary to maintain a
products to make available. quality, efficient, low-price overnight accommodation. In contrast,
the Ritz-Carlton provides every imaginable service a guest might
Selling The exchange process is expedited through selling.
desire and strives to ensure that all service is of the highest quality.
Marketers usually view selling as a persuasive activity that is
Customers judge which type of accommodation offers them the
accomplished through promotion (advertising, personal sell-
best value according to the benefits they desire and their willing-
ing, sales promotion, publicity, and packaging).
ness and ability to pay for the costs associated with the benefits.
Transporting Transporting is the process of moving prod- Customer costs include anything a buyer must give up to obtain
ucts from the seller to the buyer. Marketers focus on transpor- the benefits the product provides. The most obvious cost is the
tation costs and services. monetary price of the product, but nonmonetary costs can be
equally important in a customer’s determination of value. Two
Storing Like transporting, storing is part of the physical distri- nonmonetary costs are the time and effort customers expend to
bution of products and includes warehousing goods. Warehouses find and purchase desired products. To reduce time and effort, a
hold some products for lengthy periods in order to create time company can increase product availability, thereby making it more
utility. Time utility has to do with being able to satisfy demand in convenient for buyers to purchase the firm’s products. Another
a timely manner. This especially pertains to a seasonal good such nonmonetary cost is risk, which can be reduced by offering basic
as orange juice. Fresh oranges are available only for a few months warranties for an additional charge. Another risk-reduction strat-
annually, but consumers demand juice throughout the entire egy is increasingly popular in today’s catalog/telephone/Internet
year. Sellers must arrange for cold storage of orange juice con- shopping environment. L.L.Bean, for example, uses a guarantee to
centrate so that they can maintain a steady supply all of the time. reduce the risk involved in ordering merchandise from its catalogs.
Grading Grading refers to standardizing products by divid- In developing marketing activities, it is important to recognize
ing them into subgroups and displaying and labeling them so that customers receive benefits based on their experiences. For
marketing concept
the idea that an organization
should try to satisfy
example, many computer buyers ingredients with natural ones such as canola oil and rosemary.
customers’ needs through
coordinated activities that consider services such as fast deliv- Frito-Lay’s goal is to create more natural snack foods while
also allow it to achieve its ery, ease of installation, technical retaining the taste of the originals.2 To remain competitive, the
own goals advice, and training assistance to company must be prepared to add to or adapt its product line
be important elements of the prod- to satisfy customers’ desires for new fads or changes in eating
uct. Customers also derive benefits habits. Each business must determine how best to implement
from the act of shopping and selecting products. These benefits the marketing concept, given its own goals and resources.
can be affected by the atmosphere or environment of a store,
Trying to determine customers’ true needs is increasingly dif-
such as Red Lobster’s nautical/seafood theme.
ficult because no one fully understands what motivates people
to buy things. However, Estée Lauder, founder of her namesake
The Marketing Concept cosmetics company, had a pretty good idea. When a prestigious
A basic philosophy that guides all marketing activities is the store in Paris rejected her perfume in the 1960s, she “acciden-
marketing concept, the idea that an organization should tally” dropped a bottle on the floor where nearby customers
try to satisfy customers’ needs through coordinated activities could get a whiff of it. So many asked about the scent that Gal-
that also allow it to achieve its own goals. According to the eries Lafayette was obliged to place an order. Lauder ultimately
marketing concept, a business must find out what consumers built an empire using then-unheard-of tactics like free samples
desire and then develop the good, service, or idea that fulfills and gifts with purchases to market her “jars of hope.”3
their needs or wants. The business must then get the product to
the customer. In addition, the business must continually alter, Although customer satisfaction is the goal of the marketing
adapt, and develop products to keep pace with changing con- concept, a business must also achieve its own objectives, such
sumer needs and wants. For instance, there has been increas- as boosting productivity, reducing costs, or achieving a percent-
ing pressure on the snack food industry to provide healthier age of a specific market. If it does not, it will not survive. For
snacks. In response to this growing health trend, Frito-Lay is example, Dell could sell computers for $50 and give customers
reengineering its snack food recipes to replace artificial a lifetime guarantee, which would be great for customers but
not so great for Dell. Obviously, the company must strike a bal-
ance between achieving organizational objectives and satisfying
customers.
To implement the marketing concept, a firm must have good
information about what consumers want, adopt a consumer ori-
entation, and coordinate its efforts throughout the entire organi-
zation; otherwise, it may be awash with goods, services, and ideas
that consumers do not want or need. Successfully implementing
the marketing concept requires that a business view the custom-
er’s perception of value as the ultimate measure of work perfor-
mance and improving value, and the rate at which this is done, as
the measure of success.4 Everyone in the organization who inter-
acts with customers—all customer-contact employees—must
know what customers want. They are selling ideas, benefits, phi-
losophies, and experiences—not just goods and services.
Someone once said that if you build a better mousetrap, the
world will beat a path to your door. Suppose you do build a bet-
Although demand for bananas is high, the competitive nature of the ter mousetrap. What will happen? Actually, consumers are not
market makes it unlikely that any one seller will gain market share. The likely to beat a path to your door because the market is so com-
marketing of bananas would therefore be quite different from marketing petitive. A coordinated effort by everyone involved with the
more differentiated goods. mousetrap is needed to sell the product. Your company must
According to the marketing concept, a business must find

out what consumers desire and then develop the good,
service, or idea that fulfills their needs or wants.

market orientation
an approach requiring
organizations to gather
reach out to customers and tell them about your mousetrap, businesspeople began to realize they information about
especially how your mousetrap works better than those offered would have to “sell” products to buy- customer needs, share that
by competitors. If you do not make the benefits of your product ers. During the first half of the 20th information throughout
widely known, in most cases, it will not be successful. Consider century, businesspeople viewed sales the firm, and use that
Apple’s 323 national and international retail stores, which mar- as the primary means of increasing information to help build
ket computers and electronics in a way unlike any other com- profits in what has become known long-term relationships
puter manufacturer or retail establishments. The upscale stores, as a sales orientation. Those who with customers
located in high-rent shopping districts, show off Apple’s prod- adopted the sales orientation per-
ucts in airy, stylish settings to encourage consumers to try new spective believed the most impor-
things—like making a movie on a computer. The stores also tant marketing activities were personal selling and advertising.
offer special events like concerts and classes to give customers Today some people still inaccurately equate marketing with a sales
ideas on how to maximize their use of Apple’s products.5 You orientation.
must also find—or create—stores willing to sell your mousetrap
to consumers. You must implement the marketing concept by The Market Orientation By the 1950s, some business-
making a product with satisfying benefits and making it avail- people began to recognize that even efficient production and
able and visible. extensive promotion did not guarantee sales. These businesses,
and many others since, found that they must first determine
Orville Wright said that an airplane is “a group of separate what customers want and then produce it, rather than making
parts flying in close formation.” This is what most companies the products first and then trying to persuade customers that
are trying to accomplish: They are striving for a team effort to they need them. Managers at General Electric first suggested
deliver the right good or service to customers. A breakdown that the marketing concept was a companywide philosophy of
at any point in the organization—whether it be in production, doing business. As more organizations realized the importance
purchasing, sales, distribution, or advertising—can result in of satisfying customers’ needs, U.S. businesses entered the mar-
lost sales, lost revenue, and dissatisfied customers. keting era, one of market orientation.
Evolution of the A market orientation requires organizations to gather infor-
mation about customer needs, share that information throughout
Marketing Concept the entire firm, and use it to help build long-term relationships
The marketing concept may seem like the obvious approach to with customers. Top executives, marketing managers, nonmar-
running a business and building relationships with customers. keting managers (those in production, finance, human resources,
However, businesspeople are not always focused on custom- and so on), and customers all become mutually dependent and
ers when they create and operate businesses. Many companies cooperate in developing and carrying out a market orientation.
fail to grasp the importance of customer relationships and fail Nonmarketing managers must communicate with marketing
to implement customer strategies. A firm’s marketing depart- managers to share information important to understanding the
ment needs to share information about customers and their customer. Consider the 120-year history of Wrigley’s gum. In
desires with the entire organization. Our society and economic 1891 the gum was given away to promote sales of baking powder
system have changed over time, and marketing has become (the company’s original product). The gum was launched as its
more important as markets have become more competitive. own product in 1893, and after four generations of Wrigley fam-
ily CEOs, the company continues to reinvent itself and focus on
The Production Orientation During the second half of consumers. In 2008, the family made the decision to sell the com-
the 19th century, the Industrial Revolution was well under way in pany to Mars. Wrigley now functions as a stand-alone subsidiary
the United States. New technologies, such as electricity, railroads, of Mars. The deal combined such popular brands as Wrigley’s
internal combustion engines, and mass-production techniques, gums and Life Savers with Mars’ M&Ms, Snickers, and Skittles to
made it possible to manufacture goods with ever increasing effi- form the world’s largest confectionary company.
ciency. Together with new management ideas and ways of using
labor, products poured into the marketplace, where demand for Trying to assess what customers want, which is difficult to begin
manufactured goods was strong. with, is further complicated by the rate at which trends, fashions,
and tastes can change. Businesses today want to satisfy custom-
The Sales Orientation By the early part of the 20th cen- ers and build meaningful long-term relationships with them.
tury, supply caught up with and then exceeded demand, and It is more efficient and less expensive for the company to retain
[ “Our society and economic system have changed over

time, and marketing has become more important
as markets have become more competitive.”
]
The Nissan Leaf is marketed as an eco-friendly vehicle for consumers The Jonas brothers promote Marquis Jet to create added value among
who care about the environment. its target market. Marquis Jet targets more of the business market
through its Marquis Jet Card, which allows card holders to purchase
flight time as needed rather than having to maintain their own fleet.
existing customers and even increase the amount of business each is, websites, telephone, fax, e-mail, and personal contact—
customer provides the organization than to find new customers. companies can personalize customer relationships.6 Like many
Most companies’ success depends on increasing the amount of online retailers, Amazon.com stores and analyzes purchase
repeat business; therefore, relationship building between company data in an attempt to understand each customer’s interests.
and customer is key. Many companies are turning to technologies This information helps the retailer improve its ability to sat-
associated with customer relationship management to help build isfy individual customers and thereby increase sales of books,
relationships and boost business with existing customers. music, movies, and other products to each customer. The ability
Communication remains a major element of any strategy to to identify individual customers allows marketers to shift their
develop and manage long-term customer relationships. By pro- focus from targeting groups of similar customers to increasing
viding multiple points of interactions with customers—that their share of an individual customer’s purchases. Regardless of
P&G MAKES INROADS single-serving, no frills packages to low- Disposable diapers, however, take up more
income global consumers. room. Competition is another problem. In India,
IN INDIA Of the countries targeted by P&G, McDon- P&G must fight against major competitors like
ald sees India as a major opportunity for Unilever and Colgate-Palmolive. P&G’s Indian
F our billion global customers may seem

like a lot, but for Procter & Gamble
CEO Bob McDonald it’s just the beginning.
expansion. Currently, P&G counts one-third
of India’s 1.2 billion consumers as customers.
The company aims to expand this number by
sales have been growing steadily, but it lags
behind Unilever with sales of $800 million ver-
sus $3.8 billion. The trick for P&G will be to bal-
McDonald intends to raise this number to 500 million with an emphasis on needs-based ance its products with the needs of its Indian
5 billion by 2015. The key to this growth is innovation and new product introduction. customers—both retailers and end users.7
through targeting emerging economies For example, P&G introduced the world’s
like India and the Philippines. The com- lowest-cost disposable diaper—at 12 cents
pany must therefore adapt its products to each—in the hopes that its convenience and
meet consumer needs in these countries. affordability will convince Indian mothers to 1. What are the marketing challenges of a
While P&G has built its profits on offer- switch from cloth to disposable diapers. large developing country with low con-
ing premium products in developed mar- The second challenge for P&G is find- sumer income?
kets, economies in which income is as ing a way to get its innovative products onto 2. How is Procter & Gamble adapting prod-
low as $1 per day require P&G to adapt shelves. With few large retailers in India, ucts for the market in India?
its marketing strategy. To work within small stores with limited space can easily 3. Why is it hard to get products available
this constraint, P&G has begun offering stock P&G items like razors and toothbrushes. to consumers in India?

marketing market a group target market total-market market market segment
strategy of people who have a specific group of approach an segmentation a a collection of individuals,
a plan of action for a need, purchasing consumers on whose approach whereby a strategy whereby a firm groups, or organizations
developing, pricing, power, and the desire needs and wants a firm tries to appeal to divides the total market who share one or more
distributing, and and authority to spend company focuses its everyone and assumes into groups of people characteristics and thus
promoting products money on goods, marketing efforts that all buyers have who have relatively have relatively similar
that meet the needs of services, and ideas similar needs similar product needs product needs and
specific customers desires
the medium through which communication occurs, customers distributing, and promoting products that meet the needs of
should ultimately be the drivers of marketing strategy because specific customers. This definition has two major components:
they understand what they want. Customer relationship man- selecting a target market and developing an appropriate mar-
agement systems should ensure that marketers listen to custom- keting mix to satisfy that target market.
ers in order to respond to their needs and concerns and build
long-term relationships. Selecting a Target Market
A market is a group of people who have a need, purchas-
ing power, and the desire and authority to spend money on
DEVELOPING goods, services, and ideas. A target market is a more spe-
cific group of consumers on whose needs and wants a com-
A MARKETING STRATEGY pany focuses its marketing efforts. For example, Crayola
To implement the marketing concept and customer relation- targets girls aged 9 to 12 with its Pop Art Pixies craft line.
ship management, a business needs to develop and maintain a After conducting focus groups, Crayola realized that many
marketing strategy, a plan of action for developing, pricing, children stopped using their products once they reached the
tween years. In response, the company began issu-
ing craft kits that would appeal to the creative side
F I G U R E 1 1 . 2 Target Market Strategies of the tween market. The kits include materials that
enable girls to build their own unique creations,
such as eco-friendly water bottles, sun catchers,
and wind chimes.8
Total-Market Approach
Marketing managers may define a target market as
Company Single Marketing Strategy a relatively small number of people within a larger
market, or they may define it as the total market
(Figure 11.2). Rolls-Royce, for example, targets its
products at a very exclusive, high-income market—
people who want the ultimate in prestige in an auto-
Total Target Market mobile. On the other hand, Ford Motor Company
manufactures a variety of vehicles including Lin-
colns, Mercurys, and Ford Trucks in order to appeal
to varied tastes, needs, and desires.
Concentration Approach
Some firms use a total-market approach, in which
Company Single Marketing Strategy they try to appeal to everyone and assume that all buy-
ers have similar needs and wants. Sellers of salt, sugar,
and many agricultural products use a total-market
approach because everyone is a potential consumer
of these products. Most firms, though, use market
Single Target Market
segmentation and divide the total market into
groups of people. A market segment is a collection
of individuals, groups, or organizations who share one
Multisegment Approach or more characteristics and thus have relatively simi-
lar product needs and desires. Women are the largest
Company Marketing Strategy 1 market segment, with 51 percent of the U.S. popula-
tion. Approximately 12.8 million firms in the United
States are owned by women.9 At the household level,
Marketing Strategy 2 segmentation can identify each woman’s social attri-
butes, culture, and stages in life to determine preferences
Multiple Target Markets
and needs.

concentration
approach a market
segmentation approach
Another market segment on which T A B L E 1 1 . 1 U.S. Buying Power Statistics by Race
whereby a company
develops one marketing many marketers are focusing is 1990 2000 2009 2014
strategy for a single market the growing Hispanic population.
Total 4,270.5 7,187.6 10,717.8 13,097.1
segment Olive Garden launched a cam-
paign to make Italian food more White 3,816.2 6,231.2 9,125.2 11,032.7
multisegment appealing to Hispanic diners. The Black 318.1 590.2 910.4 1,136.8
approach a market restaurant chain created a Span- American Indian 19.7 39.1 64.7 82.7
segmentation approach ish version of its website, provided
whereby the marketer aims Asian 116.5 268.7 508.6 696.5
all locations with menus in Span-
its efforts at two or more Multiracial N/A 58.4 108.9 148.3
ish, and even sponsored several
segments, developing a
marketing strategy for each segments on Univision television Source: Jeffrey M. Humphreys, “The Multicultural Economy 2009,” GBEC
shows.10 One of the challenges for 69 (3rd Quarter, 2009), p. 3, www.terry.uga.edu/selig/docs/GBEC0903q.pdf
marketers in the future will be to
effectively address an increasingly racially diverse United States.
The minority population of the United States is about 107.2 mil- Market Segmentation Approaches In the concentration
lion (35 percent of the total population).11 In future decades, the approach, a company develops one marketing strategy for
purchasing power of minority market segments is set to grow by a single market segment. The concentration approach allows
leaps and bounds. Table 11.1 shows the buying power and market a firm to specialize, focusing all its efforts on the one market
share percentages of different market segments. Companies will segment. Porsche, for example, directs all its marketing efforts
have to learn how to most effectively reach these growing seg- toward high-income individuals who want to own high-
ments. Companies use market segmentation to focus their efforts performance vehicles. A firm can generate a large sales volume
and resources on specific target markets so that they can develop by penetrating a single market segment deeply. The concen-
a productive marketing strategy. Two common approaches to tration approach may be especially effective when a firm can
segmenting markets are the concentration approach and the identify and develop products for a segment ignored by other
multisegment approach. companies in the industry.
A firm can generate a large sales volume by penetrating

a single market segment deeply.
In the multisegment approach, the marketer aims its mar-

keting efforts at two or more segments, developing a marketing
strategy for each. Many firms use a multisegment approach that
includes different advertising messages for different segments.
Companies also develop product variations to appeal to different
market segments. The U.S. Post Office, for example, offers per-
sonalized stamps; Mars Inc. sells personalized M&M’s through
mymms.com; various on-demand television services ensure that
consumers watch only what they want to watch; and LEGO toy
company offers a service through its website wherein children
can design their own sets. Companies also develop product
variations to appeal to different market segments. For example,
Samsung has widened its range of smartphones to appeal to the
high-end and lower-end consumer. The company offers models
for those who want a smartphone with the maximum capabili-
Procter & Gamble uses a multisegment marketing strategy around the ties. However, Samsung has also developed an ultra-cheap model
globe. In China, it offers an advanced laundry detergent formula for the high targeted at consumers in developing countries, where consum-
end of the market, a mid-priced brand for the medium end of the market, ers have not traditionally been able to afford smartphones.12
and a basic inexpensive product for the low end of the market. Many other firms also attempt to use a multisegment approach

marketing mix the
four marketing activities—
product, price, promotion,
to market segmentation, such as the manufacturer of Raleigh product usage. Climate, for exam-
and distribution—that
bicycles, which has designed separate marketing strategies for ple, influences consumers’ pur-
the firm can control to
racers, tourers, commuters, and children. chases of clothing, automobiles,
achieve specific goals
heating and air conditioning
Niche marketing is a narrow market segment focus when efforts within a dynamic marketing
equipment, and leisure activity
environment
are on one small, well-defined group that has a unique, spe- equipment.
cific set of needs. Many airlines cater to first-class flyers, who
3. Psychographic —personality
comprise only 10 percent of international air travelers. To meet characteristics, motives, lifestyles. Soft-drink marketers pro-
the needs of these elite customers, airlines include special perks vide their products in several types of packaging, including
along with the spacious seats. Continental offers business pas- two-liter bottles and cases of cans, to satisfy different life-
sengers traveling overseas an in-flight menu featuring broiled styles and motives.
beef tenderloin and seafood-filled pastry blossoms, and Delta is
4. Behavioristic—some characteristic of the consumer’s behav-
installing flat-bed seats on dozens of airplanes.13
ior toward the product. These characteristics commonly
For a firm to successfully use a concentration or multisegment involve some aspect of product use.
approach to market segmentation, several requirements must
be met:
1. Consumers’ needs for the product must be heterogeneous.
Developing a Marketing Mix
The second step in developing a marketing strategy is to create
2. The segments must be identifiable and divisible. and maintain a satisfying marketing mix. The marketing mix
3. The total market must be divided in a way that allows estimated refers to four marketing activities—product, price, distribution,
sales potential, cost, and profits of the segments to be compared. and promotion—that the firm can control to achieve specific
goals within a dynamic marketing environment (Figure 11.3).
4. At least one segment must have enough profit potential to jus-
tify developing and maintaining a special marketing strategy.
The buyer or the target market is the central focus of all mar-
keting activities.
5. The firm must be able to reach the chosen market segment
with a particular market strategy.
Product A product—whether a good, a service, an idea, or
some combination—is a complex mix of tangible and intan-
Bases for Segmenting Markets Companies segment gible attributes that provide satisfaction and benefits. A good is
markets on the basis of several variables: a physical entity you can touch. A Porsche Cayenne, a Hewlett-
1. Demographic—age, sex, race, ethnicity, income, education, Packard printer, and a kitten available for adoption at an ani-
occupation, family size, religion, social class. These charac- mal shelter are examples of goods. A service is the application of
teristics are often closely related to customers’ product needs human and mechanical efforts to people or objects to provide
and purchasing behavior, and they can be readily measured. intangible benefits to customers. Air travel, dry cleaning, hair-
For example, deodorants are often segmented by sex: Secret cuts, banking, insurance, medical care, and day care are exam-
and Soft n’ Dri for women; Old Spice and Mennen for men. ples of services. Ideas include concepts, philosophies, images,
2. Geographic—climate, terrain, natural resources, population den- and issues. For instance, an attorney, for a fee, may advise you
sity, subcultural values. These influence consumers’ needs and about what rights you have in the event that the IRS decides
to audit your tax return. Other mar-
keters of ideas include political parties,
F I G U R E 1 1 . 3 The Marketing Mix: Product, Price, Promotion, and Distribution churches, and schools.
A product has emotional and psycho-

logical, as well as physical character-
Product
istics, that include everything that the
buyer receives from an exchange. This
definition includes supporting ser-
Promotion Customer Price
vices such as installation, guarantees,
product information, and promises
of repair. Products usually have both
favorable and unfavorable attributes;
Distribution therefore, almost every purchase or
exchange involves trade-offs as con-
sumers try to maximize their benefits
Marketing Environment and satisfaction and minimize unfa-
vorable attributes.

TWITTER TREASURE the Peninsula site. One of Sutherland’s store traffic. One business’s website traffic
tactics is the Twitter Treasure Hunt. First, jumped 400 percent for the day, while
HUNT GETS Sutherland tweets trivia questions about a Martha’s Pastries’ sales rose 7 percent for
CONSUMERS TO HUNT local company. Participants who correctly the quarter. Overall, Sutherland says the
answer the questions can win a prize. For Twitter Treasure Hunt surpasses traditional
WHILE THEY PLAY example, Sutherland challenged partici- click-through e-mail marketing adver-
pants to identify the business located at tisements with a response rate of up to
J ason Sutherland’s Peninsula Shops

have become a friend to small busi-
nesses in the California Bay Area. For an
325 Sharon Park Drive in Menlo Park. The
answer was Martha’s Pastries, and the
winner received a $10 gift certificate. While
26 percent versus 5 percent. With his inno-
vative way to reward consumers and help
businesses, Sutherland creates a profitable
annual fee of $180, Sutherland promotes a the winners are pleased, local business situation for both.14
local company on Twitter, Facebook, and owners are also thrilled with increased
Products are among a firm’s most visible contacts with consum- efficiently from producers to consumers or industrial buyers.
ers. If they do not meet consumer needs and expectations, sales These activities involve transporting, warehousing, materi-
will be difficult, and product life spans will be brief. The product als handling, and inventory control, as well as packaging and
is an important variable—often the central focus—of the mar- communication.
keting mix; the other variables (price, promotion, and distribu-
tion) must be coordinated with product decisions. Critics who suggest that eliminating wholesalers and other
middlemen would result in lower prices for consumers do not
Price Almost anything can be assessed by a recognize that eliminating intermediaries would
price, a value placed on an object exchanged not do away with the need for their services.
between a buyer and a seller. Although the seller Other institutions would have to perform those
usually establishes the price, it may be negoti- services, and consumers would still have to pay
ated between buyer and seller. The buyer usually for them. In addition, in the absence of whole-
exchanges purchasing power—income, credit, salers, all producers would have to deal directly
wealth—for the satisfaction or utility associ- with retailers or customers, keeping voluminous
ated with a product. Because financial price records and hiring extra people to deal with
is the measure of value commonly used in an customers.
exchange, it quantifies value and is the basis of
DID YOU KNOW?
most market exchanges. Promotion Promotion is a persuasive form
Marketers view price as much more than a way During its first year of communication that attempts to expedite a
of assessing value, however. It is a key element of operation, sales of marketing exchange by influencing individu-
of the marketing mix because it relates directly als, groups, and organizations to accept goods,
Coca-Cola averaged
to the generation of revenue and profits. Prices services, and ideas. Promotion includes advertis-
just nine drinks per ing, personal selling, publicity, and sales promo-
can also be changed quickly to stimulate demand
day for total first-year tion, all of which we will look at more closely in
or respond to competitors’ actions. The sudden
increase in the cost of commodities such as oil sales of $50. Today, Chapter 12.
can create price increases or a drop in consumer Coca-Cola products
The aim of promotion is to communicate
demand for a product. When gas prices rise, con- are consumed at the directly or indirectly with individuals, groups,
sumers purchase more fuel-efficient cars; when rate of 1.7 billion and organizations to facilitate exchanges. When
prices fall, consumers return to larger vehicles drinks per day.15 marketers use advertising and other forms of
with a smaller price tag.16 promotion, they must effectively manage their
promotional resources and understand product
Distribution Distribution (sometimes referred to as and target-market characteristics to ensure that these promo-
“place” because it helps to remember the marketing mix as the
tional activities contribute to the firm’s objectives.
“4 Ps”) is making products available to customers in the quan-
tities desired. For example, consumers can rent DVDs and Most major companies have set up websites on the Internet
videogames from a physical store, a vending machine, or an to promote themselves and their products. The home page for
online service. Intermediaries, usually wholesalers and retail- Betty Crocker, for example, offers recipes; meal planning; blogs
ers, perform many of the activities required to move products and message boards; the company’s history; descriptions for its

price a value placed
on an object exchanged
between a buyer and a
at least 1.5 percent each year for seller
the next 5 to 10 years. This shift in
consumer preferences is already distribution making
changing the way companies pro- products available to
duce and market bottled bever- customers in the quantities
ages.17 Marketing research is vital desired
because the marketing concept
promotion a persuasive
cannot be implemented without form of communication
information about customers. that attempts to expedite
A marketing information system is a marketing exchange by
influencing individuals,
a framework for accessing informa-
groups, and organizations
tion about customers from sources to accept goods, services,
both inside and outside the orga- and ideas
nization. Inside the organization,
there is a continuous flow of infor- marketing research
mation about prices, sales, and a systematic, objective
expenses. Outside the organization, process of getting
data are readily available through information about potential
private or public reports and cen- customers to guide
Redbox departed from the more traditional brick-and-mortar rental stores marketing decisions
sus statistics, as well as from many
by choosing to distribute its DVD rentals through vending machines. other sources. Computer network- primary data
ing technology provides a frame- marketing information that
products; online shopping for complementary items such as work for companies to connect to is observed, recorded, or
dinnerware, linens, and gifts; and the ability to print a shop- useful databases and customers collected directly from
ping list based on recipes chosen or ingredients on hand in the with instantaneous information respondents
consumer’s kitchen. The websites for The Gap and Old Navy about product acceptance, sales
provide consumers with the opportunity to purchase clothing performance, and buying behavior.
and other items from the convenience of their homes or offices. This information is important to planning and marketing strategy
Some sites, however, simply promote a company’s products but development.
do not offer them for sale online.
[ “The aim of promotion is to communicate directly or

indirectly with individuals, groups, and organizations
to facilitate exchanges.”
]
Two types of data are usually available to decision makers.
MARKETING RESEARCH Primary data are observed, recorded, or collected directly
from respondents. If you’ve ever participated in a telephone
AND INFORMATION survey about a product, recorded your TV viewing habits
for ACNielsen or Arbitron, or even responded to a political
SYSTEMS opinion poll, you provided the researcher with primary data.
Before marketers can develop a marketing mix, they must col- Primary data must be gathered by researchers who develop a
lect in-depth, up-to-date information about customer needs. method to observe phenomena or research respondents. Many
Marketing research is a systematic, objective process of companies use “mystery shoppers” to visit their retail establish-
getting information about potential customers to guide mar- ments and report on whether the stores were adhering to the
keting decisions. Such information might include data about companies’ standards of service. These undercover customers
the age, income, ethnicity, gender, and educational level of document their observations of store appearance, employee
people in the target market, their preferences for product fea- effectiveness, and customer treatment. This $1.5 billion
tures, their attitudes toward competitors’ products, and the fre- industry provides valuable information that helps companies
quency with which they use the product. For example, demand improve their organizations and refine their marketing strat-
for most carbonated beverages has been declining for several egies.18 Table 11.2 provides the results of an online mystery
years as consumers turn away from high-calorie bottled bever- shopping study of several retailers. Companies also use surveys
ages. Experts predict that soft-drink sales will continue to fall and focus groups to gauge customer opinion. A weakness of
secondary data
information that is
compiled inside or outside
surveys is that respondents are how they buy it—represents marketing research of the future.
an organization for some
purpose other than changing sometimes untruthful in order to New information technologies are changing the way businesses
the current situation avoid seeming foolish or ignorant. learn about their customers and market their products. Inter-
active multimedia research, or virtual testing, combines sight,
Some methods for marketing
sound, and animation to facilitate the testing of concepts as
research use passive observation
well as packaging and design features for consumer products.
of consumer behavior and open-ended questioning techniques.
The evolving development of telecommunications and com-
Called ethnographic or observational research, the approach
puter technologies is allowing marketing researchers quick and
can help marketers determine what consumers really think
easy access to a growing number of online services and a vast
about their products and how different ethnic or demographic
database of potential respondents.
groups react to them.
Marketing research can use digital media and social network-
Secondary data are compiled inside or outside the organi- ing sites to gather useful information for marketing decisions.
zation for some purpose other than changing the current situ- Sites such as Twitter, Facebook, Myspace, and LinkedIn can be
ation. Marketers typically use information compiled by the good substitutes for focus groups. Online surveys can serve as
U.S. Census Bureau and other government agencies, databases an alternative to mail, telephone, or personal interviews.
created by marketing research firms, as well as sales and other
Social networks are a great way to obtain information from
internal reports, to gain information about customers.
consumers who are willing to share their experiences about
products and companies. In a way, this process identifies those
Online Marketing Research consumers who develop an identity or passion for certain prod-
The marketing of products and collecting of data about buy- ucts, as well as those consumers who have concerns about qual-
ing behavior—information on what people actually buy and ity or performance. It is possible for firms to tap into existing
Marketers can go to Marketing News to learn more about new approaches

Starbucks conducts research to understand buyer behavior and provides being developed for research and to learn about top marketing research
motivational incentives to encourage consumers to patronize its stores. firms in the world.

buying behavior
the decision processes
and actions of people who
T A B L E 1 1 . 2 Online Mystery Shopping Study: Customer Service Leaders
purchase and use products
Number of Clicks
Number of from Product Number of perception the process
Hours for E-mail Customer Service Selection through Business Days for by which a person selects,
Response Rep Knowledgea Checkout Delivery organizes, and interprets
information received from
Blue Nile 0.22 2.0 5.0 3.0
his or her senses
Brooks Brothers 3.07 3.0 5.0 3.0
Coach 2.48 2.0 4.0 3.0 motivation inner drive
that directs a person’s
Crutchfield 1.27 3.0 5.0 3.0
behavior toward goals
Green Mountain 19.73 3.0 5.0 3.0
Museum of Modern Art 20.48 2.0 4.0 4.0 learning changes in a
person’s behavior based on
Lands’ End 6.52 2.5 4.0 3.0 information and experience
REI 0.37 2.0 5.0 3.0
attitude knowledge and
Saks Fifth Avenue 0.88 3.0 5.0 4.0
positive or negative feelings
Zappos 0.98 3.0 3.0 1.0 about something
Average of 100 retailers 20.69 2.24 5.42 4.05
personality the
a
Based on a scale of 1 to 3, with 3 being the most knowledgeable. organization of an
Source: “E-retailers Reach Out to Engage Shoppers,” Internet Retailer, April 2010, www.internetretailer.com/article. individual’s distinguishing
asp?id=34189 (accessed April 1, 2010). character traits, attitudes,
or habits
online social networks and simply “listen” to what consumers Psychological Variables of Buying
have on their mind. Firms can also encourage consumers to
join a community or group so that they can share their opin- Behavior
ions with the business. Psychological factors include the following:
A good outcome from using social networks is the opportu- • Perception is the process by which a person selects, orga-
nity to reach new voices and gain varied perspectives on the nizes, and interprets information received from his or her
creative process of developing new products and promotions. senses, as when hearing an advertisement on the radio or
For example, websites such as 99designs.com assist with prod- touching a product to better understand it.
uct design. To some extent, social networking is democratiz-
• Motivation, as we said in Chapter 9, is an inner drive that
ing design by welcoming consumers to join in the development
directs a person’s behavior toward goals. A customer’s behav-
process for new products.19 ior is influenced by a set of motives rather than by a single
motive. A buyer of a home computer, for example, may be
BUYING BEHAVIOR motivated by ease of use, ability to communicate with the
office, and price.
Carrying out the marketing concept is impossible unless mar-
keters know what, where, when, and how consumers buy; • Learning brings about changes in a person’s behavior based
conducting marketing research into the factors that influence on information and experience. If a person’s actions result
buying behavior helps marketers develop effective market- in a reward, he or she is likely to behave the same way in
similar situations. If a person’s actions bring about a negative
ing strategies. Buying behavior refers to the decision pro-
result, however—such as feeling ill after eating at a certain
cesses and actions of people who purchase and use products. It restaurant—he or she will probably not repeat that action.
includes the behavior of both consumers purchasing products
for personal or household use as well as organizations buying • Attitude is knowledge and positive or negative feelings
products for business use. Marketers analyze buying behav- about something. For example, a person who feels strongly
ior because a firm’s marketing strategy should be guided by about protecting the environment may refuse to buy products
an understanding of buyers. People view pets as part of their that harm the earth and its inhabitants.
families, and they want their pets to have the best of everything. • Personality refers to the organization of an individual’s
Iams, which markets the Iams and Eukanuba pet food brands, distinguishing character traits, attitudes, or habits. Although
recognized this trend and shifted its focus. Today, it markets market research on the relationship between personality and
high-quality pet food, fancy pet treats, sauces, and other items. buying behavior has been inconclusive, some marketers
Both psychological and social variables are important to an believe that the type of car or clothing a person buys reflects
understanding of buying behavior. his or her personality.

social roles a set of
expectations for individuals
based on some position
they occupy Social Variables
reference of Buying Behavior
groups groups with Social factors include social roles,
whom buyers identify and which are a set of expectations for
whose values or attitudes individuals based on some posi-
they adopt tion they occupy. A person may
have many roles: mother, wife,
social classes a student, executive. Each of these
ranking of people into roles can influence buying behav-
higher or lower positions of
ior. Consider a woman choosing
respect
an automobile. Her father advises
her to buy a safe, gasoline-efficient
car, such as a Volvo. Her teenaged
daughter wants her to buy a cool car, such as a Ford Mustang;
her young son wants her to buy a Ford Explorer to take on
camping trips. Some of her colleagues at work say she should
buy a hybrid Prius to help the environment. Thus, in choosing
which car to buy, the woman’s buying behavior may be affected
by the opinions and experiences of her family and friends and by
her roles as mother, daughter, and employee.
Other social factors include reference groups, social classes,
and culture.
• Reference groups include families, professional groups,
civic organizations, and other groups with whom buyers iden-
tify and whose values or attitudes they adopt. A person may
use a reference group as a point of comparison or a source
People’s cultures have a big impact on what they buy. The food-
of information. A person new to a community may ask other
seller Goya Foods sells more than three dozen types of beans to U.S.
group members to recommend a family doctor, for example.
supermarkets because people with different cultural roots demand
• Social classes are determined by ranking people into different types of beans. Which products are delivered to certain stores
higher or lower positions of respect. Criteria vary from one depends on the heritage of those living in each area.
YELP: WHERE negative reviews. All a business owner refuse to advertise through Yelp’s paid
can do is respond either publicly on the site system. To combat complaints, Yelp has
CONSUMERS HOLD or privately via e-mail to a reviewer. Yelp made filtered reviews visible, although they
THE POWER also runs an algorithm that filters certain are clearly marked as filtered. Stoppel-
reviews, claiming that this helps weed out man continues to support the company’s
false reviews. algorithm and claims that Yelp is striving
I f you want recommendations on a busi-
ness, Yelp may be just what you need.
Founded by Jeremy Stoppelman and Rus-
Yelp earns money by selling ad space
on the site to represented businesses, but
for greater transparency. Whether or not
Yelp’s actions serve to pacify its detractors,
sel Simmons, Yelp is a site on which con- according to Stoppelman, this does not companies are increasingly realizing that
sumers can rate and review businesses. allow business owners any greater free- the power structure between business and
Approximately 30 million users visit the site dom to control review content. What it consumer is changing—often in the con-
monthly. Yet while consumers may love does give them is the ability to eliminate sumer’s favor.20
Yelp, the site has a love-hate relationship advertisements of other companies on their
with many business owners. pages, the possibility for their ads to appear Discussion Questions
On the one hand, businesses with loyal on other pages, and the opportunity to post
1. What is the benefit of Yelp to consumers?
customers who post positive reviews on photo and video content.
Despite Stoppleman’s assurances, busi- 2. What challenges face businesses that
Yelp appreciate the viral nature of the site.
nesses have accused Yelp of manipulating are evaluated on Yelp?
A positive review can influence a range
reviews either to gain more advertising 3. How does Yelp contribute to improving
of potential customers. On the other hand,
customers or to punish companies that competition and the quality of products?
Yelp makes it easy for consumers to post

culture the integrated,
accepted pattern of human
behavior, including thought,
society to another. People within a particular social class may consumer behavior shifted from speech, beliefs, actions,
develop common patterns of behavior. People in the upper- conspicuous consumption to more and artifacts
middle class, for example, might buy a Lexus or a Cadillac as responsible purchasing. Consum-
a symbol of their social class. ers became more price conscious
• Culture is the integrated, accepted pattern of human and increased their use of coupons and other promotions. Bar-
behavior, including thought, speech, beliefs, actions, and gain stores like Dollar Tree Inc. and Family Dollar, for instance,
artifacts. Culture determines what people wear and eat and received many new customers who opted to “trade down” from
where they live and travel. Many Hispanic Texans and New more prestigious retailers. Even after the recession ended, sev-
Mexicans, for example, buy masa trigo, the dough used to eral consumers indicated that they would continue to shop at
prepare flour tortillas, which are basic to southwestern and these bargain stores for certain items.21 Retailers must adjust to
Mexican cuisine. meet these new needs of consumers.22
Understanding Buying Behavior

Although marketers try to understand buying behavior, it is THE MARKETING
extremely difficult to explain exactly why a buyer purchases a
particular product. The tools and techniques for analyzing con- ENVIRONMENT
sumers are not exact. Marketers may not be able to determine A number of external forces directly or indirectly influence the
accurately what is highly satisfying to buyers, but they know development of marketing strategies; the following political,
that trying to understand consumer wants and needs is the legal, regulatory, social, competitive, economic, and techno-
best way to satisfy them. During the last economic recession logical forces comprise the marketing environment.
Polo appeals to people who want to express social roles or identify with a reference group.

• Political, legal, and regulatory forces—laws and regulators’ planet’s largest contributor to greenhouse gases. For example,
interpretation of laws; law enforcement and regulatory activi- 80 percent of electricity generation in China is derived from
ties; regulatory bodies; legislators and legislation; and politi- coal, while coal generates only 45 percent of the total electric-
cal actions of interest groups. Specific laws, for example, ity in the United States. China’s pollution will create an envi-
require that advertisements be truthful and that all health
ronmental catastrophe unless there is increased pressure to
claims be documented.
utilize alternate energy sources.23
• Social forces—the public’s opinions and attitudes toward
issues such as living standards, ethics, the environment, life- The average American generates about five tons of greenhouse
styles, and quality of life. For example, social concerns have gases annually. Many people are disturbed by this statistic and
led marketers to design and market safer toys for children. have resolved to take actions that reduce their energy usage and
their impact on the environment through the use of carpool-
• Competitive and economic forces—competitive relationships,
ing, driving hybrid cars, using Energy Star products, and even
unemployment, purchasing power, and general economic
washing their clothes in cold water instead of hot. In addition
conditions (prosperity, recession, depression, recovery, prod-
uct shortages, and inflation). to fueling the demand for low-energy products, these devel-
opments are also accelerating the development of renewable
• Technological forces—computers and other technological energy such as solar and wind.24 If there is a cap on carbon
advances that improve distribution, pro- emissions in the United States, the prices
motion, and new-product development.
would rise for fossil fuels such as coal, oil,
Marketing requires creativity and con- and gas. More expensive renewable energy
sumer focus because environmental forces sources such as solar, wind, and biofuels
can change quickly and dramatically. TEAM EXERCISE would have a better chance for growth.
Changes can arise from social concerns Form groups and assign the responsi- For example, if turbine wind farms and
and economic forces such as price bility of finding examples of companies transmission lines were built in Montana
increases, product shortages, and alter- that excel in one dimension of the and the Dakotas, the region would have
ing levels of demand for commodities. marketing mix (price, product, promo- enough wind to provide 886 million mega-
Recently, climate change, global warming, tion, and distribution). Provide several watt hours a year, which would generate
and the impact of carbon emissions on our company and product examples, and billions of dollars in revenue and improve
environment have become social concerns defend why this would be an exem- prosperity.25
plary case. Present your research to
and are causing businesses to rethink Because such environmental forces are
the class.
marketing strategies. Possibly the most interconnected, changes in one may cause
important concern is to make businesses, changes in others. Consider that because of
consumers, and governments consider evidence linking children’s consumption
carbon emissions and how their purchases of soft drinks and fast foods to health
affect the environment. Escalating fossil fuel use in econo- issues such as obesity, diabetes, and osteoporosis, marketers of
mies such as China and India has placed strong upward pres- such products have experienced negative publicity and calls for
sure on oil prices. China’s fast development has made it the legislation regulating the sale of soft drinks in public schools.
Although the forces in the market-
F I G U R E 1 1 . 4 The Marketing Mix and the Marketing Environment ing environment are sometimes called
uncontrollables, they are not totally
so. A marketing manager can influ-
Political, Social ence some environmental variables.
Legal, and Forces
Regulatory For example, businesses can lobby leg-
Forces islators to dissuade them from passing
Product
unfavorable legislation. Figure 11.4
shows the variables in the marketing
environment that affect the marketing
Promotion Customer Price mix and the buyer. ■
Distribution
Technological Competitive
Forces and Economic
Forces
Marketing Environment

SO YOU WANT A JOB // in Marketing /
Y ou probably did not think as a child how
great it would be to grow up and become
a marketer. That’s because often marketing is
type, size, and location of the firm. An entry-
level market analyst may make between $24,000
and $50,000, while a market research director
customer loyalty. Information technology
plays a huge role in such marketing jobs,
as you need to combine technical skills and
associated with sales jobs, but opportunities in may earn from $75,000 to $200,000 or more. marketing knowledge to effectively com-
marketing, public relations, product manage- One of the most dynamic areas in market- municate with customers. Job titles include
ment, advertising, e-marketing, and customer ing is direct marketing, where a seller solic- e-marketing manager, customer relationship
relationship management and beyond represent its a response from a consumer using direct manager, and e-services manager. A CRM
almost one-third of all jobs in today’s business communications methods such as telephone, customer service manager may receive a
world. To enter any job in the marketing field, online communication, direct mail, or cata- salary in the $40,000 to $45,000 range, and
you must balance an awareness of customer logs. Jobs in direct marketing include buyers, experienced individuals in charge of online
needs with business knowledge while mixing in catalog managers, research/mail-list man- product offerings may earn up to $100,000.
creativity and the ability to obtain useful infor- agers, or order fulfillment managers. Most A job in any of these marketing fields will
mation to make smart business decisions. positions in direct marketing involve planning require a strong sense of the current trends
Marketing starts with understanding the and market analysis. Some require the use of in business and marketing. Customer service
customer. Marketing research is a vital aspect databases to sort and analyze customer infor- is vital to many aspects of marketing, so the
in marketing decision making and presents mation and sales history. ability to work with customers and to com-
many job opportunities. Market researchers Use of the Internet for retail sales is municate their needs and wants is important.
survey customers to determine their habits, growing, and the Internet continues to be Marketing is everywhere, from the corner
preferences, and aspirations. Activities include very useful for business-to-business sales. grocery or local nonprofit organization to the
concept testing, product testing, package test- E-marketing offers many career opportuni- largest multinational corporation, making it a
ing, test-market research, and new-product ties, including customer relationship manage- shrewd choice for an ambitious and creative
research. Salaries vary, depending on the ment (CRM). CRM helps companies market to person. We will provide additional job oppor-
nature and level of the position as well as the customers through relationships, maintaining tunities in marketing in Chapter 12.
GET ONLINE
mhhe.com/FerrellM3e
and video

twelve
dimensions of
marketing strategy
introduction
he key to developing a mar-
T
LEARNING OBJECTIVES
keting strategy is selecting a LO1 Describe the role of product in

the marketing mix, including how
target market and maintaining products are developed, classified,
a marketing mix that creates long- and identified.
LO2 Define price, and discuss its
term relationships with customers. importance in the marketing mix,
Getting just the right mix of product, including various pricing strategies
a firm might employ.
price, promotion, and distribution is
LO3 Identify factors affecting
critical if a business is to satisfy its distribution decisions, such as
target customers and achieve its own marketing channels and intensity of
market coverage.
objectives (implement the marketing LO4 Specify the activities involved in
concept). promotion, as well as promotional
strategies and promotional
In Chapter 11, we introduced the positioning.
concept of marketing and the vari-
ous activities important in develop-
ing a marketing strategy. In this
chapter, we’ll take a closer look at
the four dimensions of the marketing
mix—product, price, distribution, and
promotion—used to develop the mar-
keting strategy. The focus of these
marketing mix elements is a market-
ing strategy that builds customer
relationships and satisfaction.
CHAPTER 12 | Dimensions of Marketing Strategy 241

THE MARKETING MIX and customization processes explain why it has secured such a
large share of the computer industry.2
The marketing mix is the part of marketing
strategy that involves decisions regarding con-
trollable variables. To develop meaningful cus-
tomer relationships, marketers have to develop
PRODUCT STRATEGY
As mentioned previously, the term product
and manage the dimensions of the marketing refers to goods, services, and ideas. Because the
mix to give their firm an advantage over com- product is often the most visible of the market-
petitors. Successful companies offer at least ing mix dimensions, managing product deci-
one dimension of value that surpasses all com- sions is crucial. In this section, we’ll consider
petitors in the marketplace in meeting customer product development, classification, mix, life
expectations. However, this does not mean that DID YOU KNOW? cycle, and identification.
a company can ignore the other dimensions of
the marketing mix; it must maintain acceptable, Less than 10 percent Developing New Products
and if possible distinguishable, differences in the of new products Each year thousands of products are introduced,
other dimensions as well. succeed in the but few of them succeed. For instance, The
Walmart, for example, emphasizes price (“Save marketplace, and 90 Coca-Cola Company spent two years develop-
money, live better”). Procter & Gamble is well percent of successes ing Coke BlāK, a Coca-Cola coffee drink aimed
known for its promotion of top consumer brands come from a handful at an older audience. The product failed to take
such as Tide, Cheer, Crest, Ivory, and Head & of companies.1 off in the United States and was discontinued
Shoulders. Dell Computers’ efficient distribution less than two years after its launch.3 Figure 12.1
While attending Yale in 1966, FedEx founder Fred Smith studied a mathematical discipline called topology, which inspired his vision for creating the
company. Realizing the potential efficiencies of connecting all points on a network through a central hub, Smith used what he learned to get FedEx off
the ground.

shows the different steps in the product development process. Research teams then present their ideas to Microsoft engineers
Before introducing a new product, a business must follow a who are developing specific products. As we said in Chapter
multistep process: idea development, the screening of new 11, ideas sometimes come from customers, too. Other sources
ideas, business analysis, product development, test marketing, are brainstorming and intracompany incentives or rewards
and commercialization. A firm can take considerable time to for good ideas. New ideas can even create a company. Las
get a product ready for the market: It took more than 20 years Vegas–based Shuffle Master, for example, grew out of entre-
for the first photocopier, for example. Although the Nissan Leaf preneur John Breeding’s idea for a card-shuffling machine.
was officially unveiled in 2009, it was not released until late The Shuffle Master now has more than 22,000 shuffling units
2010. This did not stop the Nissan Leaf from winning the Green installed around the world.5
Car Vision Award in 2010, several months before its release.4
New Idea Screening The next step in developing a new
Idea Development New ideas can come from marketing product is idea screening. In this phase, a marketing manager
research, engineers, and outside sources such as advertising should look at the organization’s resources and objectives and
agencies and management consultants. Microsoft has a sepa- assess the firm’s ability to produce and market the product.
rate division—Microsoft Research—where scientists devise Important aspects to be considered at this stage are consumer
technology of the future. The division has more than 800 desires, the competition, technological changes, social trends,
researchers who work in a university-like research atmosphere. and political, economic, and environmental considerations.
Each year thousands of products are introduced,

but few of them succeed.
Basically, there are two reasons new products succeed: They are
FIGURE 12.1 able to meet a need or solve a problem better than products
Product Development Process already available or they add variety to the product selection
currently on the market. Bringing together a team of knowl-
edgeable people including designers, engineers, marketers, and
Idea generation customers is a great way to screen ideas. Using the Internet to
encourage collaboration represents a rich opportunity for mar-
keters to screen ideas. Most new product ideas are rejected dur-
Product screening ing screening because they seem inappropriate or impractical
for the organization.
Business Analysis Business analysis is a basic assessment

Concept testing of a product’s compatibility in the marketplace and its potential
profitability. Both the size of the market and competing prod-
ucts are often studied at this point. The most important ques-
tion relates to market demand: How will the product affect the
Business analysis firm’s sales, costs, and profits?
Product Development If a product survives the first

Product three steps, it is developed into a prototype that should reveal
development the intangible attributes it possesses as perceived by the con-
sumer. Product development is often expensive, and few
product ideas make it to this stage. New product research and
Testing marketing development costs vary. Adding a new color to an existing item
may cost $100,000 to $200,000, but launching a completely
new product can cost millions of dollars. The Coca-Cola Co.
reduced the time and cost of product development research
Commercialization
by 50 percent when it created an online panel of 100 teenag-
ers and asked them how to remake its Powerade sports drink.6

test marketing commercialization consumer business products
a trial minilaunch of the full introduction of a products products products that are used
a product in limited complete marketing strategy intended for household or directly or indirectly in the
During product development,
areas that represent the and the launch of the product family use operation or manufacturing
various elements of the mar-
potential market for commercial success processes of businesses
keting mix must be developed
for testing. Copyrights, tenta-
tive advertising copy, packag-
FIGURE 12.2 ing, labeling, and descriptions of a target
ACNielsen Market Decisions market are integrated to develop an over-
all marketing strategy.
Market Decisions Test Marketing Test marketing

Test Market Locations
is a trial minilaunch of a product in limited
areas that represent the potential market.
It allows a complete test of the marketing
Portland
strategy in a natural environment, giv-
Boise ing the organization an opportunity to
discover weaknesses and eliminate them
before the product is fully launched. Con-
Peoria sider Tide Basic, a product released by
Colorado Evansville
Springs Procter & Gamble to appeal to money-con-
Lexington
scious consumers during the most recent
recession. Tide Basic was a stripped-down
Charleston
version of the company’s Tide laundry
Tucson detergent that cost 20 percent less. It was
meant to appeal to consumers who needed
to save money but still wanted the same
Permanent Test Markets basic benefits that Tide had to offer. P&G
(“Data Markets”) started out by testing it in limited markets
and then initially introduced the new prod-
Additional “Custom” Test Markets
uct into only 100 stores in the South. How-
ever, the product was not on the market for
Source: “Test Marketing,” ACNielsen (n.d.), www.acnielsen.com/services/testing/test1.htm (accessed June
long before Procter & Gamble discontin-
5, 2004). Reprinted with permission of ACNielsen Market Decisions.
ued it. Tide Basic demonstrates that even
at the test marketing stage, products have a
high chance of being discarded.7 Because test marketing requires
significant resources and expertise, market research companies
like ACNielsen can assist firms in test marketing their products.
Figure 12.2 shows the permanent sites as well as custom locations
for test marketing.
Commercialization Commercialization is the full

introduction of a complete marketing strategy and the launch of
the product for commercial success. During commercialization,
the firm gears up for full-scale production, distribution, and pro-
motion. To compete more effectively against coffee chains like
Starbucks, McDonald’s introduced its first American McCafé
in Chicago in 2001. In 2007, the company introduced iced cof-
fee to its menu and began testing its new line of espresso-based
beverages. However, it took two more years before McDonald’s
implemented nationwide commercialization of its McCafés.
The launch was McDonald’s largest in 30 years.8
Classifying Products
When consumers are shopping for specialty products such as rare Products are usually classified as either consumer products or
antiques, they go to great lengths to get what they want and often aren’t industrial products. Consumer products are for household
willing to accept substitutes. or family use; they are not intended for any purpose other than

product line
a group of closely related
products that are treated
daily living. They can be further classified as convenience prod- such as paper, pencils, paint,
as a unit because of
ucts, shopping products, and specialty products on the basis of cleaning supplies, and so on.
similar marketing strategy,
consumers’ buying behavior and intentions. • Industrial services include finan- production, or end-use
• Convenience products, such as eggs, milk, bread, and news- cial, legal, marketing research, considerations
papers, are bought frequently, without a lengthy search, and security, janitorial, and exter-
minating services. Purchasers product mix
often for immediate consumption. Consumers spend virtually
decide whether to provide these all the products offered by
no time planning where to purchase these products and usually
services internally or to acquire an organization
accept whatever brand is available.
them from an outside supplier.
• Shopping products, such as furniture, audio equipment, cloth-
ing, and sporting goods, are purchased after the consumer has Product Line
compared competitive products and “shopped around.” Price,
product features, quality, style, service, and image all influ- and Product Mix
ence the decision to buy. Product relationships within an organization are of key impor-
• Specialty products, such as ethnic foods, designer clothing tance. A product line is a group of closely related products
and shoes, art, and antiques, require even greater research that are treated as a unit because of a similar marketing strat-
and shopping effort. Consumers know what they want and go egy. At Colgate-Palmolive, for example, the oral-care product
out of their way to find it; they are not willing to accept a line includes Colgate toothpaste, toothbrushes, and dental floss.
substitute. A product mix is all the products offered by an organization.
Figure 12.3 displays a sampling of the product mix and product
Business products are used directly or indirectly in the lines of the Colgate-Palmolive Company.
operation or manufacturing processes of businesses. They
are usually purchased for the operation of an organization Product Life Cycle
or the production of other products; thus, their purchase is Like people, products are born, grow, mature, and eventually
tied to specific goals and objectives. They too can be further die. Some products have very long lives. Ivory Soap was intro-
classified: duced in 1879 and is still popular. In contrast, a new computer
• Raw materials are natural products taken from the earth, chip is usually outdated within a year because of technological
oceans, and recycled solid waste. Iron ore, bauxite, lumber, breakthroughs and rapid changes in the computer industry.
cotton, and fruits and vegetables are examples. There are four stages in the life cycle of a product: introduc-
• Major equipment covers large, expensive items used in pro- tion, growth, maturity, and decline (Figure 12.4). The stage a
duction. Examples include earth-moving equipment, stamp- product is in helps determine marketing strategy. While pickup
ing machines, and robotic equipment used on auto assembly trucks have historically sold very well in the United States, sales
lines. have reached the maturity stage, declining after a peak in 2004.
The percentage of new vehicles sold reveals more car sales than
• Accessory equipment includes items used for produc-
tion, office, or management purposes, which usually do not truck sales. As oil prices continue to fluctuate and carbon out-
become part of the final product. Computers, fax machines, puts become more of a concern, consumers are looking for
calculators, and hand tools better gas mileage, and the demand for fuel-efficient cars is on
are examples.
• Component parts are fin- FIGURE 12.3
ished items, ready to be Colgate-Palmolive’s Product Mix and Product Lines
assembled into the company’s
final products. Tires, window Product Mix
glass, batteries, and spark
plugs are component parts of Oral Care Personal Care Household Care Pet Nutrition
Colgate Total Softsoap Liquid Soaps Palmolive Dishwashing Hill’s Science Diet
automobiles.
Toothpaste Softsoap Foam Works for Liquids Hill’s Prescription Diet
• Processed materials are things Colgate MaxFresh Kids Murphy Oil Soap
used directly in production Toothpaste Ajax Powder Cleanser
Product Lines
or management operations
but are not readily identifi- Colgate 360˚ Irish Spring bar soaps Suavitel Liquid Fabric
Toothbrush Speed Stick Conditioners
able as component parts.
Colgate Wave Lady Speed Stick Suavital Dryer Sheets
Varnish, for example, is a pro-
cessed material for a furniture Colgate 2in1 Kids Afta Aftershave
manufacturer. Colgate Dora the Skin Bracer Aftershave
Explorer
• Supplies include materials that
make production, management, Source: “Colgate World of Care,” Colgate-Palmolive Company, 2008, www.colgate.com/app/Colgate/US/HomePage.
and other operations possible, cvsp (accessed April 8, 2010).

SILLY BANDZ: A to make a sturdier version into a bracelet. Marvel Comics and Justin Bieber to rep-
Croak believed that kids would be drawn to resent Marvel’s characters and Bieber’s
FLASH IN THE PAN, collecting and trading these bands. In terms likeness in Silly Bandz form. The company
OR HERE TO STAY? of marketing, Croak claims that everything has introduced Silly Necklaces, Silly Ringz,
was done virally via social media sites like and Silly Caribinerz. Croak is also in talks
Facebook, YouTube, and the Silly Bandz with Zoo Games to develop a videogame.
T he title for toy fad in 2010 went to Silly
Bandz, the company credited with
beginning the U.S. craze for stretchy brace-
website. Although Croak has no publicist
or marketing plan, this hasn’t seemed to
Will these efforts be enough to extend the
brand for years to come? Or will Silly Bandz
lets. Yet for all of its popularity, it is uncer- deter the product’s success. In 2009 the soon become a product beloved only by
tain whether Silly Bandz is a fad (something company sold 100 packages per week. One collectors?9
that quickly ascends in popularity and just year later, it was selling roughly one million
as quickly vanishes) or a trend (something packages weekly. Discussion Questions
with lasting relevance). Silly Bandz founder The question is whether this item has a 1. Do you think Silly Bandz are a fad or a
Robert Croak is determined to make Silly future. Retailers have begun cutting back trend?
Bandz last through multiple product lines, on Silly Bandz, with 7-Eleven reporting a 2. Why do you think children are drawn to
licensing deals, and more. 97 percent drop in sales since its peak. Silly Bandz?
Silly Bandz was born when Croak visited Croak wants to extend the product’s life by
3. Can you think of ways to extend the Silly
a Chinese trade show and discovered rub- introducing related products and improv-
Bandz brand?
ber bands shaped like animals. He decided ing existing ones. He has signed deals with
FIGURE 12.4
point-and-shoot nozzle, the company started
The Life Cycle of a Product a major media campaign to spread aware-
ness of the product and its benefits. By using
a combination of word-of-mouth advertising,
social networking sites, and large publicity
Introduction Growth Maturity Decline stunts like forming a team to cook more than
76,000 pancakes in a record eight hours, the
Sales company has gotten Batter Blaster into 15,000
Volume U.S. outlets and realized annual revenues
of $19.5 million.11 Figure 12.5 shows some
familiar products at different stages of the
product life cycle. Sales accelerate as the prod-
Profit
uct enters the growth stage of the life cycle.
In the growth stage, sales increase rapidly and

profits peak, then start to decline. One rea-
son profits start to decline during the growth
stage is that new companies enter the market,
driving prices down and increasing market-
ing expenses. Consider Apple’s iPod, the most
popular digital music player with more than 70
percent of the music player market. Since its
launch, 275 million iPods have been sold and
the rise. Electric vehicles are in the introductory stage but with over 10 billion songs sold. To maintain its high growth, Apple
continued demand will quickly pass into the growth stage.10 has also introduced the iTunes 10, the iPod Classic, and the iPod
Touch.12 During the growth stage, the firm tries to strengthen
In the introductory stage, consumer awareness and acceptance its position in the market by emphasizing the product’s benefits
of the product are limited, sales are zero, and profits are nega- and identifying market segments that want these benefits.
tive. Profits are negative because the firm has spent money on
research, development, and marketing to launch the prod- Sales continue to increase at the beginning of the maturity
uct. During the introductory stage, marketers focus on mak- stage, but then the sales curve peaks and starts to decline while
ing consumers aware of the product and its benefits. When profits continue to decline. This stage is characterized by severe
former restaurant owner Sean O’Connor introduced Batter competition and heavy expenditures. In the highly competitive
Blaster, a canned organic pancake and waffle batter mix with a snack food industry, Quaker is converting mature products

branding
the process of naming and
identifying products
FIGURE 12.5
Products at Different Stages of the Life Cycle trademark
a brand that is registered
Introduction Growth Maturity Decline with the U.S. Patent and
3D television DVRs Flat-screen televisions AM/FM radios Trademark Office and is
thus legally protected from
YouTube movies Netflix Laptop computers VCRs use by any other firm
Electric cars Tablet computers Netbook computers Desktop computers
to single-serve lower-calorie treats. Because 100-calorie packs activities that help position a product appropriately for its tar-
were a smash success for Quaker and competitor Kraft, rivals get market.
across the industry are introducing 90-, 80-, even 60-calorie
versions of mature products in hopes of maintaining sales.13 Branding Branding is the process of naming and iden-
tifying products. A brand is a name, term, symbol, design,
During the decline stage, sales continue to or combination that identifies a product
fall rapidly. Profits also decline and may and distinguishes it from other products.
even become losses as prices are cut and
necessary marketing expenditures are During the Consider that Google, iPod, and TiVo
are brand names that are used to identify
made. As profits drop, firms may elimi-
nate certain models or items. To reduce
decline stage, entire product categories, much like Xerox
has become synonymous with photocopy-
expenses and squeeze out any remaining sales continue to ing and Kleenex with tissues. Protecting
profits, marketing expenditures may be cut a brand name is important in maintain-
back, even though such cutbacks acceler- fall rapidly. Profits ing a brand identity. The world’s 10 most
ate the sales decline. Finally, plans must
be made for phasing out the product and also decline and valuable brands are shown in Table 12.1.
The brand name is the part of the brand
introducing new ones to take its place. In
2010, General Motors sold its final Hum-
may even become that can be spoken and consists of letters,
words, and numbers—such as WD-40
mer SUVs at steeply reduced prices. The losses as prices are lubricant. A brand mark is the part of the
company discontinued the brand because brand that is a distinctive design, such
of its poor fuel economy, negative public cut and necessary as the silver star on the hood of a Mer-
opinion, and plummeting sales. GM also
phased out its Saturn and Pontiac brands. marketing cedes or McDonald’s golden arches logo.
A trademark is a brand that is registered
At the same time, it should be noted that expenditures with the U.S. Patent and Trademark Office
product stages do not always go one way. and is thus legally protected from use by
Some products that have moved to the are made. any other firm.
maturity stage or to the decline stage can
still rebound through redesign or new uses TABLE 12.1 The 10 Most Valuable Brands in the World
for the product. One prime example is baking
soda. Originally, baking soda was used only for % Brand Value Change
Rank Brand Brand Value 2011 ($M) 2011 vs. 2010
cooking, which meant it reached the maturity
stage very quickly. However, once it was dis- 1 Apple $153,285 84%
covered that baking soda could be used as a 2 Google 111,498 – 2
deodorizer, sales shot up and bumped baking
soda back into the growth stage.14 Similarly, 3 IBM 100,849 17
Mattel is trying to make a comeback with Bar- 4 McDonald’s 81,016 23
bie by releasing new lines of redesigned dolls. 5 Microsoft 78,243 2
For example, their “fashionista” dolls have 12 6 Coca-Cola 73,752 8
movable joints and wear clothes similar to what
7 AT&T 69,916 N/A
is found on the runway. Mattel also released So
in Style, its first line of black dolls.15 8 Marlboro 67,522 18
9 China Mobile 57,326 9
Identifying Products 10 GE 50,318 12
Branding, packaging, and labeling can be used Source: “Brandz Top 100 Most Valuable Global Brands 2011,” Millward Brown Optimor, www.
to identify or distinguish one product from millwardbrown.com/libraries/optimor_brandz_files/2011_brandz_top100_chart.sflb.ashx (accessed
others. As a result, they are key marketing August 11, 2011).

manufacturer private distributor generic products packaging
brands brands brands brands, products with no brand the external container that
initiated and owned by the which may cost less than name that often come holds and describes the
Another type of brand that
manufacturer to identify manufacturer brands, that in simple packages and product
products from the point of are owned and controlled carry only their generic has developed is generic
production to the point of by a wholesaler or retailer name products—products with no
purchase brand name at all. They often
come in plain simple pack-
ages that carry only the generic
name of the product—peanut
butter, tomato juice, aspirin, dog food, and so on. They appeal
to consumers who may be willing to sacrifice quality or product
consistency to get a lower price.
Companies use two basic approaches to branding multiple
products. In one, a company gives each product within its
complete product mix its own brand name. Warner-Lambert,
for example, sells many well-known consumer products—
Dentyne, Chiclets, Listerine, Halls, Rolaids, and Trident—
each individually branded. This branding policy ensures that
the name of one product does not affect the names of others,
and different brands can be targeted at different segments of
the same market, increasing the company’s market share (its
percentage of the sales for the total market for a product).
Another approach to branding is to develop a family of brands
with each of the firm’s products carrying the same name or
at least part of the name. Gillette, Sara Lee, and IBM use this
approach. Finally, consumers may react differently to domes-
tic versus foreign brands, Table 12.2 provides a snapshot of
the most popular car brands with the majority from different
countries.
This phone with no brand name would appear to be a generic product
and does not provide a signal to the consumer as to product quality.
Packaging The packaging, or external container that
holds and describes the product, influences consumers’ atti-
tudes and their buying decisions. In a Harris Interactive Panel,
three-fourths of respondents replied they would be willing to
Two major categories of brands are manufacturer brands pay more money for certain packaging attributes. Some of the
and private distributor brands. Manufacturer brands are more important attributes cited included reusability, “staying
brands initiated and owned by the manufacturer to identify
products from the point of production to the point of pur-
chase. Kellogg’s, Sony, and Texaco are examples. Private
distributor brands, which may be less expensive than man- TABLE 12.2 Best-Selling Vehicle Brands
ufacturer brands, are owned and controlled by a wholesaler Ranking Car Model Country of Origin
or retailer, such as Kenmore appliances (Sears) and Sam’s
grocery products (Walmart and Sam’s Wholesale Club). The 1 Ford F-Series Pickup United States
names of private brands do not usually identify their manu- 2 Chevrolet Silverado United States
facturer. While private-label brands were once considered 3 Toyota Camry Japan
cheaper and of poor quality, such as Walmart’s Ol’Roy dog
4 Honda Accord Japan
food, many private-label brands are increasing in quality and
image and are competing with national brands. For instance, 5 Toyota Corolla Japan
several companies are hiring professional designers to design 6 Nissan Altima Japan
their private-label brands, replacing the traditional two-color 7 Honda Civic Japan
packaging schemes often associated with private-label prod-
8 Ford Fusion United States
ucts. In fact, the grocery retailer Tesco has several types of
private-label brands, and its branding strategy has performed 9 Chevrolet Malibu United States
so effectively that consumers may end up paying more for 10 Hyundai Sonata South Korea
Tesco’s own products than for branded goods.16 Manufac- Source: Joann Muller, “The Year’s Bestselling Cars,” ABC News, November
turer brands are fighting hard against private distributor 10, 2010, http://abcnews.go.com/Business/forbes-years-bestselling-cars/
brands. story?id=12069787 (accessed January 14, 2011).

labeling
the presentation of important
information on a package
fresh longer,” and stating that the product is “made in the customers. Quality products are
United States.”17 It is estimated that consumers’ eyes linger often referred to as reliable, dura- quality the degree to
only 2.5 seconds on each product on an average shopping trip; ble, easily maintained, easily used, which a good, service, or
therefore, product packaging should be designed to attract and a good value, or a trusted brand idea meets the demands
hold consumers’ attention. name. The level of quality is the and requirements of
amount of quality that a product customers
A package can perform several functions including protec-
possesses, and the consistency of
tion, economy, convenience, and promotion. Beverage man-
quality depends on the product
ufacturers have been redesigning their bottles to make them
maintaining the same level of quality over time.
more convenient for consumers and to promote them to cer-
tain markets. Scientists videotaped people drinking from dif- Quality of service is difficult to gauge because it depends on
ferent types of bottles and made plaster casts of their hands. customers’ perceptions of how well the service meets or exceeds
They found that the average gulp is around 1 ounce and that their expectations. In other words, service quality is judged by
half the population would rather suck liquid through a pop-up consumers, not the service providers. A bank may define ser-
top than sip it. Since the early 1990s, soft drinks in 20-ounce vice quality as employing friendly and knowledgeable employ-
plastic bottles revitalized U.S. sales for Coca-Cola and PepsiCo ees, but the bank’s customers may be more concerned with
by getting Americans to drink larger servings. Recent concerns waiting time, ATM access, security, and statement accuracy.
about health and the desire for lower-priced options have led Similarly, an airline traveler considers on-time arrival, on-board
both companies to test a variety of smaller container sizes to food service, and satisfaction with the ticketing and boarding
win back lost customers.18 process. The American Customer Satisfaction Index produces
customer satisfaction scores for 10 economic sectors, 44 indus-
Labeling Labeling, the presentation of important informa- tries, and more than 200 companies. The latest results show that
tion on the package, is closely associated with packaging. The overall customer satisfaction was 75.7 (out of a possible 100),
content of labeling, often required by law, may include ingredi- with increases in some industries balancing drops in others.
ents or content, nutrition facts (calories, fat, etc.), care instruc- Customer satisfaction with the banking industry has started
tions, suggestions for use (such as recipes), the manufacturer’s to recover, while satisfaction with health insurance went down
address and toll-free number, website, and other useful infor- 2.7 percent.19 Table 12.3 shows the rankings of nine U.S. airline
mation. This information can have a strong impact on sales. carriers. Southwest Airlines had the least customer complaints,
The labels of many products, particularly food and drugs, must whereas Delta had the highest customer complaint rate.20
carry warnings, instructions, certifications, or manufacturers’
The quality of services provided by businesses on the Inter-
identifications.
net can be gauged by consumers on such sites as Consumer-
Product Quality Quality reflects the degree to which a Reports.org and BBBOnline. The subscription service offered
good, service, or idea meets the demands and requirements of by ConsumerReports.org provides consumers with a view of
e-commerce sites’ business, security, and privacy policies, while
BBBOnline is dedicated to promoting responsibility online.
As consumers join in by posting business and product reviews
on the Internet on sites such as Yelp, the public can often get a
T A B L E 1 2 . 3 Airline Rankings According to Customer

Complaints (From Least to Greatest)
Rank Airline
1 Southwest
2 Alaska
3 AirTran
4 JetBlue
5 American
6 Continental
7 US Airways
8 United
9 Delta
The labels on these Clorox Green Works cleaning supplies inform Source: Scott McCartney, “The Big Guys Finish Last in 2010 Airline Rankings,”
consumers that the chemicals are derived from natural sources. The Wall Street Journal, January 13, 2011, p. D1.

Google built a high-quality search engine that soon dominated the industry and made it one of the most valuable brands worldwide.
FIGURE 12.6
Calculating the Value of Your Product
Step 1: Step 2: Step 3: Step 4:
Determine Calculate
Identity target Identity their best value based on its
your product’s
customers. alternative. differentiation.
difference.
Source: Rafi Mohammed, “Use Price to Profit and Grow,” Forbes.com, March 25, 2010, www.forbes.com/2010/03/25/
profit-gain-value-mckinsey-sears-whirlpool-cmo-network-rafi-mohammed.html (accessed March 31, 2010).
much better idea of the quality of certain goods and services.

Quality can also be associated with where the product is made. PRICING STRATEGY
For example, “Made in U.S.A.” labeling can be perceived as hav- Previously, we defined price as the value placed on an object
ing a different value and quality. There are differences in the exchanged between a buyer and a seller. Buyers’ interest in price
perception of quality and value between the U.S. consumers stems from their expectations about the usefulness of a product
and Europeans when comparing products made in the United or the satisfaction they may derive from it. Because buyers have
States, Japan, Korea, and China.21 limited resources, they must allocate those resources to obtain the

price skimming
charging the highest possible
price that buyers who want
products they most desire. They must decide whether the bene- Talisman collection of rough-cut the product will pay
fits gained in an exchange are worth the buying power sacrificed. and uncut diamond jewelry capital-
Almost anything of value can be assessed by a price. Many factors izing on ancient beliefs of the power penetration price
may influence the evaluation of value, including time constraints, and allure of uncut diamonds.23 a low price designed to help
price levels, perceived quality, and motivations to use available a product enter the market
Price is probably the most flex-
information about prices.22 Figure 12.6 illustrates a method for and gain market share rapidly
ible variable in the marketing mix.
calculating the value of your product. Indeed, consumers vary
Although it may take years to
in their response to price: Some focus solely on the lowest price,
develop a product, establish chan-
while others consider quality or the prestige associated with a
nels of distribution, and design and implement promotion, a
product and its price. Some types of consumers are increasingly
product’s price may be set and changed in a few minutes. Under
“trading up” to more status-conscious products, such as auto-
certain circumstances, of course, the price may not be so flex-
mobiles, home appliances, restaurants, and even pet food, yet
ible, especially if government regulations prevent dealers from
remain price-conscious for other products such as cleaning and
controlling prices. Of course, price also depends on the cost to
grocery goods. In setting prices, marketers must consider not just
manufacture a good or provide a service or idea. A firm may
a company’s cost to produce a product or service, but the per-
temporarily sell products below cost to match competition, to
ceived value of that item in the marketplace. Products’ perceived
generate cash flow, or even to increase market share, but in the
value has benefited marketers at Starbucks, Sub-Zero, BMW, and
long run it cannot survive by selling its products below cost.
Petco—which can charge premium prices for high-quality, pres-
tige products—as well as Sam’s Clubs and Costco—which offer
basic household products at everyday low prices.
Pricing Objectives
Pricing objectives specify the role of price in an organization’s
Price is a key element in the marketing mix because it relates marketing mix and strategy. They usually are influenced not
directly to the generation of revenue and profits. In large part, only by marketing mix decisions but also by finance, account-
the ability to set a price depends on the supply of and demand ing, and production factors. Maximizing profits and sales,
for a product. For most products, the quantity demanded goes boosting market share, maintaining the status quo, and survival
up as the price goes down, and as the price goes up, the quan- are four common pricing objectives.
tity demanded goes down. Changes in buyers’ needs, variations
in the effectiveness of other marketing mix variables, the pres- Specific Pricing Strategies
ence of substitutes, and dynamic environmental factors can Pricing strategies provide guidelines for achieving the com-
influence demand. New demand has greatly increased prices for pany’s pricing objectives and overall marketing strategy. They
industrial-grade diamonds as jewelers have turned to the impure specify how price will be used as a variable in the marketing
gems, typically used for drill bits and saws, as a fashion statement. mix. Significant pricing strategies relate to the pricing of new
Even diamond giant De Beers has turned to the fashion, with its products, psychological pricing, and price discounting.
Pricing New Products Setting the price for a new prod-

uct is critical: The right price leads to profitability; the wrong
price may kill the product. In general, there are two basic
strategies to setting the base price for a new product. Price
skimming is charging the highest possible price that buy-
ers who want the product will pay. Starbucks’ new Via coffee,
for example, sells at a price of $2.95 for a trio of single-serve
packets and $9.95 for 12 packets. Per serving, Via is priced
four times higher than market leader Nestlé.24 This strategy
allows the company to generate much-needed revenue to help
offset the costs of research and development. Conversely, a
penetration price is a low price designed to help a product
enter the market and gain market share rapidly. For exam-
ple, when Industrias Añaños introduced Kola Real to capi-
talize on limited penetration of Coca-Cola and Pepsi Cola in
Peru, it set an ultralow penetration price to appeal to the poor
who predominate in the region. Kola Real quickly secured
one-fifth of the Peruvian market and has since made signifi-
cant gains in Ecuador, Venezuela, and Mexico, forcing larger
soft-drink marketers to cut prices.25 Penetration pricing is
In a highly competitive industry, CenturyLink has developed a pricing objective less flexible than price skimming; it is more difficult to raise a
of boosting market share with its $14.95 discounted Internet service. penetration price than to lower a skimming price. Penetration

are many types, quantity, seasonal, and promotional discounts
are among the most widely used. Quantity discounts reflect the
economies of purchasing in large volume. Seasonal discounts to
buyers who purchase goods or services out of season help even
out production capacity. Promotional discounts attempt to
improve sales by advertising price reductions on selected prod-
ucts to increase customer interest. Often promotional pricing is
geared toward increased profits. Taco Bell, with its reputation
for value, has been labeled the “best-positioned U.S. brand” to
do well in a recession economy as consumers look for cheaper
fast-food options. Taco Bell offers a Why Pay More? menu
with selections priced at 79¢, 89¢, and 99¢. KFC, Wendy’s, and
McDonald’s all offer Value Menus as well, with items priced
around $1.
DISTRIBUTION STRATEGY
The best products in the world will not be successful unless
companies make them available where and when cus-
tomers want to buy them. In this section, we will explore
dimensions of distribution strategy, including the channels
through which products are distributed, the intensity of mar-
ket coverage, and the physical handling of products during
distribution.
Marketing Channels
A marketing channel, or channel of distribution, is a
group of organizations that move products from their pro-
The pricing strategy of an independently owned ice cream business can
ducer to customers. Marketing channels make products
have a premium price objective because of the quality of the product available to buyers when and where they desire to purchase
and the unique atmosphere. them. Organizations that bridge the gap between a product’s
manufacturer and the ultimate consumer are called middle-
men, or intermediaries. They create time, place, and owner-
pricing is used most often when marketers suspect that com- ship utility. Two intermediary organizations are retailers and
petitors will enter the market shortly after the product has wholesalers.
been introduced.
Retailers buy products from manufac-
Psychological Pricing Psychological turers (or other intermediaries) and sell
pricing encourages purchases based on them to consumers for home and house-
emotional rather than rational responses hold use rather than for resale or for use
to the price. For example, the assumption Today, in producing other products. Toys ‘Я’ Us,
behind even/odd pricing is that people will for example, buys products from Mattel
buy more of a product for $9.99 than $10 there are too many and other manufacturers and resells them
because it seems to be a bargain at the odd to consumers. Retailing usually occurs in a
price. The assumption behind symbolic/pres-
stores competing for store, but the Internet, vending machines,
tige pricing is that high prices connote high too few customers, mail-order catalogs, and entertainment,
quality. Thus the prices of certain fragrances such as going to a Chicago Bulls basket-
are set artificially high to give the impression and, as a result, ball game, also provide opportunities for
of superior quality. Some over-the-counter retailing. By bringing together an assort-
drugs are priced high because consumers competition between ment of products from competing produc-
associate a drug’s price with potency. ers, retailers create utility. Retailers arrange
similar retailers has for products to be moved from producers
Price Discounting Temporary price never been more to a convenient retail establishment (place
reductions, or discounts, are often utility). They maintain hours of operation
employed to boost sales. Although there intense. for their retail stores to make merchandise

psychological discounts marketing channel retailers wholesalers
pricing encouraging temporary price reductions, a group of organizations intermediaries who buy intermediaries who buy
purchases based on often employed to boost that move products from products from manufacturers from producers or from
emotional rather than rational sales their producer to customers; (or other intermediaries) and other wholesalers and sell
responses to the price also called a channel of sell them to consumers for to retailers
distribution home and household use
rather than for resale or
for use in producing other
products
available when consumers want it (time utility). They also stores, and online retailers. Many traditional retailers, such as
assume the risk of ownership of inventories (ownership util- Walmart and Macy’s, have created online shopping sites to
ity). Table 12.4 describes various types of general merchandise retain customers and compete with online-only retailers. One
retailers. of the best-known online-only, or cyber, merchants is Ama-
zon.com. Amazon offers millions of products from which to
Today, there are too many stores competing for too few cus-
choose, all from the privacy and convenience of the purchaser’s
tomers, and, as a result, competition between similar retailers
home. In some cases, Web merchants offer wide selections,
has never been more intense. In addition, retailers face chal-
ultra-convenience, superior service, knowledge, and the best
lenges such as shoplifting, as indicated in Table 12.5. Further,
products.
competition between different types of stores is changing
the nature of retailing. Supermarkets compete with specialty Wholesalers are intermediaries who buy from producers or
food stores, wholesale clubs, and discount stores. Department from other wholesalers and sell to retailers. They usually do not
stores compete with nearly every other type of store includ- sell in significant quantities to ultimate consumers. Wholesal-
ing specialty stores, off-price chains, category killers, discount ers perform the functions listed in Table 12.6.
TABLE 12.4 General Merchandise Retailers

Type of Retailer Description Examples
Department store Large organization offering wide product mix and organized into separate Macy’s, JCPenney, Sears
departments
Discount store Self-service, general merchandise store offering brand name and private Walmart, Target
brand products at low prices
Supermarket Self-service store offering complete line of food products and some nonfood Kroger, Albertson’s, Winn-Dixie
products
Superstore Giant outlet offering all food and nonfood products found in supermarkets, as Walmart Supercenters
well as most routinely purchased products
Hypermarket Combination supermarket and discount store, larger than a superstore Carrefour
Warehouse club Large-scale, members-only establishments combining cash- Sam’s Club, Costco
and-carry wholesaling with discount retailing
Warehouse showroom Facility in a large, low-cost building with large on-premises inventories and Ikea
minimum service
Catalog showroom Type of warehouse showroom where consumers shop from a catalog and Service Merchandise
products are stored out of buyers’ reach and provided in manufacturer’s carton
Source: William M. Pride and O. C. Ferrell, Marketing: Concepts and Strategies, 2008, p. 428. Copyright 2008 by Houghton Mifflin Company. Reprinted with permission.
TABLE 12.5 Statistics on Shoplifting in the United States
Number of shoplifters in the United States 27 million (1 in 11 people)

Amount retailers lose per year More than $13 billion (more than $35 million per day)
Percentage of shoplifters who are adults 75%
Percentage of adult shoplifters who started in their teens 55%
Average frequency of habitual shoplifters About 1.6 times per week
Source: “Shoplifting Statistics,” National Association for Shoplifting Prevention, www.shopliftingprevention.org/WhatNASPOffers/NRC/PublicEducStats.htm

TABLE 12.6 Major Wholesaling Functions
Supply chain management Creating long-term partnerships among channel members
Promotion Providing a sales force, advertising, sales promotion, and publicity
Warehousing, shipping, and product handling Receiving, storing, and stockkeeping
Packaging
Shipping outgoing orders
Materials handling
Arranging and making local and long-distance shipments
Inventory control and data processing Processing orders
Controlling physical inventory
Recording transactions
Tracking sales data for financial analysis
Risk taking Assuming responsibility for theft, product obsolescence, and excess inventories
Financing and budgeting Extending credit
Making capital investments
Forecasting cash flow
Marketing research and information systems Providing information about market
Conducting research studies
Managing computer networks to facilitate exchanges and relationships
Source: William M. Pride and O. C. Ferrell, Marketing: Concepts and Strategies, 2008, p. 389. Copyright 2008 by Houghton Mifflin Company. Reprinted with permission.
Wholesalers are extremely important because of the marketing needed” basis, is now open, honest, and ongoing. Perhaps most
activities they perform, particularly for consumer products. importantly, the points of contact in the relationship expand from
Although it is true that wholesalers can be eliminated, their one-on-one at the salesperson–buyer level to multiple interfaces
functions must be passed on to some other entity, such as the at all levels and in all functional areas of the various organizations.
producer, another intermediary, or even the customer. Whole-
salers help consumers and retailers by buying in large quanti- Channels for Consumer Products Typical market-
ties, then selling to retailers in smaller quantities. By stocking an ing channels for consumer products are shown in Figure 12.7.
assortment of products, wholesalers match products to demand. In Channel A, the product moves from the producer directly
to the consumer. Farmers who sell their fruit and vegetables to
Supply Chain Management In an effort to improve consumers at roadside stands use a direct-from-producer-to-
distribution channel relationships among manufacturers and consumer marketing channel.
other channel intermediaries, supply chain management creates In Channel B, the product goes from producer to retailer to
alliances between channel members. In Chapter 8, we defined consumer. This type of channel is used for products such as
supply chain management as connecting and integrating all college textbooks, automobiles, and appliances. In Channel C,
parties or members of the distribution system in order to satisfy the product is handled by a wholesaler and a retailer before
customers. It involves long-term partnerships among market- it reaches the consumer. Producer-to-wholesaler-to-retailer-
ing channel members working together to reduce costs, waste, to-consumer marketing channels distribute a wide range of
and unnecessary movement in the entire marketing channel products including refrigerators, televisions, soft drinks, ciga-
in order to satisfy customers. It goes beyond traditional chan- rettes, clocks, watches, and office products. In Channel D, the
nel members (producers, wholesalers, retailers, customers) to product goes to an agent, a wholesaler, and a retailer before
include all organizations involved in moving products from going to the consumer. This long channel of distribution is
the producer to the ultimate customer. In a survey of business especially useful for convenience products. Candy and some
managers, a disruption in the supply chain was viewed as the produce are often sold by agents who bring buyers and sellers
number-one crisis that could decrease revenue.26 together.
The focus shifts from one of selling to the next level in the chan- Services are usually distributed through direct marketing chan-
nel to one of selling products through the channel to a satisfied nels because they are generally produced and consumed simul-
ultimate customer. Information, once provided on a guarded, “as taneously. For example, you cannot take a haircut home for

later use. Many services require the cus- FIGURE 12.7
tomer’s presence and participation: The Marketing Channels for Consumer Products
sick patient must visit the physician to
receive treatment; the child must be at the
day care center to receive care; the tourist A B C D
must be present to sightsee and consume
tourism services. Producer Producer Producer Producer
Channels for Business Products

In contrast to consumer goods, more
than half of all business products, espe- Agents
cially expensive equipment or techni- (Intermediaries)
cally complex products, are sold through
direct marketing channels. Business
customers like to communicate directly
with producers of such products to gain Wholesalers Wholesalers
(Intermediaries) (Intermediaries)
the technical assistance and personal
assurances that only the producer can
offer. For this reason, business buyers
prefer to purchase expensive and highly Retailers Retailers Retailers
complex mainframe computers directly (Intermediaries) (Intermediaries) (Intermediaries)
from IBM, Cray, and other mainframe
producers. Other business products may
be distributed through channels employ-
ing wholesaling intermediaries such as Consumers Consumers Consumers Consumers
industrial distributors and/or manufac-
turer’s agents.
Intensity of Market
Coverage
A major distribution decision is how widely to distribute a Intensive distribution makes a product available in as many
product—that is, how many and what type of outlets should outlets as possible. Because availability is important to purchas-
carry it. The intensity of market coverage depends on buyer ers of convenience products such as bread, milk, gasoline, soft
behavior, as well as the nature of the target market and the drinks, and chewing gum, a nearby location with a minimum
competition. Wholesalers and retailers provide various inten- of time spent searching and waiting in line is most important to
sities of market coverage and must be selected carefully to the consumer. To saturate markets intensively, wholesalers and
ensure success. Market coverage may be intensive, selective, or many varied retailers try to make the product available at every
exclusive. location where a consumer might desire to purchase it. Zoom
WILL BABY CARROTS marketing campaign to promotionally posi- the installation of carrot vending machines.
tion baby carrots as a healthier, hip snack The machines have already met with some
BECOME THE NEW food in the minds of consumers. As part success. At one school, students began
SNACK FOOD? of the campaign, baby carrot sellers are purchasing baby carrots—at 50 cents
switching to chiplike packaging and edgy a pack—soon after the machine was
slogans. The website babycarrots.com was installed. If Bolthouse and its compatriots
B olthouse Farms and similar companies

are challenging the $18 billion salty
snack food industry by making baby car-
also launched to promote this new image,
featuring a baby carrots iPhone game app,
are correct, kids are just as open to healthy
snacks as they are to junk food. The mar-
fun videos, and more. In addition, Bolt- keting campaigns simply have to resonate
rots just as fun as junk food. The baby house is working to intensively distribute with them.27
carrot industry has launched a $25 million its revamped products into schools through

intensive selective exclusive physical distribution transportation
distribution distribution distribution the all the activities necessary the shipment of products to
a form of market coverage a form of market coverage awarding by a manufacturer to move products from buyers
whereby a product is made whereby only a small to an intermediary of the sole producers to customers—
available in as many outlets number of all available right to sell a product in a inventory control,
as possible outlets are used to expose defined geographic territory transportation, warehousing,
products and materials handling
Selective distribution uses only a small number of all avail-

able outlets to expose products. It is used most often for prod-
ucts that consumers buy only after shopping and comparing
price, quality, and style. Many products sold on a selective basis
require salesperson assistance, technical advice, warranties,
or repair service to maintain consumer satisfaction. Typical
products include automobiles, major appliances, clothes, and
furniture.
Exclusive distribution exists when a manufacturer gives an
intermediary the sole right to sell a product in a defined geo-
graphic territory. Such exclusivity provides an incentive for a
dealer to handle a product that has a limited market. Exclusive
distribution is the opposite of intensive distribution in that prod-
Railroads are one of the least expensive transportation modes for
ucts are purchased and consumed over a long period of time,
shipping products. However, they lack the flexibility that trucks have.
and service or information is required to develop a satisfactory
sales relationship. Products distributed on an exclusive basis
Systems provides robotic vending machines for products beyond include high-quality musical instruments, yachts, airplanes, and
candy and drinks. Zoom has more than a thousand machines in high-fashion leather goods.
airports and hotels across the United States, some selling items
such as Apple iPods, Neutrogena hair and skin products, and Physical Distribution
Sony products. The vending machines accept credit cards and
Physical distribution includes all the activities necessary
allow sales to occur in places where storefronts would be impos-
to move products from producers to customers—inventory
sible.28 Through partnering with different companies, today’s
control, transportation, warehousing, and materials handling.
ZoomShops sell a variety of brands including products from
Physical distribution creates time and place utility by making
Sephora, Best Buy, Macy’s, and Rosetta Stone.29
products available when they are wanted, with adequate service
and at minimum cost. Both goods and services require physi-
cal distribution. Many physical distribution activities are part
of supply chain management, which we discussed in Chapter 8;
we’ll take a brief look at a few more now.
Transportation Transportation, the shipment of prod-

ucts to buyers, creates time and place utility for products, and
thus is a key element in the flow of goods and services from
producer to consumer. The five major modes of transporta-
tion used to move products between cities in the United States
are railways, motor vehicles, inland waterways, pipelines, and
airways.
Railroads offer the least expensive transportation for many
products. Heavy commodities, foodstuffs, raw materials, and
coal are examples of products carried by railroads. Trucks
have greater flexibility than railroads because they can reach
more locations. Trucks handle freight quickly and economi-
cally, offer door-to-door service, and are more flexible in
their packaging requirements than are ships or airplanes.
Air transport offers speed and a high degree of dependabil-
Actress Vanessa Hudgens endorses the junior fashion brand Candie’s. ity but is the most expensive means of transportation; ship-
Candie’s is exclusively sold through Kohl’s Department Stores. ping is the least expensive and slowest form. Pipelines are

warehousing
the design and operation of
facilities to receive, store,
used to transport petroleum, natural gas, semiliquid coal, increase a warehouse’s useful and ship products
wood chips, and certain chemicals. Many products can be capacity and improve customer
moved most efficiently by using more than one mode of service. Well-coordinated loading materials handling
transportation. and movement systems increase the physical handling and
efficiency and reduce costs. movement of products
Factors affecting the selection of a mode of transportation in warehousing and
include cost, capability to handle the product, reliability, and
availability, and, as suggested, selecting transportation modes
Importance of transportation
requires trade-offs. Unique characteristics of the product and Distribution in a

consumer desires often determine the mode selected. Marketing Strategy
Distribution decisions are among the least flexible market-
Warehousing Warehousing is the design and operation
ing mix decisions. Products can be changed over time; prices
of facilities to receive, store, and ship products. A warehouse
can be changed quickly; and promotion is usually changed
facility receives, identifies, sorts, and dispatches goods to stor-
regularly. But distribution decisions often commit resources
age; stores them; recalls, selects, or picks goods; assembles the
and establish contractual relationships that are difficult if not
shipment; and finally, dispatches the shipment.
impossible to change. As a company attempts to expand into
Companies often own and operate their own private ware- new markets, it may require a complete change in distribution.
houses that store, handle, and move their own products. They Moreover, if a firm does not manage its marketing channel in
can also rent storage and related physical distribution services the most efficient manner and provide the best service, then a
from public warehouses. Regardless of whether a private or a new competitor will evolve to create a more effective distribu-
public warehouse is used, warehousing is important because it tion system.
makes products available for shipment to match demand at dif-
ferent geographic locations.
Materials Handling Materials handling is the physical PROMOTION STRATEGY

handling and movement of products in warehousing and trans- The role of promotion is to communicate with individuals,
portation. Handling processes may vary significantly due to groups, and organizations to facilitate an exchange directly or
product characteristics. Efficient materials-handling procedures indirectly. It encourages marketing exchanges by attempting to
FINDING THE REAL other ingredients remain unsustainable. on companies making false claims. For
This might be akin to a company claiming now consumers must investigate green
GREEN PRODUCTS that its product is green since one of the claims for themselves. Such an investiga-
ingredients is organic cotton, while simulta- tion could include looking for third-party
W hat makes a green product green?

This question is actually quite
complicated. The growing popularity of
neously glossing over the fact that the prod-
uct also consists of nonrecyclable plastics
certification of a product’s “greenness,”
paying attention to ingredient lists, and
or chemicals. Unfortunately, the subjective looking for information at trustworthy
eco-friendly products is encouraging busi- nature of greenwashing makes it harder to websites. However, until more stringent
nesses to create and sell more green items. detect, as consumers themselves differ on guidelines are created, the term green is
However, some businesses are cutting what is green and what is greenwashing. likely to remain steeped in subjectivity.30
corners by touting their products as green For instance, some consumers feel misled
when they really aren’t—a form of mis- by Cascade Farm’s logo of a small idyllic Discussion Questions
conduct known as greenwashing. Green- farm when they discover that the brand is 1. How do you tell if a product is really
washers make unjustifiable “green” claims actually owned by General Mills. Others are green?
about their products to appeal to the eco- unconcerned as long as the brand’s organic 2. Are you concerned that Cascade Farms,
friendly consumer. As a result, 40 percent claims are true. owned by General Mills, is making valid
of consumers claim that they don’t know The topic of greenwashing has become organic claims?
how to ensure that a company is really so pervasive that it is prompting govern-
eco-friendly. 3. What will happen to companies and their
ment intervention. The Federal Trade Com-
One common way that companies products if consumers find their green
mission is releasing guidelines to define
engage in greenwashing is by sustainably claims are false?
what is acceptable in green advertising.
sourcing one product ingredient while the The FTC has also begun cracking down

integrated marketing advertising advertising campaign
communications a paid form of nonpersonal designing a series of
coordinating the promotion communication transmitted advertisements and placing
mix elements and through a mass medium, such them in various media to reach Advertising Perhaps the best-known
synchronizing promotion as a as television commercials or a particular target market form of promotion, advertising is a paid
unified effort magazine advertisements form of nonpersonal communication trans-
mitted through a mass medium, such as tele-
vision commercials, magazine advertisements
or online ads. Even Google, one of the most
persuade individuals, groups, and organizations to accept goods, powerful brands in the world, advertises. Google has turned
services, and ideas. Promotion is used not only to sell products to outdoor advertising on buses, trains, and ballparks in San
but also to influence opinions and attitudes toward an orga- Francisco and Chicago to promote its Google Maps feature.31
nization, person, or cause. The state of Texas, for example, has Commercials featuring celebrities, customers, or unique cre-
successfully used promotion to educate people about the costs ations (the Energizer Bunny, for example) serve to grab view-
of highway litter, which has thereby reduced littering. Most ers’ attention and pique their interest in a product. Table 12.7
people probably equate promotion with advertising, but it also shows companies that spent more than $1 billion on ads in the
includes personal selling, publicity, and sales promotion. The United States in one year.
role that these elements play in a marketing strategy is extremely
important. An advertising campaign involves designing a series of
advertisements and placing them in various media to reach
The Promotion Mix a particular target audience. The basic content and form of
Advertising, personal selling, publicity, and sales promotion are an advertising campaign are a function of several factors. A
collectively known as the promotion mix because a strong promo- product’s features, uses, and benefits affect the content of the
tion program results from the careful selection and blending of campaign message and individual ads. Characteristics of the
these elements. The process of coordinating the promotion mix people in the target audience—gender, age, education, race,
elements and synchronizing promotion as a unified effort is called income, occupation, lifestyle, and other attributes—influence
integrated marketing communications. When planning both content and form. When Procter & Gamble promotes
promotional activities, an integrated marketing communications Crest toothpaste to children, the company emphasizes daily
approach results in the desired message for customers. Differ- brushing and cavity control, whereas it promotes tartar control
ent elements of the promotion mix are coordinated to play their and whiter teeth when marketing to adults. To communicate
appropriate roles in delivery of the message on a consistent basis. effectively, advertisers use words, symbols, and illustrations
ADVERTISING MEDIA ARE THE VEHICLES OR FORMS OF

COMMUNICATION USED TO REACH A DESIRED AUDIENCE.
TABLE 12.7 Top 10 Leading National Advertisers
that are meaningful, familiar, and attractive to people in the
Advertising Expenditures target audience.
Organization (in millions)
An advertising campaign’s objectives and platform also affect
1. Procter & Gamble $4,188.9
the content and form of its messages. If a firm’s advertis-
2. Verizon Communications 3,020.0 ing objectives involve large sales increases, the message may
3. AT&T 2,797.0 include hard-hitting, high-impact language and symbols.
4. General Motors Co. 2,214.9 When campaign objectives aim at increasing brand awareness,
5. Johnson & Johnson 2,060.9
the message may use much repetition of the brand name and
words and illustrations associated with it. Thus, the advertis-
6. Pfizer 2,097.0
ing platform is the foundation on which campaign messages
7. Walt Disney Company 2,003.8 are built.
8. Time Warner 1,848.1
Advertising media are the vehicles or forms of communication
9. L’Oreal 1,833.6 used to reach a desired audience. Print media include newspa-
10. Kraft Foods 1,748.4 pers, magazines, direct mail, and billboards, while electronic
Source: “Marketer Trees 2010,” Ad Age Data Center, December 20, 2010,
media include television, radio, and cyber ads. Newspapers,
http://adage.com/datacenter/marketertrees2010update#225 (accessed April 7, television, and direct mail are the most widely used advertising
2011). media.

This advertisement for Perrier water promotes a message of hope and relief. While many advertisers are informative in nature, this particular ad focuses
more on making an emotional impact.
Choice of media obviously influences the content and form of technique is to blur the lines between television and online
the message. Effective outdoor displays and short broadcast advertising. TV commercials may point viewers to a website
spot announcements require concise, simple messages. Maga- for more information, where short “advertainment” films con-
zine and newspaper advertisements can include considerable tinue the marketing message. For instance, Super Bowl adver-
detail and long explanations. Because several kinds of media tisers are beginning to use social media sites to complement
offer geographic selectivity, a precise message can be tailored their television advertisements. Mercedes-Benz and Audi both
to a particular geographic section of the target audience. For created social media contests to offer rewards to consumers
example, a company advertising in Time might decide to use who were willing to promote the brands through these sites in
one message in the New England region and another in the rest unconventional ways. The contests were held before the 2011
of the nation. A company may also choose to advertise in only Super Bowl. The companies hoped to create longer lasting rela-
one region. Such geographic selectivity lets a firm use the same tionships with consumers than they would have done if they
message in different regions at different times. had simply used a 30-second television slot during the Super
Bowl.32
The use of online advertising is increasing. However, adver-
tisers are demanding more for their ad dollars and proof that Infomercials—typically 30-minute blocks of radio or televi-
they are working. Certain types of ads are more popular than sion air time featuring a celebrity or upbeat host talking about
pop-up ads and banner ads that consumers find annoying. One and demonstrating a product—have evolved as an advertising

personal selling publicity
direct, two-way communication nonpersonal communication
with buyers and potential buyers transmitted through the mass 3. Presenting: Getting the prospect’s attention with a product
media but not paid for directly by demonstration.
the firm
4. Handling objections: Countering reasons for not buying the
product.
5. Closing: Asking the prospect to buy the product.
method. Toll-free numbers and website addresses are usually 6. Following up: Checking customer satisfaction with the pur-
provided so consumers can conveniently purchase the product chased product.
or obtain additional information. Although many consum-
ers and companies have negative feelings about infomercials, Publicity Publicity is nonpersonal communication trans-
apparently they get results. mitted through the mass media but not paid for directly by
the firm. A firm does not pay the media cost for publicity and
Personal Selling Personal selling is direct, two-way is not identified as the originator of the message; instead, the
communication with buyers and potential buyers. For many message is presented in news story form. Obviously, a com-
products—especially large, expensive ones with specialized pany can benefit from publicity by releasing to news sources
uses, such as cars, appliances, and houses—interaction between newsworthy messages about the firm and its involvement with
a salesperson and the customer is probably the most important the public. Many companies have public relations departments
promotional tool. to try to gain favorable publicity and minimize negative public-
Personal selling is the most flexible of the promotional methods ity for the firm.
because it gives marketers the greatest opportunity to communi-
Although advertising and publicity are both carried by the
cate specific information that might trigger a purchase. Only per-
mass media, they differ in several major ways. Advertising
sonal selling can zero in on a prospect and attempt to persuade that
messages tend to be informative, persuasive, or both; pub-
person to make a purchase. Although personal selling has a lot of
licity is mainly informative. Advertising is often designed to
advantages, it is one of the most costly forms of promotion. A sales
have an immediate impact or to provide specific information
call on an industrial customer can cost as much as $200 or $300.
to persuade a person to act; publicity describes what a firm
There are three distinct categories of salespersons: order takers is doing, what products it is launching, or other newsworthy
(for example, retail sales clerks and route salespeople), creative information, but seldom calls for action. When advertising is
salespersons (for example, automobile, furniture, and insur- used, the organization must pay for media time and select the
ance salespeople), and support salespersons (for example, cus- media that will best reach target audiences. The mass media
tomer educators and goodwill builders who usually do not take willingly carry publicity because they believe it has general
orders). For most of these salespeople, personal selling is a six- public interest. Advertising can be repeated a number of
step process: times; most publicity appears in the mass media once and is
not repeated.
1. Prospecting: Identifying potential buyers of the product.
2. Approaching: Using a referral or calling on a customer with- Advertising, personal selling, and sales promotion are espe-
out prior notice to determine interest in the product. cially useful for influencing an exchange directly. Publicity is
extremely important when communication focuses on a com-
pany’s activities and products and is directed at interest groups,
current and potential investors, regulatory agencies, and soci-
ety in general.
A variation of traditional advertising is buzz marketing, in
which marketers attempt to create a trend or acceptance of
a product. Companies seek out trendsetters in communi-
ties and get them to “talk up” a brand to their friends, family,
co-workers, and others. For example, to create buzz around
the newest season of the television show Mad Men, the AMC
network and partnering sponsors hold a “New York’s Gone
Mad” event in Manhattan’s Time Square. The event features a
live screening of the premiere, a 1960s costume contest, trivia
contest, and cocktail party. Digital media is also heavily uti-
lized to publicize the event.33 Other marketers using the buzz
technique include Hebrew National (“mom squads” grilled the
Many Internet companies, such as Google, offer advertising services to company’s hot dogs), and Chrysler (its retro PT Cruiser was
companies who want to target consumers through digital media. planted in rental fleets). The idea behind buzz marketing is that

sales promotion
direct inducements offering
added value or some other
an accepted member of a particular social group will be more purchasing and increases dealer incentive for buyers to
credible than any form of paid communication.34 The concept effectiveness in selling products. enter into an exchange
works best as part of an integrated marketing communication It is used to enhance and supple-
program that also includes traditional advertising, personal ment other forms of promotion. push strategy
selling, sales promotion, and publicity. Test drives allow salespersons an attempt to motivate
to demonstrate vehicles, which intermediaries to push
A related concept is viral marketing, which describes the con- the product down to their
can help purchase decisions.
cept of getting Internet users to pass on ads and promotions customers
Sampling a product may also
to others. For example, the restaurant Kogi, which operates
encourage consumers to buy. pull strategy
Korean taco trucks that traverse the Los Angeles area, was
PepsiCo, for example, used sam- the use of promotion to
dubbed by Newsweek as “America’s First Viral Restaurant”
pling to promote its Sierra Mist create consumer demand for
after it began using Twitter and the Web to announce the
soft drink to reach more than 5 a product so that consumers
whereabouts of its taco trucks.35
million potential consumers at exert pressure on marketing
well-traveled sites such as Times channel members to make it
Sales Promotion Sales promotion involves direct
Square and Penn Station.37 In a available
inducements offering added value or some other incentive
given year, almost three-fourths
for buyers to enter into an exchange. Sales promotions are
of consumer product companies
generally easier to measure and less expensive than advertis-
may use sampling.
ing. The major tools of sales promotion are store displays,
premiums, samples and demonstrations, coupons, contests
and sweepstakes, refunds, and trade shows. Coupon-clipping
Promotion Strategies:
in particular has become more common during the recent To Push or To Pull
recession. While coupons in the past decade tradition- In developing a promotion mix, organizations must decide
ally had a fairly low redemption rate, with about 2 percent whether to fashion a mix that pushes or pulls the product
being redeemed, the recent recession caused an upsurge in (Figure 12.8). A push strategy attempts to motivate inter-
coupon usage. In one marketing research study, 60 percent mediaries to push the product down to their customers. When
of respondents under the age of 35 reported using coupons a push strategy is used, the company attempts to motivate
during a six-month period. The website “Coupon Mom” also wholesalers and retailers to make the product available to their
saw a significant rise in membership, from a membership of customers. Sales personnel may be used to persuade interme-
100,000 per month to 1.5 million per month one year later.36 diaries to offer the product, distribute promotional materials,
While coupons can be a valuable tool in sales promotion, and offer special promotional incentives for those who agree
they cannot be relied upon to stand, but should be part of an to carry the product. For example, Kimberly-Clark has begun
overall promotion mix. Sales promotion stimulates customer partnering with its retailers to create a “win–win situation” for
both types of companies. By sharing point-of-sales data with
retailers and running more effective promotions, Kimberly-
Clark hopes to create favorable relationships with its inter-
mediaries to push its products through the system.38 A pull
strategy uses promotion to create consumer demand for a
product so that consumers exert pressure on marketing chan-
nel members to make it available. For example, Anheuser-
Busch launched the “Budweiser Happy Hour”—a nationwide
event where consumers 21 years and older could receive free
Budweiser samples—in order to generate interest among
younger beer drinkers. Although beer demand is high for con-
sumers between the ages of 21 and 30, younger beer drinkers
have largely ignored the Budweiser brand. Anheuser-Busch is
thereby using a pull strategy in an attempt to create demand
among this age group.39 Such sampling prior to a product roll-
out encourages consumers to request the product from their
favorite retailer.
A company can use either strategy, or it can use a variation
Companies use a pull strategy by offering coupons through the or combination of the two. The exclusive use of advertis-
RetailMeNot website in the hopes of convincing customers to visit their ing indicates a pull strategy. Personal selling to marketing
stores. channel members indicates a push strategy. The allocation of

promotional
positioning
the use of promotion to
promotional resources to various mar- For example, auto manufacturers often provide rebates, free
create and maintain an
keting mix elements probably deter- options, or lower-than-market interest rates to stabilize sales
image of a product in
buyers’ minds mines which strategy a marketer uses. and thereby keep production lines moving during temporary
slowdowns. A stable sales pattern allows the firm to run effi-
Objectives of ciently by maintaining a consistent level of production and
Promotion storage and utilizing all its functions so that it is ready when
sales increase.
The marketing mix a company uses depends on its objectives.
It is important to recognize that promotion is only one element An important role of any promotional program is to inform
of the marketing strategy and must be tied carefully to the goals potential buyers about the organization and its products. A
of the firm, its overall marketing objectives, and the other ele- major portion of advertising in the United States, particularly
ments of the marketing strategy. Firms use promotion for many in daily newspapers, is informational. Providing information
reasons, but typical objectives are to stimulate demand, to sta- about the availability, price, technology, and features of a prod-
bilize sales, and to inform, remind, and reinforce customers. uct is very important in encouraging a buyer to move toward a
Increasing demand for a product is probably the purchase decision. Nearly all forms of promo-
most typical promotional objective. Stimulat- tion involve an attempt to help consumers
ing demand, often through advertising and learn more about a product and a company.
sales promotion, is particularly important TEAM EXERCISE Promotion is also used to remind con-
when a firm is using a pull strategy. Form groups and search for examples
sumers that an established organization is
of convenience products, shopping
Another goal of promotion is to stabilize still around and sells certain products that
products, specialty products, and
sales by maintaining the status quo—that business products. How are these have uses and benefits. Often advertising
is, the current sales level of the product. products marketed? Provide examples reminds customers that they may need to
During periods of slack or decreasing sales, of any ads that you can find to show use a product more frequently or in certain
contests, prizes, vacations, and other sales examples of the promotional strate- situations. Pennzoil, for example, has run
promotions are sometimes offered to cus- gies for these products. Report your television commercials reminding car own-
tomers to maintain sales goals. Advertising findings to the class. ers that they need to change their oil every
is often used to stabilize sales by making 3,000 miles to ensure proper performance
customers aware of slack use periods. of their cars.
FIGURE 12.8
Push and Pull Strategies
Push Strategy
Producer Wholesalers Retailers Consumers
Pull Strategy
Producer Wholesalers Retailers Consumers
Flow of Communications

SO YOU WANT TO BE // a Marketing Manager /
M any jobs in marketing are closely tied to
the marketing mix functions: distribu-
tion, product, promotion, and price. Often the
manager can be rewarding both financially
and psychologically.
Some of the most creative roles in the
jobs can be found in large department stores.
A section manager coordinates inventory
and promotions and interacts with buyers,
job titles could be sales manager, distribution business world are in the area of advertising. salespeople, and consumers. The buyer’s
or supply chain manager, advertising account Advertising pervades our daily lives, as busi- job is fast-paced, often involving much travel
executive, or store manager. nesses and other organizations try to grab and pressure. Buyers must be open-minded
A distribution manager arranges for trans- our attention and tell us about what they have and foresighted in their hunt for new, poten-
portation of goods within firms and through to offer. Copywriters, artists, and account tially successful items. Regional managers
marketing channels. Transportation can be executives in advertising must have creativ- coordinate the activities of several retail
costly, and time is always an important fac- ity, imagination, artistic talent, and expertise stores within a specific geographic area,
tor, so minimizing their effects is vital to the in expression and persuasion. Advertising is usually monitoring and supporting sales,
success of a firm. Distribution managers an area of business in which a wide variety of promotions, and general procedures. Retail
must choose one or a combination of trans- educational backgrounds may be useful, from management can be exciting and chal-
portation modes from a vast array of options, degrees in advertising itself, to journalism or lenging. Growth in retailing is expected to
taking into account local, federal, and inter- liberal arts degrees. Common entry-level posi- accompany the growth in population and is
national regulations for different freight tions in an advertising agency are found in the likely to create substantial opportunities in
classifications; the weight, size, and fragility traffic department, account service (account the coming years.
of products to be shipped; time schedules; coordinator), or the media department (media While a career in marketing can be very
and loss and damage ratios. Manufacturing assistant). Advertising jobs are also avail- rewarding, marketers today agree that the
firms are the largest employers of distribution able in many manufacturing or retail firms, job is getting tougher. Many advertising and
managers. nonprofit organizations, banks, professional marketing executives say the job has gotten
A product manager is responsible for associations, utility companies, and other much more demanding in the past 10 years,
the success or failure of a product line. This arenas outside of an advertising agency. viewing their number-one challenge as bal-
requires a general knowledge of advertis- Although a career in retailing may begin ancing work and personal obligations. Other
ing, transportation modes, inventory control, in sales, there is much more to retailing than challenges include staying current on indus-
selling and sales management, promotion, simply selling. Many retail personnel occupy try trends or technologies, keeping motivated/
marketing research, packaging, and pricing. management positions, focusing on select- inspired on the job, and measuring success. If
Frequently, several years of selling and sales ing and ordering merchandise, promotional you are up to the challenge, you may find that
management experience are prerequisites activities, inventory control, customer credit a career in marketing is just right for you to
for such a position as well as college training operations, accounting, personnel, and store utilize your business knowledge while exer-
in business administration. Being a product security. Many specific examples of retailing cising your creative side as well.
Reinforcement promotion attempts to assure current users result of market segmentation. In both promotional position-
of the product that they have made the right choice and tells ing and market segmentation, the firm targets a given prod-
them how to get the most satisfaction from the product. Also, uct or brand at a portion of the total market. A promotional
a company could release publicity statements through the news strategy helps differentiate the product and makes it appeal to
media about a new use for a product. Additionally, firms can a particular market segment. For example, to appeal to safety-
have salespeople communicate with current and potential cus- conscious consumers, Volvo heavily promotes the safety and
tomers about the proper use and maintenance of a product—all crashworthiness of Volvo automobiles in its advertising. Volks-
in the hope of developing a repeat customer. wagen has done the same thing with its edgy ads showing car
crashes. Promotion can be used to change or reinforce an image.
Promotional Positioning Effective promotion influences customers and persuades them
Promotional positioning uses promotion to create and to buy. ■
maintain an image of a product in buyers’ minds. It is a natural

GET ONLINE
mhhe.com/FerrellM3e
and video

thirteen

digital marketing
+ social networking
introduction 1
he Internet and information tech- its fast, easy-to-use search engine,
T nology have dramatically changed

the environment for business.
Marketers’ new ability to convert all
Google became number one and is now
challenging many industries, includ-
ing advertising, newspapers, mobile
types of communications into digital phones, and book publishing. Despite its
media has created efficient, inexpen- victory, Google is constantly being chal-
sive ways of connecting businesses and lenged itself by competitors like Yahoo
consumers and has improved the flow and Baidu. The Chinese search engine
and the usefulness of information. Busi- Baidu represents a particular threat
nesses have the information they need continued on p. 268
to make more informed decisions, and
consumers have access to a greater LEARNING OBJECTIVES
variety of products and more informa- LO1 Define digital media and digital mar-
keting and recognize their increasing
tion about choices and quality. value in strategic planning.
The defining characteristic of infor- LO2 Understand the characteristics of
mation technology in the 21st century is digital media and how they differ-
entiate these methods from tradi-
accelerating change. New systems and tional marketing activities.
applications advance so rapidly that LO3 Demonstrate the role of digital
marketing and social networking in
it is almost impossible to keep up with today’s business environment.
the latest developments. Startup com- LO4 Show how digital media affect the
panies emerge that quickly overtake marketing mix.
LO5 Define social networking and illustrate
existing approaches to digital media. how businesses can use different
When Google first arrived on the scene, types of social networking media.
a number of search engines were fight- LO6 Identify legal and ethical consider-
ations in digital media.
ing for dominance, including Excite,
Infoseek, Lycos, and Webcrawler. With
CHAPTER 13 | Digital Marketing and Social Networking 267

e-business digital media digital marketing addressability
carrying out the goals of business electronic media that function uses all digital media, including the ability of a business to identify
through utilization of the Internet using digital codes via computers, the Internet and mobile and customers before they make
cellular phones, smartphones, interactive channels, to develop purchases
and other digital devices that have communication and exchanges
been released in recent years with customers
continued from p. 267 digital codes—when we refer to digital media, we mean media
available via computers and other digital devices, including
as it is the fifth-largest “pure-play” Internet company (after
mobile and wireless ones like cell phones and smartphones.
Google, Amazon.com, Tencent, and eBay) and has the majority
Digital marketing uses all digital media, including the Inter-
of the Chinese Internet market. Google is also being challenged net and mobile and interactive channels, to develop commu-
by social networks, which most observers believe will dominate nication and exchanges with customers. Digital marketing is a
term we will use often because we are interested in all types of
digital communication in the future.2 Today, people spend more
digital communications, regardless of the electronic channel
time on social networking sites, such as Facebook, than they that transmits the data.
spend on e-mail.
In this chapter we first provide some key definitions related GROWTH AND
to digital marketing and social networking. Next we discuss
using digital media in business and marketing. We look at
BENEFITS OF DIGITAL
marketing mix considerations when using digital media and COMMUNICATION
pay special attention to social networking. Then we focus The Internet has created tremendous opportunities for busi-
nesses to forge relationships with consumers and business
on digital marketing strategies—particularly new commu- customers, target markets more precisely, and even reach pre-
nication channels like social networks—and consider how viously inaccessible markets at home and around the world.
The Internet also facilitates business transactions, allowing
consumers are changing their information searches and con-
companies to network with manufacturers, wholesalers, retail-
sumption behavior to fit emerging technologies and trends. ers, suppliers, and outsource firms to serve customers more
Finally, we examine the legal and social issues associated quickly and more efficiently. The telecommunication opportu-
nities created by the Internet have set the stage for digital mar-
with information technology, digital media, and e-business. keting’s development and growth.
Digital communication offers a completely new dimension in
connecting with others. Some of the characteristics that distin-
guish digital from traditional communication are addressabil-
ity, interactivity, accessibility, connectivity, and control. Let’s
WHAT IS DIGITAL look at what these mean and how they enhance marketing.
The ability of a business to identify customers before they make
MARKETING? a purchase is addressability. Digital media make it possible
Let’s start with a clear understanding of our focus in this for visitors on a website like Amazon.com to provide infor-
chapter. First, we can distinguish e-business from tradi- mation about their needs and wants before they buy. A social
[ “Digital communication offers a completely new

dimension in connecting with others.” ]
tional business by noting that conducting e-business means network such as Facebook lets users create a profile to keep in
carrying out the goals of business through the use of the Inter- touch or to build a network of identified contacts including
net. Digital media are electronic media that function using friends, colleagues, and businesses. Companies such as Procter

interactivity accessibility connectivity control
allows customers to express their allows consumers to find information the use of digital networks to provide consumers’ ability to regulate the
needs and wants directly to the firm in about competing products, prices, and linkages between information information they receive via the
response to its communications reviews and become more informed providers and users Internet, and the rate and sequence of
about a firm and the relative value of their exposure to that information
its products
The website Nextag puts power in the hands of consumers by allowing them to compare prices of products at different stores before buying.
& Gamble create social network accounts to share information customers can stay in constant touch. Benjamin Moore & Co.
with consumers and find out their opinions about products and has an iPhone app (application) that allows customers to match
reactions to new ideas. anything, such as their own home-decorating color samples
and photographs, with shades of Benjamin Moore® paint. Many
Interactivity allows customers to express their needs and wants
companies are adopting a digital media philosophy of open com-
directly to the firm in response to its communications. In tra-
munication with customers; for example, a firm can go to a site
ditional one-way forms of communications, such as television
such as GeniusRocket.com, a marketing firm that provides cus-
advertising, the customer must contact the company by phone
tomized services linking businesses with customers, to request
or other means. Interactivity relies on digital media that can
ideas for new products.
make a conversation between the firm and the customer hap-
pen without any delay; thus, real relationships become possible. Connectivity keeps customers, employees, and businesses
Digital media such as blogs and social networks allow marketers connected with each other. It involves the use of digital net-
to engage with customers, shape their expectations and percep- works to provide linkages between information providers and
tions, and benefit from broader market reach at lower cost. users. Social networking is a key form of connectivity made eas-
ier on a global scale by Facebook, Myspace, LinkedIn, Twitter,
Accessibility allows consumers to find information about
and other networking sites. Facebook has a larger audience than
competing products, prices, and reviews and become more
any television network that has ever existed. Firms can also tar-
informed about a firm and the relative value of its products.
get precise markets through local social networking sites such
Mobile devices—including smartphones, mobile computing
as Orkut, a Google-owned service operating in India and Brazil.
devices like the iPad, and PDAs—allow customers to leave their
desktops and access digital networks from anywhere. Thanks to Control refers to consumers’ ability to regulate the information
the popularity of the iPhone and BlackBerry, businesses and their they receive via the Internet, and the rate and sequence of their

exposure to that information. Consumers choose the websites the most successful e-businesses, ranked number 100 on the
they view, the blogs they follow, and the social networking sites Fortune 500 list of America’s largest corporations.3 Amazon is a
to which they belong. This trend toward a consumer-controlled true global e-business, and was one of the early success stories
market requires marketers to approach their jobs in a different in the industry, getting 50 percent of its revenue from interna-
way than they did in traditional marketing. tional sales.4 Many of you may not remember a world before
Amazon because it has completely transformed how many peo-
ple shop. Previously, consumers had to travel store to store in
USING DIGITAL MEDIA order to find goods and compare prices.
IN BUSINESS Because it is fast and inexpensive, digital communication is mak-

ing it easier for businesses to conduct marketing research, pro-
The phenomenal growth of digital media has provided new
vide and obtain price and product information, and advertise, as
ways of conducting business. Given almost instant communi-
well as to fulfill their business goals by selling goods and services
cation with precisely defined consumer groups, firms can use
online. Even the U.S. government engages in digital market-
real-time exchanges to stimulate interactive communication,
ing activities—marketing everything from Treasury bonds and
forge closer relationships, and learn more accurately about con-
other financial instruments to oil-drilling leases and wild horses.
sumer and supplier needs. Consider that Amazon.com, one of
Procter & Gamble uses the Internet as a fast, cost-effective
means for marketing research, judging consumer demand for
potential new products by inviting online consumers to sample
new-product prototypes and provide feedback. If a product gets
rave reviews from the samplers, the company might decide to
introduce it. By testing concepts online, companies can save sig-
nificant time and money in getting new products to market.
New businesses and even industries are evolving that would not
exist without digital media. Hulu is a video website that lets con-
sumers watch a broad collection of premium videos from more
than 260 content companies, anytime and from anywhere. The
company has partnered with several companies to advertise on
their sites, including Johnson & Johnson and Best Buy. In fact,
Hulu’s growing popularity is allowing it to compete with YouTube.5
The reality, however, is that Internet markets are more similar
to traditional markets than they are different. Thus, successful
e-business strategies, like traditional business strategies, focus
on creating products that customers need or want, not merely
developing a brand name or reducing the costs associated with
online transactions. Instead of changing all industries, e-business
has had much more impact in certain industries where the cost
of business and customer transactions has been very high. For
example, investment trading is less expensive online because cus-
tomers can buy and sell investments, such as stocks and mutual
funds, on their own. Firms such as Charles Schwab Corp., the
biggest online brokerage firm, have been innovators in promot-
ing online trading. Traditional brokers such as Merrill Lynch
have had to follow with online trading for their customers.
Because the Internet lowers the cost of communication, it can con-
tribute significantly to any industry or activity that depends on the
flow of digital information such as entertainment, health care, gov-
ernment services, education, and computer services like software
development. The publishing industry is transitioning away from
print newspapers, magazines, and books as more consumers pur-
chase e-readers, like the Kindle or iPad, or read the news online.
Even your textbook is available electronically. Because publishers
Need paint? Benjamin Moore & Co. has an app that can help you save money on paper, ink, and shipping, many times electronic
pick out the perfect color on your iPhone. versions of books are cheaper than their paper counterparts.

NEW BUSINESSES AND EVEN INDUSTRIES ARE
EVOLVING THAT WOULD NOT EXIST WITHOUT DIGITAL MEDIA.
Digital media can also improve communication within and online social networkers are Australians, followed by Brit-
between businesses. In the future, most significant gains will ish, Italians, and Americans.7 With digital media, even small
come from productivity improvements within businesses. Com- businesses can reach new markets through these inexpensive
munication is a key business function, and improving the speed communication channels. Brick-and-mortar companies like
and clarity of communication can help businesses save time and Walmart utilize online catalogs and company websites and
improve employee problem-solving abilities. Digital media can blogs to supplement their retail stores. Internet companies like
be a communications backbone that helps to store knowledge, Amazon.com and Zappos.com that lack physical stores let cus-
information, and records in management information systems tomers post reviews of their purchases on their websites, creat-
so co-workers can access it when faced with a problem to solve. A ing company-sponsored communities.
well-designed management information system that utilizes dig-
One aspect of marketing that has not changed with digital media
ital technology can, therefore, help reduce confusion, improve
is the importance of achieving the right marketing mix. Product,
organization and efficiency, and facilitate clear communica-
distribution, promotion, and pricing are as important as ever for
tions. Given the crucial role of communication and information
successful online marketing strategies. More than one-fourth
in business, the long-term impact of digital media on economic
of the world’s population now uses the Internet.8 That means
growth is substantial, and it will inevitably grow over time.
it is essential for businesses large and small to use digital media
Firms also need to control access to their digital communica- effectively, not only to grab or maintain market share but also to
tion systems to ensure worker productivity. This can be a chal- streamline their organizations and offer customers entirely new
lenge. For example, in companies across the United States, benefits and convenience. Let’s look at how businesses are using
employees are surfing the Internet for as much as an hour dur- digital media to create effective marketing strategies on the Web.
ing each workday. Many firms are trying to curb this practice
by limiting employees’ access to instant messaging services, Product Considerations Like traditional marketers, dig-
streaming music, and websites with adult content.6 ital marketers must anticipate consumer needs and preferences,
tailor their products and services to meet these needs, and con-
tinually upgrade them to remain competitive. The connectiv-
DIGITAL MEDIA AND THE ity created by digital media provide the opportunity for adding
services and can enhance product benefits. Some products, such
MARKETING MIX as online games, applications and virtual worlds, are only avail-
able via digital media. Netflix offers a much wider array of mov-
While digital marketing shares some similarities with conven-
tional marketing techniques, a few valuable differences stand out. ies and games than the average movie rental stores, along with
First, digital media make customer communications faster and a two-week free trial, quick delivery and easy returns, online
interactive. Second, digital media help companies reach new tar- video streaming of some movies, and no late fees. Netflix also
get markets more easily, affordably, and quickly than ever before. prides itself on its recommendation engine, which recommends
Finally, digital media help marketers utilize new resources in movies for users based on their previous rental history and how
seeking out and communicating with customers. One of the they rate movies they have seen. As Netflix demonstrates, the
most important benefits of digital marketing is the ability of Internet can make it much easier to anticipate consumer needs.
marketers and customers to easily share information. Through However, fierce competition makes quality product and service
websites, social networks, and other digital media, consumers offerings more important than ever.9
can learn about everything they consume and use in their lives,
ask questions, voice complaints, indicate preferences, and other-
Distribution Considerations The Internet is a new dis-
tribution channel for making products available at the right time,
wise communicate about their needs and desires. Many market-
at the right place, and in the right quantities. Marketers’ ability
ers use e-mail, mobile phones, social networking, wikis, video
to process orders electronically and increase the speed of com-
sharing, podcasts, blogs, videoconferencing, and other technolo-
munications via the Internet reduces inefficiencies, costs, and
gies to coordinate activities and communicate with employees,
redundancies while increasing speed throughout the marketing
customers, and suppliers. Twitter, considered both a social net-
channel. Shipping times and costs have become an important
work and a micro blog, illustrates how these digital technologies
consideration in attracting customers, prompting many compa-
can combine to create new communication opportunities.
nies to offer consumers low shipping costs or next-day delivery.
Nielsen Marketing Research revealed that consumers now For example, Walmart is attempting to take market share away
spend more time on social networking sites than they do on from e-marketers like Amazon.com by reducing delivery time
e-mail, and social network use is still growing. The most avid and creating a “site to store” system that eliminates shipping

Walmart is experimenting with a new distribution system to compete against online retailers. The company is eliminating shipping costs for consumers
who order products online and then pick them up at the store. The company hopes to capture market share away from competitors that charge
shipping costs.
NESTLÉ EXPERIENCES Greenpeace began its attack by releas- sourcing guidelines. Despite its response,
ing a report, protesting outside Nestlé’s Nestlé continued to get hammered in the
THE DARK SIDE OF headquarters, and launching a video on press for its initial handling of protesters.
SOCIAL MEDIA YouTube. Greenpeace altered Nestlé’s As this situation demonstrates, the rela-
Kit-Kat logo to read Killer. Although Nestlé tive newness of social media has left many
forced Greenpeace to pull the video, thou- companies with their guard down. In the
S ocial media can have an ugly side, as
Nestlé found out firsthand after an
attack launched by environmental organi-
sands of protesters had already shared it via
their Facebook and Twitter accounts. The
future, Nestlé and other businesses should
consider using social media not as a way to
zation Greenpeace. It started after Green- commentary on Nestlé’s Facebook page quench negative publicity, but as a method
peace discovered that Nestlé was sourcing and Twitter feed was scathing. Worse yet, to address consumer concerns.10
a portion of its palm oil (an ingredient used the news had gone viral, making it nearly
in its chocolate bars) nonsustainably. impossible for Nestlé to contain. Discussion Questions
The problem from Greenpeace’s per- Nestlé responded by severing ties with 1. Do you think consumers of Nestlé’s
spective is that many palm oil producers the company in question and promised to Kit-Kat bar would not buy the product if
destroy rain forests in order to grow the do a thorough audit of all third-party suppli- they knew about the palm oil source?
plants from which the oil is harvested; ers. It made a commitment to source 50 per- 2. Did Nestlé handle the protests appro-
it is argued that this action increases cent of sustainable palm oil by 2011 and priately?
global warming and threatens orangutan 100 percent by 2015. Nestlé also partnered
3. What should Nestlé do in the future to
populations. with The Forest Trust to create responsible
avoid negative social media publicity?

social network
a Web-based meeting
place for friends, family,
costs for consumers who pick up their deliveries in the store. This free samples to generate consumer co-workers, and peers that
offer has the increased benefit of getting customers into the store, demand for their products. lets users create a profile
where they might make add-on purchases. Walmart has even and connect with other
tested a new distribution concept to complement store pickups: Social Networking users for a wide range of
a drive-through window that allows customers to pick up the A social network is “a web- purposes
products they ordered through Walmart’s website. Through even based meeting place for friends,
more sophisticated distribution systems, Walmart hopes to over- family, co-workers and peers that
take online retailers to become the biggest online merchant.11 lets users create a profile and connect with other users for the
Social networks are a valued part of marketing because

they are changing the way consumers communicate
with each other and with firms.
purposes that range from getting acquainted, to keeping in

Promotion Considerations Perhaps one of the best
touch, to building a work related network.”13 Social networks
ways businesses can utilize digital media is for promotion
are a valued part of marketing because they are changing the
purposes—whether they are increasing brand awareness, con-
way consumers communicate with each other and with firms.
necting with consumers, or taking advantage of social net-
Sites such as Facebook, Myspace, Twitter, and LinkedIn have
works or virtual worlds (discussed later) to form relationships
emerged as opportunities for marketers to build communities,
and generate positive publicity or “buzz” about their prod-
provide product information, and learn about consumer needs.
ucts. Thanks to online promotion, consumers can be more
By the time you read this, it is possible there will be new social
informed than ever, including reading customer-generated
network sites that continue to advance digital communication
content before making purchasing decisions. Consumer con-
and opportunities for marketers.
sumption patterns are radically changing, and marketers must
adapt their promotional efforts to meet them. You might be surprised to know that social networks have existed
in some form or other for 40 years. The precursors of today’s
These effects are not limited to the Western world. In a revo-
social networks began in the 1970s as online bulletin boards
lutionary shift in China, where online shopping had not been
that allowed users with common interests to interact with one
widely adopted by consumers, businesses are now realizing
another. The first modern social network was Six Degrees.com,
the benefits of marketing online. One of the first adopters of
Internet selling was the Chinese company Taobao, a consumer
auction site that also features sections for Chinese brands and
retailers. Taobao provides online promotion of retailers and
products featured on its site. The majority of online sales in
China take place on Taobao.12 Consumer trends like these
demonstrate that the shift to digital media promotion is well
under way worldwide.
Pricing Considerations Price is the most flexible ele-

ment of the marketing mix. Digital marketing can enhance
the value of products by providing extra benefits such as ser-
vice, information, and convenience. Through digital media,
discounts and other promotions can be quickly communi-
cated. As consumers have become better informed about their
options, the demand for low-priced products has grown, lead-
ing to the creation of deal sites where consumers can directly
compare prices. Expedia.com, for instance, provides consum-
ers with a wealth of travel information about everything from
flights to hotels that lets them compare benefits and prices. Twitter allows the Chicago Bulls to post event updates and interact with
Many marketers offer buying incentives like online coupons or loyal fans.

blog
a Web-based journal
in which a writer can
editorialize and interact with
launched in 1997. This system We’ll have more to say about how marketers utilize social net-
other Internet users permitted users to create a pro- works later in this chapter.
file and connect with friends—
An important question relates to how social media sites are
wiki the core attributes of today’s
adding value to the economy. Marketers at companies like
software that creates an networks.14 Although Six Degrees
interface that enables users Ford and Zappos, for instance, are using social media to pro-
eventually shut down for lack of
to add or edit the content of mote products and build consumer relationships. Most corpo-
interest, the seed of networking
some types of websites rations are supporting Facebook pages and Yammer accounts
had been planted.15 Other social
for employees to communicate across departments and divi-
viral marketing networks followed, with each new
sions. Professionals such as professors, doctors, and engineers
a marketing tool that uses generation becoming increasingly
also share ideas on a regular basis. Even staffing organiza-
the Internet, particularly sophisticated. Today’s sites offer a
tions use social media, bypassing traditional e-mail and tele-
social networking and video multitude of consumer benefits,
phone channels. While billions of dollars in investments are
sharing sites, to spread a including the ability to download
message and create brand
being funneled into social media, it may be too early to assess
music, games, and applications;
awareness. the exact economic contribution of social media to the entire
upload photos and videos; join
economy.17
groups; find and chat with friends;
comment on friends’ posts; and
post and update status messages. Table 13.1 lists some popular
social networks in different countries. TYPES OF CONSUMER-
As the number of social network users increases, interactive
marketers are finding opportunities to reach out to consumers
GENERATED MARKETING
in new target markets. MyYearBook.com is a social networking
site that offers teenagers a forum in which to write about par-
AND DIGITAL MEDIA
While digital marketing has generated exciting opportunities
ticular subjects important to them, including sensitive topics for companies to interact with their customers, digital media
facing today’s younger generation. Its popularity with teenag- are also more consumer-driven than traditional media. Inter-
ers is rising; the site’s traffic has increased 36 percent annually, net users are creating and reading consumer-generated content
with most users coming from the United States. For advertis- as never before and are having a profound effect on marketing
ers, the site is an opportunity to connect with teens and young in the process.
adults, a demographic that is difficult to reach with traditional
marketing. Advertisers from Nikon and Paramount Pictures Two factors have sparked the rise of consumer-generated
have both made deals to advertise through MyYearBook.com.16 information:
1. The increased tendency of consumers to publish their own
thoughts, opinions, reviews, and product discussions through
T A B L E 1 3 . 1 Popular Social Networking Sites in Different blogs or digital media.
Countries
2. Consumers’ tendencies to trust other consumers over cor-
South Korea Cyworld porations. Consumers often rely on the recommendations of
friends, family, and fellow consumers when making purchas-
Netherlands Hyves
ing decisions.
Japan Mixi
Brazil Orkut
Marketers who know where online users are likely to express
their thoughts and opinions can use these forums to interact
China QZone
with them, address problems, and promote their companies.
France SkyRock Types of digital media in which Internet users are likely to
Germany StudiVZ participate include blogs, wikis, video sharing sites, podcasts,
Spain Tuenti social networking sites, virtual reality sites, and mobile applica-
tions. Let’s look a little more closely at each.
Russia Vkontakte
United Kingdom Bebo Blogs and Wikis
United States Facebook Today’s marketers must recognize that the impact of consumer-
Source: “Nine Extremely Successful Non-English Social Networking Sites,” generated material like blogs and wikis and their significance to
Pingdom, September 9, 2009, http://royal.pingdom.com/2009/09/09/ online consumers have increased a great deal. Blogs (short for
nine-extremely-successful-non-english-social-networking-sites/ (accessed web logs) are Web-based journals in which writers can editori-
March 25, 2010); Sorav Jain, “40 Most Popular Social Networking Sites
alize and interact with other Internet users. Two-thirds of Inter-
of the World,” Social Media Today, http://socialmediatoday.com/index.
php?q=soravjain/195917/40-most-popular-social-networking-sites-world net users read blogs, and more than half of bloggers say they
(accessed January 17, 2011). blog about topics and brands about which they feel strongly.18

The blogging phenomenon is not limited to North America. In Video Sharing
South Korea, for example, more than two-thirds of the online
Video sharing sites allow virtually anybody to upload videos, from
population creates blogs or similar material.19
professional marketers at Fortune 500 corporations to the aver-
Blogs give consumers power, sometimes more than compa- age Internet user. Some of the most popular video sharing sites
nies would like. Bloggers can post whatever they like about a include YouTube, Video, Yahoo.com, Metacafe.com, and Hulu.
company or its products, whether their opinions Video sharing sites give companies the oppor-
are positive or negative, true or false. When a tunity to upload ads and informational videos
Korean Dunkin’ Donuts worker created a blog about their products. A few videos become viral at
alleging that a company factory had unsanitary any given time, and although many of these gain
conditions, the company forced him to delete popularity because they embarrass the subject in
the blog. However, readers had already created some way, others reach viral status because people
copies of it and spread it across the Internet find them entertaining. Viral marketing occurs
after the original’s removal.21 In other cases, a when a message gets sent from person to person
positive review of a product or service posted to person. It can be an extremely effective tool for
on a popular blog can result in large increases in marketers—particularly on the Internet, where one
DID YOU KNOW?
sales. Thus, blogs can represent a potent threat click can send a message to dozens or hundreds of
or opportunity to marketers. Searching is the people simultaneously. However, viral market-
most popular online ing often requires marketers to develop an offbeat
Rather than trying to eliminate blogs that cast
sense of humor and creativity in order to catch the
their companies in a negative light, some firms activity, while social
viewer’s attention—something with which some
are using their own blogs, or employee blogs, to networking and marketers may not be comfortable. For instance,
answer consumer concerns or defend their cor- blogging are fourth.20 IBM created a series of six videos called “The Art
porate reputations. Boeing operates a corporate
of the Sale,” which presents three attributes of
blog to highlight company news and to post cor-
22 the company’s mainframe computer in a humor-
respondence from Boeing enthusiasts from all over the world.
ous format reminiscent of episodes of The Office. Though some
As blogging changes the face of media, smart companies are
wrote off the video as a forced attempt at humorous marketing, it
using it to build enthusiasm for their products and create rela-
received hundreds of thousands of hits on YouTube.26
tionships with consumers.
Businesses have also begun to utilize consumer-generated
Wikis are websites where users can add to or edit the con- video content, saving money they would have spent on hir-
tent of posted articles. One of the best known is Wikipedia, an ing advertising firms to develop professional advertising
online encyclopedia with over 17 million entries in over 250 campaigns. Unilever is one of many companies incorporat-
languages on nearly every subject imaginable (Encyclopedia ing consumer-generated content into its marketing strategies.
Britannica only has 120,000 entries).23 Wikipedia is one of Its Consumer Creative Challenge encourages consumers to
the 10 most popular sites on the Web, and because much of
its content can be edited by anyone, it is easy for online con-
sumers to add detail and supporting evidence and to correct
inaccuracies in content. Wikipedia used to be completely open
to editing, but in order to stop vandalism, the site had to make
some topics off-limits that are now editable only by a small
group of experts.
Like all digital media, wikis have advantages and disadvan-
tages for companies. Wikis about controversial companies like
Walmart and Nike often contain negative publicity, such as
about workers’ rights violations. However, monitoring relevant
wikis can provide companies with a better idea of how consum-
ers feel about the company or brand. Some companies have
also begun to use wikis as internal tools for teams working on
projects that require a great deal of documentation.24
There is too much at stake financially for marketers to ignore
wikis and blogs. Despite this fact, less than one-fifth of Fortune
500 companies have a blog.25 Marketers who want to form Procter & Gamble launched a successful campaign on Twitter featuring
better customer relationships and promote their company’s the Old Spice Man (former NFL receiver Isaiah Mustafa). Fans were
products must not underestimate the power of these two media invited to interact with Mustafa through Twitter posts. The number of
outlets. Old Spice fans significantly increased after the campaign.

podcast
an audio or video file
that can be downloaded
from the Internet with
send in their amateur videos for
a subscription that Unilever brands such as Ben &
automatically delivers new Jerry’s, Vaseline, and Axe. The
content to listening devices 2010 grand-prize winner received
or personal computers £7,000 (more than $11,000) and
had her Vaseline video aired at the
London Film Festival. Unilever
announced that it would integrate
the video into future marketing campaigns.27 Marketers believe
consumer videos appear more authentic and create enthusiasm
for the product among consumer participants.
Google is so confident that video sharing sites will revo-
lutionize online marketing that it purchased YouTube for
$1.65 billion in 2006.28 If Google is correct in its predictions,
then online videos clips—both corporate-sponsored and NPR supplements its radio station with podcasts downloadable through
consumer-generated—are likely to revolutionize the market- the iTunes site.
ing industry.
One of Flickr’s rivals is Picasa Web Albums, a Google photo
Photo Sharing sharing site that developed out of Google’s photo-editing pro-
gram Picasa. The program has grown rapidly and is growing in
Photo sharing sites allow users to upload and share their pho-
popularity, as it provides more features than Flickr and other
tos and short videos with the world. Well-known photo sharing
major photo sharing websites. Picasa Web Albums is free, and
sites include SmugMug, Webshots, Photobucket, and Flickr.
generates revenues through ads shown on the site. If users want
Flickr is owned by Yahoo and is the most popular photo shar-
to use more than 1 GB of storage space, they can rent additional
ing site on the Internet. A Flickr user can upload images, edit
space up to 16 TBs.
them, classify the images, create photo albums, and share pho-
tos with friends without having to e-mail bulky image files or As one Web marketer puts it, companies that use photo shar-
send photos through the mail. Flickr is so popular that the site ing “add a personal touch to their businesses.”33 Although it is
experiences thousands of new image uploads every minute. too early to gauge the effects of marketing through photo shar-
[ “Podcasting offers the benefit of convenience, giving users the

ability to listen to or view content when and where they choose.” ]
Most users have free accounts that allow them to upload two ing sites, more and more marketers will likely use the site as an
videos and 100 MB of photos per month, but for around $25 a inexpensive way to reach their audience.
year, users can open an unlimited Pro account.29 Photo sharing
represents an opportunity for companies to market themselves Podcasting
visually by displaying snapshots of company events, company Podcasts are audio or video files that can be downloaded
staff, and/or company products. Companies can direct viewers from the Internet via a subscription that automatically delivers
to their photostreams (their sets of photographs) by marking new content to listening devices or personal computers. Pod-
their pictures with the appropriate keywords, or tags.30 Tags are casting offers the benefit of convenience, giving users the ability
essential for marketing on Flickr as they help direct traffic to to listen to or view content when and where they choose.
the corporate photostreams.
Podcasting is rapidly gaining in popularity. Dozens of online
Many businesses with pictures on Flickr have a link connecting programs, such as Apple’s iPodderX and Podcast Studio or
their Flickr photostreams to their corporate websites.31 General Android’s dPod, offer podcasting services. Other companies,
Motors, for example, uses Flickr not only to showcase its cars such as Yodio, combine podcasting with photos to create cus-
and important events, but also to provide links that connect tomized online greeting card–style messages. It is estimated
users to GM’s blog.32 In addition to the White House’s stream that by 2013, more than 37 million U.S. consumers will be
of photos by official White House photographers, President downloading podcasts every month. Most current podcast
Obama has his own Flickr photostream, which he used to post users are between 18 and 29 years of age, making podcasts a
images that relate directly to his legislative bills. good marketing tool for reaching this demographic.34 The

Student Loan Network offers a free weekly Financial Aid Pod- various topics (called forums), network with friends and col-
cast to college-age students. It gives advice on affordable college leagues, and play games. Since 2006, Myspace has been acces-
education, credit cards, and other financial subjects important sible in a variety of languages, including Swedish, Chinese,
to young people. Listeners also have the added benefit of mak- Spanish, Portuguese, and Turkish. Alternate versions also exist
ing comments and offering feedback on the podcasts.35 depending on the locality.38
As podcasting continues to catch on, radio stations and televi- Businesses have come up with unique ways to utilize Myspace
sion networks like CBC Radio, NPR, MSNBC, and PBS are cre- to interact with consumers. Before it retired him, Burger King
ating podcasts of their shows to profit from this growing trend. had created a fictional profile for its mascot, The King, on
Many companies hope to use podcasts to create brand aware- Myspace to appeal to a younger age group. By allowing con-
ness, promote their products, and encourage customer loyalty. sumers to become “friends,” businesses can provide updates to
everyone in their network and permit users to post comments.
Social Networks Companies also advertise through Myspace. For instance,
It is estimated that two-thirds of consumers in the United Google renewed its contract to sell ads through Myspace, and
States have visited social networks or blogs.36 One in three the social media site became a part of Google’s DoubleClick
South Korean and one in five Japanese Internet users partici- Ad Exchange that allows publishers to sell display advertising
pate in social networks.37 As social networks evolve, both mar- in an auction.39 Additionally, Myspace offers aspiring artists
keters and the owners of social networking sites are realizing a chance to showcase their talent and has become the largest
the opportunities such networks offer—an influx of advertising artist community on the Web. Emerging musicians are using
dollars for site owners and a large reach for the advertiser. As a Myspace to record and share their music, and users can cre-
result, marketers have begun investigating and experimenting ate social playlists of music from brand name artists.40 Myspace
with promotion on social networks. Four of the most promi- can be a creative means of marketing through the use of pro-
nent sites are Myspace, Facebook, LinkedIn, and Twitter. files, advertising, music, videos, and other forms of media.
Myspace Myspace offers users the chance to create a pro- Facebook In April 2008, the social networking site Face-
file and connect with other Myspace members across the world. book surpassed Myspace in its number of members, becom-
Users can invite people to be their friends, watch videos, listen ing the most popular social networking site in the world.41 It
to and promote music, instant message their friends, write on is estimated that nearly a third of Internet users have visited
FACEBOOK AND One challenge is frequent monitoring of Glee. Viewers found the overlays intrusive
Facebook and Twitter pages. Simply post- and distracting. The campaign was a fail-
TWITTER OFFER ing ads or creating Facebook fan pages is ure. Other companies have accounts on
BUSINESSES BOTH not enough. As consumers are frequently both Facebook and Twitter, but they simply
turning to these social media sites to haven’t done anything to make them excit-
OPPORTUNITIES AND post complaints or concerns, companies ing. These setbacks show that although
CHALLENGES must be vigilant to respond. Additionally, social media offers exciting new marketing
although it contains several features to opportunities, campaigns must be care-
support company advertisements, Face- fully thought out and implemented to be
T o advertise on social media sites, or
not to advertise? It depends on who
you ask. Users of social media are increas-
book cannot always enforce appropriate
ad content. It counts on users to complain
successful.42
ingly coming upon advertisements on their when inappropriate ads are posted. This Discussion Questions
pages, and some are unhappy about it. can be a problem for both consumers, 1. Do you think consumers would be willing
They feel that social media sites are a place who might be exposed to ads they feel are to pay for the use of social media sites if
to have fun, not to be subjected to yet more inappropriate, and businesses, who could there were no marketing activities?
marketing. Marketers, on the other hand, unintentionally alienate their target market. 2. Why do some marketers post what are
love the added exposure they receive; with (Facebook is currently updating its rules considered by some as inappropriate
over 400 million Facebook users and 100 and restrictions.) advertisements?
million Twitter users, these sites offer busi- Businesses must also face the fact
3. What do marketers need to do to make
nesses access to many market segments that their social media marketing activi-
advertising on social media sites accept-
at once. However, businesses soon learn ties can still bomb. Fox found this out the
able to consumers?
that marketing their brands on social media hard way when it began broadcasting live
sites is not so easy. Twitter overlays over reruns of Fringe and

MANY MARKETERS ARE TURNING TO FACEBOOK
TO MARKET PRODUCTS, INTERACT WITH CONSUMERS,
AND GAIN PUBLICITY.
the site.43 Facebook users create profiles, which they can make for movies like Toy Story 3. These new opportunities for busi-
public or private, and then search the network for people with nesses demonstrate the evolution of Facebook into a market-
whom to connect. Users must be a “friend” of the person whose ing destination.49
profile they are trying to view before they can see that user’s
personal information. Many believe Facebook appeals to a LinkedIn LinkedIn is a social networking site geared toward
broader demographic than does Myspace, attracting parents professionals from all over the world. With 120 million profes-
and grandparents as well as teens and college students.44 In fact, sional members, including executives from all the Fortune 500
the fastest-growing group on Facebook is women 55 and over.45 companies, it is the fourth-largest social networking site and
logs several million visitors a month.50
For this reason, many marketers are turning to Facebook to
market products, interact with consumers, and gain publicity. A LinkedIn profile resembles a résumé. It contains informa-
It is possible for a consumer to become a “fan” of a major com- tion about past and current job experiences, qualifications,
pany like Starbucks by clicking on the “Like” icon on the coffee goals, and educational background. Like all social network-
retailer’s Facebook page. Companies are also using Facebook ing sites, it lets users locate and connect with other members
to generate awareness about their companies and encourage and join groups, which are often professional organizations.
repeat visits. Allstate held a contest on Facebook that encour- LinkedIn facilitates job searches and allows companies to
aged fans to revisit the company’s Facebook page. Each day search the network for potential employees with the neces-
during the contest, Allstate would post a picture on its page and sary skills. Microsoft, Target, eBay, and Netflix have all used
invite fans to “tag” themselves into the picture. The first “tag- the LinkedIn network to recruit new employees.51 Employ-
gers” would be eligible to win a Ford Fusion Hybrid. Everyone ees are also using LinkedIn to search for potential employers.
else who tagged themselves would be eligible to win one of 440 Approximately 28 percent of college students have indicated
Visa gift cards.46 that they plan to use LinkedIn to search for employment
opportunities.52
Social networking sites are also useful for small businesses.
Hansen Cakes in Beverly Hills uses interactive marketing on a Although a professional networking site like LinkedIn seems
social networking outlet to drum up more business.47 One of more like a recruiting site than a marketing tool, companies
the bakery’s cake decorators provides updates on her current do use it to familiarize users with their business. In addition to
projects and offers free cake samples to local Facebook users. listing job openings, Target’s LinkedIn page also offers stock
Facebook lets companies better engage in relationship mar- information, a link to the company website, some background
keting, or the creation of relationships that mutually benefit on the business, and links to news updates on company activi-
the marketing business and the customer. Other companies ties and products. Procter & Gamble has a LinkedIn page that
that have utilized relationship marketing to help consum- allows users to locate professionals, research careers, and get
ers feel more connected to their products are Pepsi and Walt updates about the company. LinkedIn Groups—a feature on
Disney Co. The Pepsi Refresh project invites consumers to the site that highlights particular industries—is a useful tool
suggest local charities that are making a positive impact. Con- for companies that want to describe their expertise and activi-
sumers vote for their favorites, and Pepsi donates money to ties. Organizations can also build a group on LinkedIn based
the winning causes. The company utilized Facebook, Twitter, around their company or industry for no charge.53 Smart mar-
and blogging to spread the word about the Refresh Project.48 keters can use LinkedIn to reach professionals not only for
The Walt Disney Co. has created many different Facebook recruiting purposes, but also to spread information about and
pages, which have succeeded in generating over 100 million interest in the company.
Facebook fans. Some of its success is attributed to the Disney
Pages promotion tab on its main Disney Facebook page. The Twitter Twitter is a hybrid of a social networking site and a
tab allows users to access promotional content without hav- micro-blogging site that asks users one simple question: “What
ing to navigate away from Facebook. In many ways, Facebook are you doing?” Members can post answers of up to 140 char-
is becoming an e-commerce platform whereby companies acters, which are then available for their registered “followers”
can sell products through the site. DigiSynd, Disney’s social to read. It sounds simple enough, but Twitter’s effect on digi-
media agency, was able to use a platform on Facebook called tal media has been immense. The site quickly progressed from
Disney Tickets Together that allowed fans to purchase tickets a novelty to a social networking staple, attracting millions of

viewers each month.54 About 11 percent of Internet users have with one another, purchase goods with virtual Linden dollars
used a micro-blogging site like Twitter.55 (convertible to real dollars at a rate of around 250 Linden dol-
lars per $1), and even own virtual businesses. For entertain-
The thrill of Twitter is that users get to tell the world about their
ment purposes, residents can shop, attend concerts, or travel
daily lives in short messages, known as “tweets.” These tweets
to virtual environments—all while spending real money. Farm-
can be mundane, such as “I’m eating a sandwich,” to interest-
ville provides a similar virtual world experience, except it is
ing. President Obama used Twitter to announce “We just made
limited to life on a farm.
history” when he won the 2008 presidential election. Halfway
across the world, Russian president Dmitry Medvedev actu- Second Life has the most potential for marketers, given that
ally had to rebuke one of his regional governors for tweeting avatars can purchase property, goods, and services. While the
during a government session on educational policy.56 Twitter businesses in Second Life are virtual ones, real-world market-
has quickly transformed from novelty to serious marketing ers and organizations have been eager to capitalize on the site’s
tool, with the company announcing plans to generate revenue popularity. Second Life allows businesses to reach consumers
through sponsored tweets and working to make the service in ways that are creative and fun. For instance, to connect with
more user-friendly.57 consumers and build brand loyalty, car companies like Toyota
and General Motors began selling virtual cars to Second Life
Although 140 characters may not seem like enough for com-
residents.62 Other businesses are looking toward Second Life to
panies to send an effective message, some have become experts
familiarize consumers with their products and services. For
at using Twitter in their marketing strategies. JetBlue and
instance, large corporations like Best Buy and H&R Block offer
KFC have both used Twitter in marketing campaigns. JetBlue
support services on Second Life.
rewarded 1,000 tickets to followers for its 10th anniversary.
KFC agreed to award $20,000 in tuition fees for the best tweet Second Life has become so popular that even professors
it received from high schoolers. These efforts are having an are using it as a way to connect with their students. Ulrike
impact; approximately 23 percent of users report that they fol- Schultz is a business professor at Southern Methodist Univer-
low businesses on Twitter.58 sity. Students can choose to attend her real-world class, the
virtual one, or both. Schultz sees virtual worlds as the next
Like other social networking tools, Twitter is also being used
step in communications and feels that it is a great way to con-
to build customer relationships. For example, Toyota recruited
nect with young people who are accustomed to being wired
social media influencers to use Twitter to create buzz about
for most of their waking hours.63 Schultz sees opportunities
one of its Lexus products. These tweets are more personalized
for businesses in virtual environments, not only to promote
than other types of media. To avoid deceiving consumers about
and sell products, but also to engage in virtual teamwork
the nature of these messages, the FTC recently created guide-
lines requiring influencers who are receiving pay for company
tweets to disclose this fact to viewers.59
Finally, companies are using Twitter to gain a competitive
advantage. Microsoft’s search engine Bing developed a partner-
ship with Twitter in which Bing sorts the millions of tweets by
relevance and the popularity of the person tweeting. By doing
a Bing-Twitter search, Twitter fans can get the most impor-
tant tweets in real time.60 Firms also have a chance to utilize
promoted tweets, promoted accounts, and promoted trends
offered on the site. Marketers can pay Twitter to highlight
advertisements or company brands to a wider array of users
while they search for specific terms or topics.61 The race is on
among companies that want to use Twitter to gain a competi-
tive edge.
Virtual Worlds
Games and programs allowing viewers to develop avatars that
exist in an online virtual world have exploded in popularity in
the 21st century. Second Life is a social network with a twist. It
is a virtual, three-dimensional game world created by users that
features its own economy, its own lands, and residents of every
shape and size. Internet users who participate in Second Life Second Life residents can purchase Linden dollars, the currency of
choose a fictional persona, called an avatar, to communicate Second Life, to buy virtual products.

between physically distant employees and in role-playing Marketing over mobile devices has been made possible largely
exercises. Prestigious universities like the University of Texas, by mobile applications or apps—programs that can be loaded
Harvard Law School, Bowling Green State University, and the onto certain mobile devices to allow users to perform a variety
University of California at Davis all have virtual classrooms in of functions, from playing games to comparing product prices
Second Life. from different stores. The latter is becoming particularly use-
ful for consumers. The smartphone’s ability to find retailers
Companies are also using Second Life to encourage residents to
and entertainment and to organize an itinerary is changing the
participate in company activities. CNN created a virtual news
nature of consumer and business relationships. Large hotels,
hub and began encouraging residents to submit stories that
such as Hilton Hotels, are increasingly using iPhone apps that
occur in this virtual world.64 Such firms are not only creating
allow guests to check in early, order room service so food is
brand loyalty by connecting with Second Life residents, they
waiting for them when they arrive, and even specify bed and
are also using consumer knowledge and money to earn virtual
pillow types.
and real-world profits. Although the presence of real-world
companies in virtual worlds is still in the experimental stages, The most important feature of apps is the convenience and
virtual worlds like Second Life offer a novel way for marketers cost savings they offer the consumer. To remain competitive,
to interact with consumers. companies are beginning to use mobile marketing to offer
additional customer incentives, with some success. Jiffy Lube
Mobile Marketing offered coupons for one of its franchises over mobile devices.
As digital marketing becomes increasingly sophisticated, con- The company estimated that 50 percent of the new custom-
sumers are beginning to utilize mobile devices like smart- ers who came to the franchise did so as a result of its mobile
phones as a highly functional communication method. The marketing.66
iPhone and BlackBerry have changed the way consumers com-
Another application that marketers are finding useful is the
municate, and a growing number of travelers are using their
QR scanning app. You might have noticed that black-and-
smartphones to find online maps, travel guides, and taxis.
white squares have begun appearing on magazines, posters,
In industries such as hotels, airlines, and car rental agencies,
storefront displays, and more. These are QR codes, and they
mobile phones have become a primary method for booking
contain messages not visible to the naked eye. To read these
reservations and communicating about services. They can act
messages, smartphone users must download the QR scanning
as airline boarding passes, GPS devices, and even hotel room
application. When coming across a QR code, they simply open
keys. Travel companies are collecting personal information so
their smartphones and scan the black-and-white square. The
they can send consumers relevant updates about travel oppor-
QR scanning app will recognize the code and open up the link,
tunities. FARELOGIX, a travel software company, is working video, or image on the phone’s screen. Marketers are using QR
with a number of airlines to introduce features that allow air- codes to market their companies and offer consumer discounts.
lines to sell services such as priority boarding. While airlines As more people adopt smartphones, these apps are likely to add
already make these services available on their websites, they a whole new layer to digital marketing.67
also want to communicate with travelers who experience unex-
pected changes on their trips. Other marketing uses of mobile
phones include sending shoppers timely messages related to
discounts and shopping opportunities.65
USING DIGITAL MEDIA TO
REACH CONSUMERS
We’ve seen that customer-generated communications and
digital media connect consumers. These connections let con-
sumers share information and experiences without company
interference so they get more of the “real story” on a product or
company feature. In many ways, these media take some of the
professional marketer’s power to control and dispense infor-
mation and place it in the hands of the consumer.
However, this shift does not have to spell doom for market-
ers, who can choose to utilize the power of the consumer and
Internet technology to their advantage. While consumers use
digital media to access more product information, marketers
can use the same sites to get better and more targeted informa-
tion about the consumer—often more than they could gather
through traditional marketing venues. Marketers increasingly
Yowza!!, a mobile phone app, uses the GPS devices in cell phones to use consumer-generated content to aid their own marketing
locate consumers and send them coupons from retailers in that area. efforts, even going so far as to incorporate Internet bloggers in

their publicity campaigns. Finally, marketers are also beginning T A B L E 1 3 . 2 Social Technographics
to use the Internet to track the success of their online market- Creators • Publish a blog
ing campaigns, creating an entirely new way of gathering mar-
• Publish your own Web pages
keting research.
• Upload video you created
The challenge for digital media marketers is to constantly adapt
• Upload audio/music you created
to new technologies and changing consumer patterns. Unfortu-
nately, the attrition rate for digital media channels is very high, • Write articles or stories and post them
with some dying off each year as new ones emerge. Social net- Critics • Post ratings/reviews of products or services
works are no exception: the earliest ones, like Six Degrees, disap- • Comment on someone else’s blog
peared when they failed to catch on with the general public, and • Contribute to online forums
Friendster, though still active, has been far surpassed by newer
• Contribute to/edit articles in a wiki
networks. As time passes, digital media are becoming more
sophisticated so as to reach consumers in more effective ways. Collectors • Use RSS feeds
Those that are not able to adapt and change eventually fail. • Add tags to Web pages or photos
Mastering digital media presents a daunting task for businesses, • “Vote” for websites online
particularly those used to more traditional means of market- Joiners • Maintain profile on a social networking site
ing. For this reason, it is essential that marketers focus on the • Visit social networking sites
changing social behaviors of consumers, the ways in which Spectators • Read blogs
they gather and use information, and the way the Internet is
• Watch video from other users
enabling them to get involved in the marketing process.
• Listen to podcasts
Charlene Li and Josh Bernoff of Forrester Research, a technol- • Read online forums
ogy and market research company, emphasize the need for
• Read customer ratings/reviews
marketers to understand these changing relationships in the
online media world. By grouping consumers into different seg- Inactives • None of the activities
ments based on how they utilize digital media, marketers can Source: Charlene Li and Josh Bernoff, Groundswell (Boston: Harvard Business
gain a better understanding of the online market and how best Press, 2008), p. 43.
to proceed.68
Table 13.2 shows six ways to group consumers based on their
Internet activity (or lack thereof). The categories are not mutu- or site that catches the eye of a collector is likely to be posted,
ally exclusive; online consumers can participate in more than discussed on collector sites, and made available to other online
one at a time. users looking for information.
Creators are consumers who create their own media out- Joiners include all who become users of Myspace, Twitter,
lets, such as blogs, podcasts, consumer-generated videos, and Facebook, or other social networking sites. It is not unusual
[ “The challenge for digital media marketers is to constantly adapt

to new technologies and changing consumer patterns.” ]
wikis.69 Consumer-generated media are increasingly impor- for consumers to be members of several social networking
tant to online marketers as a conduit for addressing consum- sites at once. Joiners use these sites to connect and network
ers directly. The second category, critics, consists of people who with other users, but as we’ve seen, marketers too can take sig-
comment on blogs or post ratings and reviews. Because many nificant advantage of these sites to connect with consumers
online shoppers read ratings and reviews to aid their purchasing and form customer relationships.71 The last two segments are
decisions, critics should be a primary component in a compa- Spectators and Inactives. Spectators, who read online informa-
ny’s digital marketing strategy. Collectors are the most recently tion but do not join groups or post anywhere, are the largest
recognized category. They collect information and organize group in most countries. Inactives are online users who do not
content generated by critics and creators.70 Because collectors participate in any digital online media, but their numbers are
are active members of the online community, a company story dwindling.

VIEWPOINTS website (the second largest) and a software reviews and share them with their friends
suite to help companies use social media to on sites like Twitter and Facebook. This
NETWORK HELPS create effective marketing campaigns. Cli- represents a growing trend where consum-
COMPANIES MANAGE ents include such well-known companies ers use the feedback of other consumers—
as Procter & Gamble, Sears, and Kraft. many that they’ve never met—in their
BRANDS ONLINE Viewpoints Network utilizes the power purchasing decisions. According to founder
of viral marketing with over a million mem- Matt Moog, this will require a significant
A s more companies turn toward social

media to promote their products, View-
points Network is there to help. Founded
bers registered on its website. When a
company hires Viewpoints Network to pro-
change in marketing: the incorporation of
the consumer into the marketing mix.72
mote a brand, Viewpoints Network invites
by entrepreneur Matt Moog in 2006, View- members, specifically opinion leaders, to try
points Network consists of a product review the product. Members then write product
Marketers who want to capitalize on social and digital media feeding-time frenzy when one greedy pet eats the other pet’s
marketing need to consider what proportion of online con- food. Barksfield paid $99 to post a concept and some drawings
sumers are creating, rating, collecting, joining, or simply read- at quirky.com, and 30,000 people passed judgment on his idea.73
ing online materials. As in traditional marketing efforts, they
need to know their target market. For instance, where specta- Consumer feedback is an important part of the digital media
tors make up the majority of the online population, companies equation. Some of the oldest forms of digital media are online
should post their own corporate messages through blogs and forums, where participants post and respond to messages and
websites promoting their organizations. discuss specific topics. About one-fifth of U.S. and Japanese
Internet users participate in discussion forums, whose top-
ics can range from consumer products to movies. Ratings and
USING DIGITAL MEDIA reviews have become exceptionally popular; 25 percent of the
U.S. online population reads this type of consumer-generated
TO LEARN ABOUT feedback.74 Retailers such as Amazon, Netflix, and Priceline
allow consumers to post comments on their sites about the
CONSUMERS books, movies, and travel arrangements they sell. Today, most
online shoppers search the Internet for ratings and reviews
Marketing research and information systems can use digital
media and social networking sites to gather useful information before making major purchase decisions.
about consumers and their preferences. Sites such as Twitter,
Facebook, Myspace, and LinkedIn can be good substitutes for
focus groups. Online surveys can serve as an alternative to mail,
telephone, or personal interviews.
Crowdsourcing describes how marketers use digital media to
find out the opinions or needs of the crowd (or potential mar-
kets). Communities of interested consumers join sites like
threadless.com, which designs t-shirts, or crowdspring.com,
which creates logos and print and Web designs. These compa-
nies give interested consumers opportunities to contribute and
give feedback on product ideas. Crowdsourcing lets companies
gather and utilize consumers’ ideas in an interactive way when
creating new products. There are even sites that crowdsource
entire advertising campaigns, like victorandspoils.com. Mobile
phone brand LG offered the public more than $80,000 for ideas
about what the mobile phone should look like in two, five,
or ten years. Barilla, the Italian pasta brand, gets consumers
involved in designing new pasta for little expense—far less than
the cost of banner ads on websites.
There is no end to the opportunities to gain information,
insights, and new-product ideas from consumers. For instance, About three-quarters of people shopping on the Web read online ratings
Rupert Barksfield developed the Multi-Pet Feeder to end pet and reviews before making a purchasing decision.

While consumer-generated content about a firm can be either these in this section, as well as steps that individuals, compa-
positive or negative, digital media forums do allow businesses nies, and the government have taken to address them.
to closely monitor what their customers are saying. In the case
of negative feedback, businesses can communicate with con- Privacy
sumers to address problems or complaints much more easily Businesses have long tracked consumers’ shopping habits with
than through traditional communication channels. Hotels and little controversy. However, observing the contents of a con-
resorts, for example, have begun monitoring social media sites sumer’s shopping cart or the process a consumer goes through
to see what their guests are saying about them. In some cases, when choosing a box of cereal generally does not result in the
guests who have complained about their rooms using digital collection of specific, personally identifying data. Although by
media have found themselves upgraded to better rooms that using credit cards, shopping cards, and coupons forces consum-
very night.75 Yet despite the ease and obvious importance of ers to give up a certain degree of anonymity in the traditional
online feedback, many companies do not yet take full advan- shopping process, they can still choose to remain anonymous
tage of the digital tools at their disposal. by paying cash. Shopping on the Internet, however, allows
businesses to track them on a far more personal level, from the
contents of their online purchases to the websites they favor.
LEGAL AND SOCIAL Current technology has made it possible for marketers to amass
vast quantities of personal information, often without consum-
ISSUES IN INTERNET ers’ knowledge, and to share and sell this information to inter-
ested third parties.
MARKETING How is personal information collected on the Web? Many
The extraordinary growth of information technology, the Inter- sites follow users online by storing a “cookie,” or an identify-
net, and e-business has generated many legal and social issues ing string of text, on users’ computers. Cookies permit website
for consumers and businesses. These issues include privacy operators to track how often a user visits the site, what he or
concerns, the risk of identity theft and online fraud, and the she looks at while there, and in what sequence. They also allow
need to protect intellectual property. The U.S. Federal Trade website visitors to customize services, such as virtual shopping
Commission (FTC) compiles an annual list of consumer com- carts, as well as the particular content they see when they log
plaints related to the Internet and digital media. Figure 13.1 onto a Web page. Users have the option of turning off cook-
outlines the major sources of complaints. We discuss each of ies on their machines, but nevertheless the potential for misuse
has left many consumers uncomfort-
able with this technology. The European
FIGURE 13.1 Union even passed a law that requires
Consumer Complaints to Government Agencies by Type companies to get users’ consent before
using cookies to track their informa-
tion. Because of this law Yahoo Inc.
22% now allows Internet users in the United
2008 52% Kingdom to choose whether to opt out of
26% having their Internet habits tracked.76
Even information that consumers will-
ingly post can be used improperly. Face-
25% book in particular has been criticized
2009 54% Other over the last few years of mishandling
Identity Theft
user information. In 2010 an online
21% security consultant collected public
Fraud user information from over 100 million
Facebook users and placed them in a file
27% for companies to download. This type
2010 19% of “scraping”—where companies offer
to collect personal information from
54% social networking sites and other online
forums—is becoming increasingly com-
0% 10% 20% 30% 40% 50% 60% mon. Since Internet privacy issues have
become such a problem, regulators are
Source: Federal Trade Commission, Consumer Sentinel Network Data Book, March 2011, www.ftc.gov/ proposing bills to address the issue. One
sentinel/reports/sentinel-annual-reports/sentinel-cy2010.pdf (accessed April 11, 2011). proposed bill, called the “do not track”

bill, has been supported by several legislators. The “do not Several nonprofit organizations have stepped in to help com-
track” bill would be an online equivalent of the “do not call” panies develop privacy policies. Among the best known are
bill for telephones, allowing users to opt out of having their TRUSTe and the Better Business Bureau Online. TRUSTe is
information tracked. A social networkers’ bill of rights for a nonprofit organization devoted to promoting global trust
users is also an option. Table 13.3 outlines some laws already in Internet technology. Companies that agree to abide by
in place to protect Internet privacy.77 TRUSTe’s privacy standards may display a “trustmark” on their
websites; thousands of websites currently do so.80 The BBBOn-
Federal regulation could pose a significant threat to Web adver-
Line program provides verification, monitoring and review,
tisers, who use consumer information to better target advertise-
consumer dispute resolution, a compliance seal, enforcement
ments. Such regulations could harm search engines and social
mechanisms, and an educational component. It is managed by
networking sites as well. According to Facebook, 80 percent of
the Council of Better Business Bureaus, an organization with
the world’s 100 largest advertisers are on Facebook. As a result
considerable experience in conducting self-regulation and
of this threat, Google, Facebook, and other Web-based compa-
dispute-resolution programs, and it employs guidelines and
nies are increasing their lobbying efforts to ward off regulation
requirements outlined by the FTC and the U.S. Department of
that may be potentially damaging. In one year, Google spent
Commerce.81 The hope among online marketers is that wide-
approximately $4 million on lobbying efforts. Self-regulation is
spread adoption of these privacy policies may prevent regula-
another option some Web advertisers are pursuing.78
tion that could make it more difficult to advertise effectively
On the other hand, certain advertising agencies, networks, and online.
industry trade groups have made the decision to work with
Internet-browser makers to create a “do-not-track” system. Identity Theft
This represents a major shift for these advertising groups, which Identity theft occurs when criminals obtain personal informa-
until recently have largely opposed such a system. However, tion that allows them to impersonate someone else in order to
although Microsoft and Mozilla have both integrated “do-not- use the person’s credit to access financial accounts and make pur-
track” features into their browsers, advertisers have a choice as chases. Many of these breaches occur at banks, universities, and
to whether they will respect users’ do-not-track requests.79 other businesses that contain sensitive consumer information.82
T A B L E 1 3 . 3 A Timeline of Internet-Related Privacy Policies

Year Legislation Major Provisions
1986 Electronic Communications Privacy Act Extended laws on wiretaps to electronic transmissions.
1987 Computer Security Act Improved the regulation of public information by making the National Institute of
Standards and Technology (NIST) responsible for the standardization of communication
protocols, data structures, and interfaces in telecommunications and computer systems.
1988 Computer Matching and Privacy Amended the 1986 Privacy Act by regulating the use of computer matching, the
Protection Act computerized comparison of individual information for purposes of determining eligibility
for federal benefits programs.
1996 Digital Millenium Copyright Act Refined copyright laws to protect digital versions of copyrighted materials, including
music and movies.
1998 European Union Directive Required companies to explain how the personal information they collect will be used
and to obtain the individual’s permission.
1999 Anti-Cyber Squatting Consumer Made it illegal to register others’ trademarks as domain names in order to profit from
Protection Act the sale or transfer of the domain name, tarnish the trademark owner’s reputation, or
mislead consumers.
1999 Uniform Electronic Transactions Act Set guidelines for electronic transactions, including the retention of records, electronic
contracts, and electronic signatures.
2000 Children’s Online Privacy and Protection Regulated the online collection of personally identifiable information (name, address,
Act (COPPA) e-mail address, hobbies, interests, or information collected through cookies) from
children under 13.
2003 Controlling the Assault of Non-Solicited Banned fraudulent or deceptive unsolicited commercial e-mail and required senders to
Pornography and Marketing Act provide information about how recipients can opt out of receiving additional messages.
(CAN-SPAM)
Sources: “Federal Statutes Relevant in the Information Sharing Environment (ISE),” Justice Information Sharing: U.S. Department of Justice, Office of Justice
Programs, February 27, 2009, www.it.ojp.gov/default.aspx?area=privacy&page=1285 (accessed February 18, 2010); Report to Congress: The Anticybersquatting
Consumer Protection Act of 1999, section 3006 concerning the abusive registration of domain names, www.uspto.gov/web/offices/dcom/olia/tmcybpiracy/
repcongress.pdf (accessed February 18, 2010).

identity theft
when criminals obtain
personal information that
This requires organizations to implement increased security personal information. It is becom- allows them to impersonate
measures to prevent database theft. As you can see in Fig- ing a major source of frustration someone else in order to
ure 13.2, the most common complaints relate to credit card among users of social networking use their credit to access
fraud, followed by utility fraud, bank fraud, employment-related sites, because cybercriminals are financial accounts and
fraud, government document fraud, and loan fraud. finding new ways to use sites like make purchases
Facebook and Twitter to commit
The Internet’s relative anonymity and speed make possible online fraud
fraudulent activities. For instance,
both legal and illegal access to databases storing Social Secu- any attempt to conduct
they will create profiles under a
rity numbers, driver’s license numbers, dates of birth, moth- fraudulent activities online
company’s name to either damage
ers’ maiden names, and other information that can be used
the company’s reputation (partic-
to establish a credit card or bank account in another person’s
ularly larger, more controversial
name in order to make fraudulent transactions. One grow-
companies) or lure that company’s customers into releasing
ing scam used to initiate identity theft fraud is the practice of
personal information the perpetrators can use for monetary
phishing, whereby con artists counterfeit a well-known website
gain.
and send out e-mails directing victims to it. There visitors find
instructions to reveal sensitive information such as their credit Another tactic is to copy a blog entry from a reputable company
card numbers. Phishing scams have faked websites for PayPal, and repost it with a link that connects the user to the criminal’s
AOL, and the Federal Deposit Insurance Corporation. own fraudulent site, where he or she attempts to sell the user
goods (under the reputable company’s name) or collect per-
Some identity theft problems are resolved quickly, while other sonal information. For instance, a fraudster may repost a blog
cases take weeks and hundreds of dollars before a victim’s bank bal- written by a professional sport organization with a fraudulent
ances and credit standings are restored. To deter identity theft, the
link that connects users to a site that sells unlicensed sporting
National Fraud Center wants financial institutions to implement
goods.83 Criminals may also use social networking sites to pose
new technologies such as digital certificates, digital signatures, and
as charitable institutions. After the 2010 earthquake in Haiti,
biometrics—the use of fingerprinting or retina scanning.
fraudsters set up fake accounts to scam Facebook users into
donating money for the fraudsters’ own financial gain.84
Online Fraud
Online fraud includes any attempt to conduct fraudulent Despite any number of safeguards, the best protection for con-
activities online, such as by deceiving consumers into releasing sumers is to be careful when they divulge information online.
The surest way to stay out of trouble is
never to give out personal information,
FIGURE 13.2 like a Social Security or credit card num-
Main Sources of Identity Theft ber, unless it is a site you trust and that
you know is legitimate.
Credit Card Fraud 15% Intellectual Property

In addition to protecting personal pri-
vacy, Internet users and others want to
Government Documents/
19% protect their rights to property they may
Benefits Fraud
create, including songs, movies, books,
and software. Such intellectual property
Phone/Utilities Fraud 14% consists of the ideas and creative mate-
rials developed to solve problems, carry
out applications, and educate and enter-
Employment Fraud 11% tain others.
Although intellectual property is gener-
ally protected by patents and copyrights,
Bank Fraud 10%
each year losses from the illegal copying
of computer programs, music, movies,
compact discs, and books reaches bil-
Loan Fraud 4%
lions of dollars in the United States alone.
This has become a particular problem
0% 5% 10% 15% 20% with digital media sites. Chinese search
engine Baidu has been accused of offer-
Source: Federal Trade Commission, Consumer Sentinel Network Data Book, March 2011, www.ftc.gov/ ing a MP3 service that allows users to
sentinel/reports/sentinel-annual-reports/sentinel-cy2010.pdf (accessed April 11, 2011). download proprietary songs for free. The

DEVELOPING A STRATEGIC UNDERSTANDING OF HOW
DIGITAL MARKETING CAN MAKE BUSINESS MORE EFFICIENT
AND PRODUCTIVE IS INCREASINGLY NECESSARY.
the Business Software Alliance.88 About 90 percent of illegal
software copying is actually done by businesses. For example,
a firm may obtain a license to install a specific application on
100 of its computers but actually installs it on 300. In some
cases, software is illegally made available through the Internet
by companies that have taken the software from the producer
and set up their own distribution system.
DIGITAL MEDIA’S IMPACT

ON MARKETING
To be successful in business, you need to know much more
The file-sharing protocol BitTorrent allows users to share and download than how to use a social networking site to communicate with
files. The U.S. Copyright Group recently obtained the IP addresses of friends. Developing a strategic understanding of how digital
users who downloaded specific movies using BitTorrent technology marketing can make business more efficient and productive
and are taking action against thousands of BitTorrent users for illegally is increasingly necessary. If you are thinking of becoming an
downloading protected content. entrepreneur, then the digital world can open doors to new
resources and customers. Smart phones,
recording industry sued Baidu in 2005 for mobile broadband, and Webcams are
Internet piracy, but the Chinese government among the tools that can make the most of
sided with Baidu.85 Another example is You- TEAM EXERCISE
Develop a digital marketing promotion
the online business world, creating greater
Tube, which has faced lawsuits over its users’ efficiency at less cost. For example, rather
for a local sports team. Use Twitter,
possible infringement of other companies’ than using traditional phone lines, Skype
Facebook, and other social network-
copyrights. In one case, Viacom Inc. sued ing media to promote ticket sales for helps people make and receive calls via the
YouTube’s owner, Google, claiming Google next season’s schedule. In your plan, Internet and provides free video calling and
had violated its copyrights by allowing users provide specific details and ideas text messaging for about 10 percent of the
to post protected film clips on YouTube.86 for the content you would use on the cost of a land line.89 It is up to businesses
Although YouTube is responsible for the sites. Also, describe how you would and entrepreneurs to develop strategies
video content shown on its sites, it can be encourage fans and potential fans to that achieve business success using existing
difficult for Google to monitor and remove go to your site. How would you use and future technology, software, and net-
all the videos that may contain copyrighted digital media to motivate sports fans
working opportunities.
content, given the many millions of clips that to purchase tickets and merchandise
and attend games? Traditional businesses accustomed to
are loaded onto YouTube daily.
using print media can find the transition
Illegal sharing of content is another major to digital challenging. New media may
intellectual property problem. Consumers require employees with new skills or addi-
rationalize the pirating of software, videogames, movies, and tional training for current employees. There is often a gap
music for a number of reasons. First, many feel they just don’t between technical knowledge of how to develop sites and how
have the money to pay for what they want. Second, because their to develop effective digital marketing strategies to enhance
friends engage in piracy and swap digital content, some users feel business success. Determining the correct blend of traditional
influenced to engage in this activity. Others enjoy the thrill of and new media requires careful consideration; the mix will vary
getting away with something with a low risk of consequences. depending on the business, its size, and its target market. Future
And finally, some people feel being tech-savvy allows them to career opportunities will require skills in both traditional and
take advantage of the opportunity to pirate content.87 digital media areas so that marketers properly understand and
The software industry loses over $50 billion globally each year implement marketing strategies that help businesses achieve a
due to theft and illegal use of software products, according to competitive advantage. ■

SO YOU WANT TO BE // a Digital Marketer /
T he business world has grown increas-
ingly dependent on digital marketing to
maintain communication with stakeholders.
reaching consumers. Many small businesses
are posting signs outside their stores with
statements such as “Follow us on Twitter” or
experience of many businesses and research
indicate digital marketing is a powerful way to
increase brand exposure and generate traffic.
Reaching customers is often a major con- “Check out our Facebook page.” In fact, a study conducted on Social Media
cern, but digital marketing can also be used to To utilize digital marketing, especially Examiner found that 85 percent of marketers
communicate with suppliers, concerned com- social networking, requires more than infor- surveyed believe generating exposure for
munity members, and special interest groups mation technology skills related to construct- their business is their number-one advan-
about issues related to sustainability, safety ing websites, graphics, videos, podcasts, and tage in Internet marketing. As consumers use
practices, and philanthropic activities. Many so on. Most importantly, one must be able to social networking for their personal commu-
types of jobs exist: account executive direc- determine how digital media can be used in nication, they will be more open to obtaining
tors of social media and director of marketing implementing a marketing strategy. All mar- information about products through this chan-
for digital products, as well as digital adver- keting starts with identifying a target market nel. Digital marketing could be the fastest-
tisers, online marketers, global digital mar- and developing a marketing mix to satisfy cus- growing opportunity in business.
keters, and brand managers are prominently tomers. Digital marketing is just another way To prepare yourself for a digital marketing
listed on career opportunity websites. to reach customers, provide information, and career, learn not only the technical aspects,
Entrepreneurs are taking advantage of the develop relationships. Therefore, your oppor- but also how social media can be used to
low cost of digital marketing, building social tunity for a career in this field is greatly based maximize marketing performance. A glance
networking sites to help market their prod- on understanding the messages, desired level at careerbuilder.com indicates that manage-
ucts. In fact, some small businesses such of interactivity, and connectivity that helps ment positions such as account manager,
as specialty publishing, personal health and achieve marketing objectives. digital marketing manager, and digital product
beauty, and other specialty products can use As social media use skyrockets, digital manager can pay from $60,000 to $170,000 or
digital marketing as the primary channel for marketing professionals will be in demand. The more per year.
GET ONLINE
mhhe.com/FerrellM3e
and video

introduction
ccounting, the financial “lan- organizations such as charities and
A guage” that organizations use

to record, measure, and inter-
pret all of their financial transactions
governments also use accounting to
demonstrate to donors and taxpayers
how well they are using their funds
and records, is very important in busi- and meeting their stated objectives.
ness. All businesses—from a small This chapter explores the role of
family farm to a giant corporation— accounting in business and its impor-
use the language of accounting to tance in making business decisions.
make sure they use their money wisely First, we discuss the uses of account-
and to plan for the future. Nonbusiness ing information and the accounting
288 PART 6 | Financing the Enterprise

fourteen
accounting
+ financial
statements
process. Then, we briefly look at LO3 Examine the various components

of an income statement in order to
some simple financial statements and evaluate a firm’s “bottom line.”
accounting tools that are useful in LO4 Interpret a company’s balance
analyzing organizations worldwide. sheet to determine its current
financial position.
LEARNING OBJECTIVES LO5 Analyze the statement of cash
flows to evaluate the increase and
LO1 Define accounting, and describe
decrease in a company’s cash
the different uses of accounting
balance.
information.
LO2 Demonstrate the accounting
process.
CHAPTER 14 | Accounting and Financial Statements 289

accounting certified public
the recording, measurement, accountant (CPA) an
and interpretation of financial individual who has been state
information certified to provide accounting
Commission’s (SEC) Public Company Accounting Oversight
services ranging from the Board. For example, Ernst & Young, a leading accounting firm,
preparation of financial records was barred from undertaking new audit clients for six months
and the filing of tax returns to as a penalty for abusing the agency’s auditor-independence
complex audits of corporate rules.1
financial records
To better understand the importance of accounting, we must
first understand who prepares accounting information and
how it is used.
THE NATURE OF Accountants

ACCOUNTING Many of the functions of accounting are carried out by public
or private accountants.
Simply stated, accounting is the recording, measurement,
and interpretation of financial information. Large numbers of Public Accountants Individuals and businesses can hire
people and institutions, both within and outside businesses, a certified public accountant (CPA), an individual who
use accounting tools to evaluate organizational operations. has been certified by the state in which he or she practices to
The Financial Accounting Standards Board has been setting provide accounting services ranging from the preparation of
the principles standards of financial accounting and report- financial records and the filing of tax returns to complex audits
ing in the private sector since 1973. Its mission is to establish of corporate financial records. Certification gives a public
and improve standards of financial accounting and report- accountant the right to express, officially, an unbiased opin-
ing for the guidance and education of the public, including ion regarding the accuracy of the client’s financial statements.
issuers, auditors, and users of financial information. How- Most public accountants are either self-employed or mem-
ever, the accounting scandals at the turn of the last century bers of large public accounting firms such as Ernst & Young,
resulted when many accounting firms and businesses failed to KPMG, Deloitte Touche Tohmatsu, and PricewaterhouseCoo-
abide by generally accepted accounting principles, or GAAP. pers, together referred to as “the Big Four.” In addition, many
Consequently, the federal government has taken a greater CPAs work for one of the second-tier accounting firms that
role in making rules, requirements, and policies for account- are much smaller than the Big Four firms, as illustrated in
ing firms and businesses through the Securities and Exchange Table 14.1.
KPMG is part of the “Big Four,”or the four largest international accounting firms. The other three are PricewaterhouseCoopers, Ernst & Young, and
Deloitte Touche Tomatsu.

private
accountants
accountants employed
T A B L E 1 4 . 1 Leading Accounting Firms the amount of capital they must by large corporations,
maintain; and the use of deriva- government agencies,
2010 U.S.
Revenues tive instruments such as options, and other organizations to
Company ($ Millions) 2010 Partners futures, and structured invest- prepare and analyze their
“Top Seven Firms” ment products. financial statements
Deloitte Touche $10,722 2,968 A growing area for public accoun- certified
Ernst & Young $7,620 2,500 tants is forensic accounting, which management
is accounting that is fit for legal accountants
PricewaterhouseCoopers $7,369 2,235
review. It involves analyzing finan- (CMAs) private
KPMG $5,076 1,847 cial documents in search of fraudu- accountants who, after
RSM/McGladrey & Pullen $1,460 751 lent entries or financial misconduct. rigorous examination, are
Grant Thornton $1,147 535 Functioning as much like detectives certified by the National
as accountants, forensic accoun- Association of Accountants
BDO $620 273 and who have some
tants have been used since the
Source: Accounting Today, Top 100 Firms, 2010, special supplement to managerial responsibility
1930s. In the wake of the account-
Accounting Today, p. 18. Published by SourceMedia, www.hawcpa.com/pdf/
actodaytop100_2010-dl%5B1%5D.pdf. ing scandals of the early 2000s,
many auditing firms are rapidly
While there will always be companies and individual money adding or expanding forensic or fraud-detection services. Addi-
managers who can successfully hide illegal or misleading tionally, many forensic accountants root out evidence of “cooked
accounting practices for a while, eventually they are exposed. books” for federal agencies like the Federal Bureau of Investiga-
After the accounting scandals of Enron and Worldcom in tion or the Internal Revenue Service. The Association of Certified
the early 2000s, Congress passed the Sarbanes-Oxley Act, Fraud Examiners, which certifies accounting professionals as cer-
which required firms to be more rigorous tified fraud examiners (CFEs), has grown to more
in their accounting and reporting practices. than 45,000 members.4
Sarbanes-Oxley made accounting firms sepa-
rate their consulting and auditing businesses Private Accountants Large corporations,
and punished corporate executives with poten- government agencies, and other organizations
tial jail sentences for inaccurate, misleading, may employ their own private accountants
or illegal accounting statements. This seemed to prepare and analyze their financial statements.
to reduce the accounting errors among non- With titles such as controller, tax accountant, or
financial companies, but declining housing internal auditor, private accountants are deeply
prices exposed some of the questionable prac- involved in many of the most important finan-
tices by banks and mortgage companies. In DID YOU KNOW? cial decisions of the organizations for which
2008–2009, the world experienced a financial they work. Private accountants can be CPAs
Corporate fraud costs
crisis—part of which was due to excessive risk and may become certified management
taking and inappropriate accounting practices. are estimated at $2.9 accountants (CMAs) by passing a rigorous
Many banks failed to understand the true state trillion annually.3 examination by the Institute of Management
of their financial health. Other banks hid risks Accountants.
from the public through a practice known as
“window-dressing,” which occurs when banks “temporar- Accounting or Bookkeeping?
ily” get rid of debt before reporting their financial informa-
The terms accounting and bookkeeping are often mistakenly
tion to the public. Citigroup Inc. engaged in this by listing
used interchangeably. Much narrower and far more mechani-
short-term debt as sales when it should have been labeled as
2 cal than accounting, bookkeeping is typically limited to
borrowings.
the routine, day-to-day recording of business transactions.
Banks also developed questionable lending practices and Bookkeepers are responsible for obtaining and recording
investments based on subprime mortgages made to individu- the information that accountants require to analyze a firm’s
als who had poor credit. When housing prices declined and financial position. They generally require less training than
people suddenly found that they owed more on their mort- accountants. Accountants, on the other hand, usually com-
gages than their homes were worth, they began to default. plete course work beyond their basic four- or five-year col-
To prevent a depression, the government intervened and lege accounting degrees. This additional training allows
bailed out some of the United States’ largest banks. Congress accountants not only to record financial information, but
is continuing to work on legislation that will strengthen the to understand, interpret, and even develop the sophisticated
oversight of financial institutions. Most likely this legisla- accounting systems necessary to classify and analyze complex
tion will limit the types of assets commercial banks can buy; financial information.

managerial cash flow budget
accounting the the movement of money an internal financial plan
internal use of accounting through an organization that forecasts expenses and
statements by managers in over a daily, weekly, income over a set period Internal Uses Managerial accounting
planning and directing the monthly, or yearly basis of time refers to the internal use of accounting state-
organization’s activities ments by managers in planning and directing
the organization’s activities. Perhaps manage-
ment’s greatest single concern is cash flow,
The Uses of Accounting the movement of money through an organization over a daily,
weekly, monthly, or yearly basis. Obviously, for any business to
Information succeed, it needs to generate enough cash to pay its bills as they
Accountants summarize the information from a firm’s busi- fall due. However, it is not at all unusual for highly successful
ness transactions in various financial statements (which we’ll and rapidly growing companies to struggle to make payments
look at in a later section of this chapter) for a variety of stake- to employees, suppliers, and lenders because of an inadequate
holders, including managers, investors, creditors, and govern- cash flow. One common reason for a so-called cash crunch, or
ment agencies. Many business failures may be directly linked shortfall, is poor managerial planning.
to ignorance of the information “hidden” inside these financial
Managerial accountants also help prepare an organization’s
statements. Likewise, most business successes can be traced to
budget, an internal financial plan that forecasts expenses
informed managers who understand the consequences of their
and income over a set period of time. It is not unusual for an
decisions. While maintaining and even increasing short-run
organization to prepare separate daily, weekly, monthly, and
profits is desirable, the failure to plan sufficiently for the future
yearly budgets. Think of a budget as a financial map, show-
can easily lead an otherwise successful company to insolvency
ing how the company expects to move from Point A to Point
and bankruptcy court.
B over a specific period of time. While most companies pre-
Basically, managers and owners use financial statements (1) to pare master budgets for the entire firm, many also prepare bud-
aid in internal planning and control and (2) for external pur- gets for smaller segments of the organization such as divisions,
poses such as reporting to the Internal Revenue Service, stock- departments, product lines, or projects. “Top-down” master
holders, creditors, customers, employees, and other interested budgets begin at the upper management level and filter down
parties. Figure 14.1 shows some of the users of the accounting to the individual department level, while “bottom-up” budgets
information generated by a typical corporation. start at the department or project level and are combined at the
RECESSION Kuehn and several others saw this as an example, rather than having a budget with
opportunity to improve the financial func- set forecasts, managers should continually
ENCOURAGED tion of budgeting. According to Keuhn, UPS review the budget and make changes when
UNITED PARCEL was forced to adapt to focus on bare bones needed. In addition, consultants are advising
costs. Instead of focusing so extensively companies to plan for a variety of scenarios.
SERVICE (UPS) on absolute targets and measures, manag- Having strategies in place can potentially
TO RETHINK THE ers began to examine the minute details save a company, and periodic reviews of the
of budgeting. As a result, they created a budget can help companies identify chang-
BUDGETING PROCESS system allowing them to match spending ing scenarios and develop appropriate strat-
to changing revenue. This new philosophy egies. The effects of the recession might
F inance managers became key players

as the recent recession forced many
companies to alter how they budget. With
was applied to every department. Focus on
growth was replaced with an emphasis on
balancing gains and losses in revenue with
just change how finance departments view
budgeting—for the better!5
plummeting revenues, the recessionary the company’s spending costs. A good por- Discussion Questions
business climate seemed to offer few position of this focus was turned toward iden- 1. Why did UPS change its budgeting
tives. For example, for the United Parcel tifying and trimming unnecessary spending. process?
Service (UPS), the recession removed the For UPS, this resulted in a more flexible 2. What changes did UPS make in its
company’s ability to predict the path its budget that received periodic reviews. The budgeting?
finances would take. Management no lon- company is now making a comeback; recent
3. Do you think that UPS’s new budgeting
ger had concrete information with which to quarterly numbers beat analyst predictions.
process would work well during a more
make such predictions. Financial consultants have long advo-
prosperous economic period?
However, instead of seeing this as a cated for this shift and continue to urge
liability, UPS Chief Financial Officer Kurt CFOs to increase budget revisions. For

annual report
summary of a firm’s
financial information,
FIGURE 14.1 Financial statements products, and growth
The Users of Accounting Information evaluate the return on plans for owners and
stockholders’ invest- potential investors
ment and the overall
quality of the firm’s
Business Activities
management team. As a result, poor per-
formance, as documented in the financial
Accounting statements, often results in changes in top man-
agement. Potential investors study the financial
Those with Direct Those with Indirect Financial Interest
statements in a firm’s annual report to deter-
Management Financial Interest
Tax Regulatory Economic Other mine whether the company meets their invest-
Owners, partners Present or Authorities Agencies Planners Groups
potential
Council of Employees
ment requirements and whether the returns
Boards of investors Federal SEC
directors
Present or
(IRS)
Stock
Economic
Advisors
and labor from a given firm are likely to compare favor-
State unions
Officers of the
company
potential creditors exchanges
Federal Financial ably with other similar companies.
Municipal ICC, FAA, Reserve Board advisors
Managers etc.
Other Government Customers Banks and other lenders look at financial state-
Department heads Other planners and the
agencies general public ments to determine a company’s ability to meet
Supervisors
current and future debt obligations if a loan or
credit is granted. To determine this ability, a
Actions That Affect Business Activities
short-term lender examines a firm’s cash flow
to assess its ability to repay a loan quickly with
cash generated from sales. A long-term lender
Source: Belverd E. Needles, Henry R. Anderson, and James C. Caldwell, Principles of Accounting, is more interested in the company’s profitabil-
4th edition. Copyright © 1990 by Houghton Mifflin Company. Reprinted with permission. ity and indebtedness to other lenders.
chief executive’s office. Generally, the larger and more rapidly

growing an organization, the greater will be the likelihood that
it will build its master budget from the ground up.
Regardless of focus, the principal value of a budget lies in its
breakdown of cash inflows and outflows. Expected operating
expenses (cash outflows such as wages, materials costs, and
taxes) and operating revenues (cash inflows in the form of pay-
ments from customers) over a set period of time are carefully
forecast and subsequently compared with actual results. Devia-
tions between the two serve as a “trip wire” or “feedback loop”
to launch more detailed financial analyses in an effort to pin-
point trouble spots and opportunities.
External Uses Managers also use accounting statements to

report the business’s financial performance to outsiders. Such
statements are used for filing income taxes, obtaining credit
from lenders, and reporting results to the firm’s stockholders.
They become the basis for the information provided in the offi-
cial corporate annual report, a summary of the firm’s finan-
cial information, products, and growth plans for owners and
potential investors. While frequently presented between slick,
glossy covers prepared by major advertising firms, the single
most important component of an annual report is the signa-
ture of a certified public accountant attesting that the required
financial statements are an accurate reflection of the underly-
ing financial condition of the firm. Financial statements meet-
ing these conditions are termed audited. The primary external
users of audited accounting information are government
agencies, stockholders and potential investors, and lenders, Even profitable businesses can become unprofitable if they don’t manage
suppliers, and employees. their cash flows right.

As one of the biggest banks in the United States, Wells Fargo specializes in banking, mortgage, and financial services. The data it provides can be
used in financial statements.
Labor unions and employees use financial statements to

establish reasonable expectations for salary and other benefit THE ACCOUNTING PROCESS
requests. Just as firms experiencing record profits are likely Many view accounting as a primary business language. It is of
to face added pressure to increase employee wages, so too are little use, however, unless you know how to “speak” it. Fortu-
employees unlikely to grant employers wage and benefit con- nately, the fundamentals—the accounting equation and the
cessions without considerable evidence of financial distress. double-entry bookkeeping system—are not difficult to learn.
Many view accounting as a primary business language.
BLOOM ENERGY developed Energy Servers (power genera- a more accessible option than those offered
tors) that utilize new fuel cell technology to by rival companies. Fortune 500 companies
SERVERS CUT produce clean economical power on-site. have started purchasing Bloom’s Energy
COSTS, INCREASE These servers are designed to reduce elec- Servers. Among users is Adobe Systems,
tricity costs as well as greenhouse gas emis- which has installed the largest installation
SUSTAINABILITY sions. The commercial version now runs of Bloom Energy Servers to date, and eBay,
$700,000 to $800,000, and Bloom is working on which claims that its devices saved $100,000
B loom Energy has been flying under the

radar for years, but now it is ready for
the spotlight. With the help of $400 million
a version for the private home. Fuel cell tech-
nology is nothing new, but Bloom CEO KR
on its power bill. Bloom’s venture capital
backers see the company as an important
Sridhar says the company’s proprietary tech- component in the overall quest toward clean
from venture capitalists, the company has nology utilizes low-cost materials—making it but affordable electricity.6

assets liabilities owners’ equity accounting equation double-entry
a firm’s economic resources, debts that a firm owes to equals assets minus liabilities assets equal liabilities plus bookkeeping a system
or items of value that it owns, others and reflects historical values owners’ equity of recording and classifying
such as cash, inventory, land, business transactions that
equipment, buildings, and maintains the balance of the
other tangible and intangible accounting equation
things
These two concepts serve as the starting point for all currently a fundamental concept in accounting and is known as the
accepted accounting principles. accounting equation:
The Accounting Equation Assets = Liabilities + Owners’ equity

Accountants are concerned with reporting an organiza-
tion’s assets, liabilities, and owners’ equity. To help illustrate Double-Entry Bookkeeping
these concepts, consider a hypothetical floral shop called
Double-entry bookkeeping is a system of recording and
Anna’s Flowers, owned by Anna Rodriguez. A firm’s eco-
classifying business transactions in separate accounts in order
nomic resources, or items of value that it owns, represent its
to maintain the balance of the accounting equation. Return-
assets—cash, inventory, land, equipment, buildings, and
ing to Anna’s Flowers, suppose Anna buys $325 worth of
other tangible and intangible things. The assets of Anna’s
roses on credit from the Antique Rose Emporium to fill a
Flowers include counters, refrigerated display cases, flowers,
wedding order. When she records this transaction, she will
decorations, vases, cards, and other gifts, as well as something
list the $325 as a liability or a debt to a supplier. At the same
known as “goodwill,” which in this case is Anna’s reputation
time, however, she will also record $325 worth of roses as an
for preparing and delivering beautiful floral arrangements on
asset in an account known as “inventory.” Because the assets
a timely basis. Liabilities, on the other hand, are debts the
and liabilities are on different sides of the accounting equa-
firm owes to others. Among the liabilities of Anna’s Flow-
tion, Anna’s accounts increase in total size (by $325) but
ers are a loan from the Small Business Administration and
remain in balance:
money owed to flower suppliers and other creditors for items
purchased. The owners’ equity category contains all of the
money that has ever been contributed to the company that
Assets = Liabilities + Owners’ equity
never has to be paid back. The funds can come from inves- $325 = $325
tors who have given money or assets to the company, or it can
come from past profitable operations. In the case of Anna’s Thus, to keep the accounting equation in balance, each busi-
Flowers, if Anna were to sell off, or liquidate, her business, ness transaction must be recorded in two separate accounts.
any money left over after selling all the shop’s assets and pay- In the final analysis, all business transactions are classified as
ing off its liabilities would comprise her owners’ equity. The either assets, liabilities, or owners’ equity. However, most orga-
relationship between assets, liabilities, and owners’ equity is nizations further break down these three accounts to provide
more specific information about a transaction. For example,
assets may be broken down into specific categories such as cash,
inventory, and equipment, while liabilities may include bank
loans, supplier credit, and other debts.
Figure 14.2 shows how Anna used the double-entry book-
keeping system to account for all of the transactions that
took place in her first month of business. These transac-
tions include her initial investment of $2,500, the loan from
the Small Business Administration, purchases of equipment
and inventory, and the purchase of roses on credit. In her
first month of business, Anna generated revenues of $2,000
by selling $1,500 worth of inventory. Thus, she deducts, or
(in accounting notation that is appropriate for assets) credits,
$1,500 from inventory and adds, or debits, $2,000 to the cash
account. The difference between Anna’s $2,000 cash inflow
A firm’s assets include tangible items, as in the case of this restaurant’s and her $1,500 outflow is represented by a credit to owners’
service tables, equipment, and even the atmosphere created by the equity, because it is money that belongs to her as the owner of
wall’s artwork. the flower shop.

accounting cycle journal a time-ordered list of
the four-step procedure of an account transactions
accounting system: examining
source documents, recording ledger a book or computer file Step Three: Post Transactions Anna next trans-
transactions in an accounting with separate sections for each fers the information from her journal into a ledger, a book
journal, posting recorded account or computer program with separate files for each account.
transactions, and preparing This process is known as posting. At the end of the accounting
financial statements period (usually yearly, but occasionally quarterly or monthly),
Anna prepares a trial balance, a summary of the balances of all
the accounts in the general ledger. If, upon totaling, the trial
balance doesn’t balance (that is, the accounting equation is not
in balance), Anna or her accountant must look for mistakes
The Accounting Cycle (typically an error in one or more of the ledger entries) and cor-
In any accounting system, financial data typically pass through a rect them. If the trial balance is correct, the accountant can then
four-step procedure sometimes called the accounting cycle. begin to prepare the financial statements.
The steps include examining source documents, recording
transactions in an accounting journal, posting recorded trans- Step Four: Prepare Financial Statements The infor-
actions, and preparing financial statements. Figure 14.3 shows mation from the trial balance is also used to prepare the compa-
how Anna works through them. Traditionally, all of these steps ny’s financial statements. In the case of public corporations and
were performed using paper, pencils, and erasers (lots of eras- certain other organizations, a CPA must attest, or certify, that the
ers!), but today the process is often fully computerized. organization followed generally accepted accounting principles
in preparing the financial statements. When these statements
Step One: Examine Source Documents Like all good have been completed, the organization’s books are “closed,” and
managers, Anna Rodriguez begins the accounting cycle by the accounting cycle begins anew for the next accounting period.
gathering and examining source documents—checks, credit
card receipts, sales slips, and other related evidence concerning
specific transactions. FINANCIAL STATEMENTS
The end result of the accounting process is a series of finan-
Step Two: Record Transactions Next, Anna records cial statements. The income statement, the balance sheet, and
each financial transaction in a journal, which is basically just the statement of cash flows are the best-known examples of
a time-ordered list of account transactions. While most busi- financial statements. They are provided to stockholders and
nesses keep a general journal in which all transactions are potential investors in a firm’s annual report as well as to other
recorded, some classify transactions into specialized journals relevant outsiders such as creditors, government agencies, and
for specific types of transaction accounts. the Internal Revenue Service.
FIGURE 14.2
The Accounting Equation and Double-Entry Bookkeeping for Anna’s Flowers

FIGURE 14.3
The Accounting Process for Anna’s Flowers

income revenue the cost of goods gross expenses the depreciation net income
statement total amount of sold the amount income (or costs incurred in the process of the total profit
a financial report money received of money a firm profit) revenues the day-to-day spreading the costs (or loss) after all
that shows an from the sale of spent to buy minus the cost of operations of an of long-lived assets expenses, including
organization’s goods or services, or produce the goods sold required organization such as buildings taxes, have been
profitability over a as well as from products it sold to generate the and equipment over deducted from
period of time— related business during the period to revenues the total number of revenue; also called
month, quarter, or activities which the income accounting periods net earnings
year statement applies in which they are
expected to be used
It is important to recognize that not all financial statements fol- pictures of the company’s overall revenues and the costs incurred
low precisely the same format. The fact that different organiza- in generating those revenues. Other names for the income state-
tions generate income in different ways suggests that when it ment include profit and loss (P&L) statement or operating state-
comes to financial statements, one size definitely does not fit ment. A sample income statement with line-by-line explanations
all. Manufacturing firms, service providers, and nonprofit orga- is presented in Table 14.3, while Table 14.4 presents the income
nizations each use a different set of accounting principles or statement of Starbucks. The income statement indicates the
rules upon which the public accounting profession has agreed. firm’s profitability or income (the bottom line), which is derived
As we have already mentioned, these are sometimes referred by subtracting the firm’s expenses from its revenues.
to as generally accepted accounting principles (GAAP). Each
country has a different set of rules that the businesses within Revenue Revenue is the total amount of money received
that country are required to use for their accounting process (or promised) from the sale of goods or services, as well as
and financial statements. Moreover, as is the case in many from other business activities such as the rental of property and
other disciplines, certain concepts have more than one name. investments. Nonbusiness entities typically obtain revenues
For example, sales and revenues are often interchanged, as are through donations from individuals and/or grants from gov-
profits, income, and earnings. Table 14.2 lists a few common ernments and private foundations. Starbucks’ income state-
equivalent terms that should help you decipher their meaning ment (see Table 14.4) shows three sources of revenue: retail
in accounting statements. sales, licensing, and food service.
For most manufacturing and retail concerns, the next major
The Income Statement item included in the income statement is the cost of goods
The question, “What’s the bottom line?” derives from the income sold, the amount of money the firm spent (or promised to
statement, where the bottom line shows the overall profit or loss spend) to buy and/or produce the products it sold during the
of the company after taxes. Thus, the income statement is a accounting period. This figure may be calculated as follows:
financial report that shows an organization’s profitability over
a period of time, be that a month, quarter, or year. By its very Cost of goods sold = Beginning inventory
design, the income statement offers one of the clearest possible + Interim purchases – Ending inventory
T A B L E 1 4 . 2 Equivalent Terms in Accounting Let’s say that Anna’s Flowers began an accounting period with
an inventory of goods for which it paid $5,000. During the
Term Equivalent Term
period, Anna bought another $4,000 worth of goods, giving the
Revenues Sales shop a total inventory available for sale of $9,000. If, at the end
Goods or services sold of the accounting period, Anna’s inventory was worth $5,500,
Gross profit Gross income the cost of goods sold during the period would have been
Gross earnings $3,500 ($5,000 + $4,000 – $5,500 = $3,500). If Anna had total
revenues of $10,000 over the same period of time, subtract-
Operating income Operating profit
ing the cost of goods sold ($3,500) from the total revenues
Earnings before interest and of $10,000 yields the store’s gross income or profit (rev-
taxes (EBIT)
enues minus the cost of goods sold required to generate the
Income before interest and revenues): $6,500. As indicated in Table 14.4, the cost of goods
taxes (IBIT)
sold was just over $4.458 billion in 2010. Notice that Starbucks
Income before taxes (IBT) Earnings before taxes (EBT) calls it cost of sales, rather than cost of goods sold. This is
Profit before taxes (PBT) because Starbucks buys raw materials and supplies and pro-
Net income (NI) Earnings after taxes (EAT) duces drinks.
Profit after taxes (PAT)
Expenses Expenses are the costs incurred in the day-to-
Income available to common Earnings available to common day operations of an organization. Three common expense
stockholders stockholders
accounts shown on income statements are (1) selling, general,

T A B L E 1 4 . 3 Sample Income Statement
The following exhibit presents a sample income statement with all the terms defined and explained.
Company Name for the Year Ended December 31
Revenues (sales) Total dollar amount of products sold (includes income from other business services such as rental-lease
income and interest income).
Less: Cost of goods sold The cost of producing the goods and services, including the cost of labor and raw materials as well as
other expenses associated with production.
Gross profit The income available after paying all expenses of production.
Less: Selling and administrative The cost of promoting, advertising, and selling products as well as the overhead costs of managing the
expense company. This includes the cost of management and corporate staff. One non-cash expense included
in this category is depreciation, which approximates the decline in the value of plant and equipment
assets due to use over time. In most accounting statements, depreciation is not separated from selling
and administrative expenses. However, financial analysts usually create statements that include this
expense.
Income before interest and taxes This line represents all income left over after operating expenses have been deducted. This is
(operating income or EBIT) sometimes referred to as operating income since it represents all income after the expenses of
operations have been accounted for. Occasionally, this is referred to as EBIT, or earnings before
interest and taxes.
Less: Interest expense Interest expense arises as a cost of borrowing money. This is a financial expense rather than an
operating expense and is listed separately. As the amount of debt and the cost of debt increase, so will
the interest expense. This covers the cost of both short-term and long-term borrowing.
Income before taxes (earnings The firm will pay a tax on this amount. This is what is left of revenues after subtracting all operating
before taxes—EBT) costs, depreciation costs, and interest costs.
Less: Taxes The tax rate is specified in the federal tax code.
Net income This is the amount of income left after taxes. The firm may decide to retain all or a portion of the income
for reinvestment in new assets. Whatever it decides not to keep it will usually pay out in dividends to its
stockholders.
Less: Preferred dividends If the company has preferred stockholders, they are first in line for dividends. That is one reason why
their stock is called “preferred.”
Income to common stockholders This is the income left for the common stockholders. If the company has a good year, there may be a lot
of income available for dividends. If the company has a bad year, income could be negative. The common
stockholders are the ultimate owners and risk takers. They have the potential for very high or very poor
returns since they get whatever is left after all other expenses.
Earnings per share Earnings per share is found by taking the income available to the common stockholders and dividing by
the number of shares of common stock outstanding. This is income generated by the company for each
share of common stock.
and administrative expenses; (2) research, development, and a manufacturer that purchases a $100,000 machine expected
engineering expenses; and (3) interest expenses (remember to last about 10 years. Rather than showing an expense of
that the costs directly attributable to selling goods or services $100,000 in the first year and no expense for that equipment
are included in the cost of goods sold). Selling expenses include over the next nine years, the manufacturer is allowed to report
advertising and sales salaries. General and administrative depreciation expenses of $10,000 per year in each of the next
expenses include salaries of executives and their staff and the 10 years because that better matches the cost of the machine
costs of owning and maintaining the general office. Research to the years the machine is used. Each time this depreciation
and development costs include scientific, engineering, and is “written off” as an expense, the book value of the machine is
marketing personnel and the equipment and information used also reduced by $10,000. The fact that the equipment has a zero
to design and build prototypes and samples. Interest expenses value on the firm’s balance sheet when it is fully depreciated (in
include the direct costs of borrowing money. this case, after 10 years) does not necessarily mean that it can
no longer be used or is economically worthless. Indeed, in some
The number and type of expense accounts vary from organiza- industries, machines used every day have been reported as hav-
tion to organization. Included in the general and administrative ing no book value whatsoever for more than 30 years.
category is a special type of expense known as depreciation,
the process of spreading the costs of long-lived assets such as Net Income Net income (or net earnings) is the total
buildings and equipment over the total number of account- profit (or loss) after all expenses including taxes have been
ing periods in which they are expected to be used. Consider deducted from revenue. Generally, accountants divide profits

T A B L E 1 4 . 4 Starbucks Corporation Consolidated Statements of Earnings (in millions, except earnings per share)
Report Date 10/03/2010 09/27/2009 09/28/2008
Net Revenues:
Company-operated retail revenue $ 8,963.5 $ 8,180.1 $ 8,771.9
Specialty:
Licensing 1,340.9 1,222.3 1,171.6
Foodservice and other 403.0 372.2 439.5
Total specialty 1,743.9 1,594.5 1,611.1
Total net revenues 10,707.4 9,774.6 10,383
Cost of sales including occupancy costs 4,458.6 4,324.9 4,645.3
Store operating expenses 3,551.4 3,425.1 3,745.1
Other operating expenses 293.2 264.4 330.1
Depreciation and amortization expenses 510.4 534.7 549.3
General and administrative expenses 569.5 453.0 456.0
Restructuring charges 53.0 332.4 266.9
Total operating expenses 9,436.1 9,334.5 9,992.7
Income from equity investees 148.1 121.9 113.6
Operating income 1,419.4 562.0 503.9
Interest income and other income, net 50.3 37.0 9.0
Interest expense (32.7) (39.1) (53.4)
Earnings before income taxes 1,437.0 559.9 455.7
Income taxes 488.7 168.4 144.0
Net earnings (attributable to Starbucks Corporation) 945.6 390.8 $ 315.5
Per common shares:
Net earnings—basic $ 1.27 $ 0.53 $ 0.43
Net earnings—diluted $ 1.24 $ 0.52 $ 0.43
Weighted average shares outstanding:
Basic 744.4 738.7 731.5
Diluted 764.2 745.9 741.7
Cash dividends per share $0.36 $0 $0
Source: Starbucks 2010 Annual Report, page 39.
into individual sections such as operating income and earnings called “Retained Earnings,” one of the owners’ equity accounts.
before interest and taxes. Starbucks, for example, lists earnings Revenues increase owners’ equity, while expenses decrease it.
before income taxes, net earnings, and earnings per share of The resulting change in the owners’ equity account is exactly
outstanding stock (see Table 14.4). Like most companies, Star- equal to the net income. This shifting of dollar values from
bucks presents not only the current year’s results but also the the revenue and expense accounts allows the firm to begin the
previous two years’ income statements to permit comparison of next accounting period with zero balances in those accounts.
performance from one period to another. Zeroing out the balances enables a company to count how
much it has sold and how many expenses have been incurred
Temporary Nature of the Income Statement during a period of time. The basic accounting equation
Accounts Companies record their operational activities (Assets = Liabilities + Owners’ equity) will not balance until
in the revenue and expense accounts during an accounting the revenue and expense account balances have been moved or
period. Gross profit, earnings before interest and taxes, and “closed out” to the owners’ equity account.
net income are the results of calculations made from the rev-
enues and expenses accounts; they are not actual accounts. At One final note about income statements: You may remember
the end of each accounting period, the dollar amounts in all that corporations may choose to make cash payments called
the revenue and expense accounts are moved into an account dividends to shareholders out of their net earnings. When

balance sheet
a “snapshot” of an
organization’s financial
a corporation elects to pay dividends, it decreases the cash debts that management does not position at a given moment
account (in the assets category of the balance sheet) as well as expect to collect. The bad-debts
a capital account (in the owners’ equity category of the balance adjustment is normally based on current assets
sheet). During any period of time, the owners’ equity account historical collections experience assets that are used or
may change because of the sale of stock (or contributions/ and is deducted from the accounts converted into cash within
withdrawals by owners), the net income or loss, or from the receivable balance to present a the course of a calendar year
dividends paid. more realistic view of the payments
accounts
likely to be received in the future, receivable money
The Balance Sheet called net receivables. Inventory owed a company by its
may be held in the form of raw clients or customers who
The second basic financial statement is the balance sheet,
materials, work-in-progress, or have promised to pay for
which presents a “snapshot” of an organization’s financial posi-
finished goods ready for delivery. the products at a later date
tion at a given moment. As such, the balance sheet indicates
what the organization owns or controls and the various sources Long-term, or fixed assets repre-
of the funds used to pay for these assets, such as bank debt or sent a commitment of organiza-
owners’ equity. tional funds of at least one year. Items classified as fixed include
long-term investments, plant and equipment, and intangible
The balance sheet takes its name from its reliance on the assets, such as corporate “goodwill,” or reputation, as well as pat-
accounting equation: Assets must equal liabilities plus owners’ ents and trademarks.
equity. Table 14.5 provides a sample balance sheet with line-
by-line explanations. Unlike the income statement, the balance Liabilities As seen in the accounting equation, total assets
sheet does not represent the result of transactions completed must be financed either through borrowing (liabilities) or through
over a specified accounting period. Instead, the balance sheet is, owner investments (owners’ equity). Current liabilities include
[ “The balance sheet takes its name from its reliance on

the accounting equation: Assets must equal liabilities
plus owners’ equity.”
by definition, an accumulation of all financial transactions con-
]
ducted by an organization since its founding. Following long-
established traditions, items on the balance sheet are listed on
the basis of their original cost less accumulated depreciation,
rather than their present values.
Balance sheets are often presented in two different formats.
The traditional balance sheet format placed the organization’s
assets on the left side and its liabilities and owners’ equity on
the right. More recently, a vertical format, with assets on top
followed by liabilities and owners’ equity, has gained wide
acceptance. Starbucks’ balance sheet for 2009 and 2010 is pre-
sented in Table 14.6. In the sections that follow, we’ll briefly
describe the basic items found on the balance sheet; we’ll take a
closer look at a number of these in Chapter 16.
Assets All asset accounts are listed in descending order of

liquidity—that is, how quickly each could be turned into cash.
Current assets, also called short-term assets, are those that
are used or converted into cash within the course of a calen-
dar year. Cash is followed by temporary investments, accounts
receivable, and inventory, in that order. Accounts receiv-
able refers to money owed the company by its clients or cus-
tomers who have promised to pay for the products at a later This type of machinery would be considered a long-term asset on the
date. Accounts receivable usually includes an allowance for bad balance sheet.

T A B L E 1 4 . 5 Sample Balance Sheet
The following exhibit presents a balance sheet in word form with each item defined or explained.
Typical Company December 31
Assets This is the major category for all physical, monetary, or intangible goods that have some dollar value.
Current assets Assets that are either cash or are expected to be turned into cash within the next 12 months.
Cash Cash or checking accounts.
Marketable securities Short-term investments in securities that can be converted to cash quickly (liquid assets).
Accounts receivable Cash due from customers in payment for goods received. These arise from sales made on credit.
Inventory Finished goods ready for sale, goods in the process of being finished, or raw materials used in the production of goods.
Prepaid expense A future expense item that has already been paid, such as insurance premiums or rent.
Total current assets The sum of the above accounts.
Fixed assets Assets that are long term in nature and have a minimum life expectancy that exceeds one year.
Investments Assets held as investments rather than assets owned for the production process. Most often the assets include small
ownership interests in other companies.
Gross property, plant, Land, buildings, and other fixed assets listed at original cost.
and equipment
Less: Accumulated The accumulated expense deductions applied to all plant and equipment over their life. Land may not be depreciated.
depreciation The total amount represents in general the decline in value as equipment gets older and wears out. The maximum
amount that can be deducted is set by the U.S. Federal Tax Code and varies by type of asset.
Net property, plant, Gross property, plant, and equipment minus the accumulated depreciation. This amount reflects the book value of the
and equipment fixed assets and not their value if sold.
Other assets Any other asset that is long term and does not fit into the above categories. It could be patents or trademarks.
Total assets The sum of all the asset values.
Liabilities and This is the major category. Liabilities refer to all indebtedness and loans of both a long-term and short-term nature.
Stockholders’ Equity Stockholders’ equity refers to all money that has been contributed to the company over the life of the firm by the owners.
Current liabilities Short-term debt expected to be paid off within the next 12 months.
Accounts payable Money owed to suppliers for goods ordered. Firms usually have between 30 and 90 days to pay this account, depending
on industry norms.
Wages payable Money owned to employees for hours worked or salary. If workers receive checks every two weeks, the amount owed
should be no more than two weeks’ pay.
Taxes payable Firms are required to pay corporate taxes quarterly. This refers to taxes owed based on earnings estimates for the quarter.
Notes payable Short-term loans from banks or other lenders.
Other current The other short-term debts that do not fit into the above categories.
liabilities
Total current The sum of the above accounts.
liabilities
Long-term liabilities All long-term debt that will not be paid off in the next 12 months.
Long-term debt Loans of more than one year from banks, pension funds, insurance companies, or other lenders. These loans often take
the form of bonds, which are securities that may be bought and sold in bond markets.
Deferred income taxes This is a liability owed to the government but not due within one year.
Other liabilities Any other long-term debt that does not fit the above two categories.
Stockholders’ equity The following categories are the owners’ investment in the company.
Common stock The tangible evidence of ownership is a security called common stock. The par value is stated value and does not
indicate the company’s worth.
Capital in excess of When shares of stock were sold to the owners, they were recorded at the price at the time of the original sale. If the
par (a.k.a. contributed price paid was $10 per share, the extra $9 per share would show up in this account at 100,000 shares times $9 per
capital) share, or $900,000.
Retained earnings The total amount of earnings the company has made during its life and not paid out to its stockholders as dividends.
This account represents the owners’ reinvestment of earnings into company assets rather than payments of cash
dividends. This account does not represent cash.
Total stockholders’ This is the sum of the above equity accounts representing the owner’s total investment in the company.
equity
Total liabilities and The total short-term and long-term debt of the company plus the owner’s total investment. This combined amount must
stockholders’ equity equal total assets.

T A B L E 1 4 . 6 Starbucks Corporation Consolidated Balance Sheet (in thousands, except per share data)
Fiscal Year Ended 10/03/2010 09/27/2009
Assets
Current assets
Cash and cash equivalents $ 1,164.0 $ 599.8
Short-term investments—available-for-sale securities 236.5 21.5
Short-term investments—trading securities 49.2 44.8
Accounts receivable, net 302.7 271.0
Inventory 543.3 664.9
Prepaid expenses and other current assets 156.5 147.2
Deferred income taxes, net 304.2 286.6
Total current assets 2,756.4 2,035.8
Long-term investments—available-for-sale securities 191.8 71.2
Equity and cost investments 341.5 352.3
Property, plant and equipment, net 2,416.5 2,536.4
Other assets 346.5 253.8
Other intangible assets 70.8 68.2
Goodwill 262.4 259.1
Total assets $ 6,385.9 $ 5,576.8
Liabilities and shareholders’ equity
Current Liabilities:
Accounts payable 282.6 267.1
Accrued compensation and related costs 400.0 307.5
Accrued occupancy costs 173.2 188.1
Accrued taxes 100.2 127.8
Insurance reserves 146.2 154.3
Other accrued expenses 262.8 147.3
Deferred revenue 414.1 388.7
Current portion of long-term debt — 0.2
Total current liabilities 1,779.1 1,581.0
Long-term debt 549.4 549.3
Other long-term liabilities 375.1 389.6
Total liabilities 2,703.6 2,519.9
Shareholders’ equity:
Common stock 0.7 0.7
Additional paid-in capital 106.2 147.0
Other additional paid-in capital 39.4 39.4
Retained earnings (accumulated deficit) 3,471.2 2,793.2
Accumulated other comprehensive income (loss) 57.2 65.4
Total shareholders’ equity 3,674.7 3,045.7
Noncontrolling Interests 7.6 11.2
Total shareholders’ equity 3,682.3 3,056.9
Total liabilities and shareholders’ equity $ 6,385.9 $ 5,576.8
Source: 2010 Starbucks Annual Report, page 40.

current liabilities accounts payable accrued expenses statement of cash
a firm’s financial obligations the amount a company an account representing all flows explains how the
to short-term creditors, owes to suppliers for goods unpaid financial obligations company’s cash changed
which must be repaid and services purchased incurred by the organization from the beginning of the
common and preferred
within one year with credit accounting period to the stock, each with differ-
end ent dividend payments
and/or voting rights.
Because each type of
stock issued represents
a firm’s financial obligations to short-term creditors, which must a different claim on the organization, each must be repre-
be repaid within one year, while long-term liabilities have lon- sented by a separate owners’ equity account, called contrib-
ger repayment terms. Accounts payable represents amounts uted capital.
owed to suppliers for goods and services purchased with credit.
For example, if you buy gas with a BP credit card, the purchase The Statement of Cash Flows
represents an account payable for you (and an account receiv-
The third primary financial statement is called the statement
able for BP). Other liabilities include wages earned by employees
of cash flows, which explains how the company’s cash
but not yet paid and taxes owed to the government. Occasionally,
changed from the beginning of the accounting period to the
these accounts are consolidated into an accrued expenses
end. Cash, of course, is an asset shown on the balance sheet,
account, representing all unpaid financial obligations incurred by
which provides a snapshot of the firm’s financial position at
the organization.
one point in time. However, many investors and other users
of financial statements want more information about the cash
Owners’ Equity Owners’ equity includes the owners’ con-
flowing into and out of the firm than is provided on the balance
tributions to the organization along with income earned by
sheet in order to better understand the company’s financial
the organization and retained to finance continued growth
health. The statement of cash flows takes the cash balance from
and development. If the organization were to sell off all of
one year’s balance sheet and compares it with the next while
its assets and pay off all of its liabilities, any remaining funds
providing detail about how the firm used the cash. Table 14.7
would belong to the owners. Not surprisingly, the accounts
presents Starbucks’ statement of cash flows.
listed as owners’ equity on a balance sheet may differ dramati-
cally from company to company. Corporations sell stock to The change in cash is explained through details in three catego-
investors, who then become the owners of the firm. Many cor- ries: cash from (used for) operating activities, cash from (used
porations issue two, three, or even more different classes of for) investing activities, and cash from (used for) financing
T A B L E 1 4 . 7 Starbucks Corporation Consolidated Statements of Cash Flows (in millions)
Report Date 10/03/2010 09/27/2009 09/28/2008

Net earnings $ 948.3 $ 390.8 $ 315.5
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization 540.8 563.3 604.5
Provision for impairments and asset disposals 67.7 224.4 325.0
Deferred income taxes (42.0) (69.6) (117.1)
Equity in income of investees (108.6) (78.4) (61.3)
Distributions of income from equity investees 91.4 53.0 52.6
Stock-based compensation 113.6 83.2 75.0
Tax benefit from exercise of stock options 13.5 2.0 3.8
Excess tax benefit from exercise of stock options (36.9) (15.9) (14.7)
Other (15.3) 5.4 (0.1)
Cash provided/(used) by changes in operating assets and liabilities:
Inventories 123.2 28.5 (0.6)
Accounts payable (3.6) (53.0) (63.9)
Accrued taxes (12.9) 57.2 7.3
Deferred revenue 24.2 16.3 72.4
Other operating assets (16.1) 120.5 (11.2)
Other operating liabilities 17.6 61.3 71.5
(continued )

T A B L E 1 4 . 7 continued
Report Date 10/03/2010 09/27/2009 09/28/2008

Net cash provided by operating activities 1,704.9 1,389.0 1,258.7
Investing Activities:
Purchase of available-for-sale securities (549.0) (129.2) (71.8)
Maturities and calls of available-for-sale securities 209.9 111.0 20.0
Sales of available-for-sale securities 1.1 5.0 75.9
Acquisitions, net of cash acquired (12.0) — (74.2)
Net purchases of equity, other investments and other assets 1.2 (4.8) (52.0)
Additions to property, plant and equipment (440.7) (445.6) (984.5)
Proceeds from sale of property, plant and equipment 0 42.5 —
Net cash used by investing activities (789.5) (421.1) (1,086.6)
Financing Activities:
Proceeds from issuance of commercial paper 0 20,965.4 65,770.8
Repayments of commercial paper 0 (21,378.5) (66,068.0)
Proceeds from short-term borrowings 0 1,338.0 528.2
Repayments of short-term borrowings 0 (1,638.0) (228.8)
Purchase of noncontrolling interest (45.8) — —
Proceeds from issuance of common stock 127.9 57.3 112.3
Excess tax benefit from exercise of stock options 36.9 15.9 14.7
Principal payments on long-term debt (6.6) (0.7) (0.6)
Cash dividends paid (171.0) — —
Repurchase of common stock (285.6) — (311.4)
Other (1.8) (1.6) (1.7)
Net cash used by financing activities (346.0) (642.2) (184.5)
Effect of exchange rate changes on cash and cash equivalents (5.2) 4.3 0.9
Net increase (decrease) in cash and cash equivalents 564.2 330.0 (11.5)
Cash and Cash Equivalents:
Beginning of Period 599.8 269.8 281.3
End of Period 1,164.0 599.8 269.8
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest, net of capitalized interest 32.0 39.8 52.7
Income taxes 527.0 162.0 259.5
Source: Starbucks 2010 Annual Report.
activities. Cash from operating activities is calculated by com- Negative cash flow is not always a bad thing, however. It may
bining the changes in the revenue accounts, expense accounts, indicate that a business is growing, with a very negative cash
current asset accounts, and current liability accounts. This flow indicating rapid growth.
category of cash flows includes all the accounts on the balance
sheet that relate to computing revenues and expenses for the Cash from investing activities is calculated from changes in the
accounting period. If this amount is a positive number, as it is long-term or fixed asset accounts. If this amount is negative,
for Starbucks, then the business is making extra cash that it can as is the case with Starbucks, the company is purchasing long-
use to invest in increased long-term capacity or to pay off debts term assets for future growth. A positive figure indicates a busi-
such as loans or bonds. A negative number may indicate a business that is selling off existing long-term assets and reducing its
ness that is in a declining position with regards to operations. capacity for the future.

ratio analysis profitability ratios profit margin net
calculations that measure ratios that measure the income divided by sales
an organization’s financial amount of operating
health income or net income an return on assets net stated goals, that really matters. Remember,
organization is able to income divided by assets while the profitability, asset utilization, liquid-
generate relative to its ity, debt ratios, and per share data we’ll look at
assets, owners’ equity, and here can be very useful, you will never see the
sales forest by looking only at the trees.
Profitability Ratios
Finally, cash from financing activities is calculated from changes Profitability ratios measure how much operating income
in the long-term liability accounts and the contributed capital or net income an organization is able to generate relative to its
accounts in owners’ equity. If this amount is negative, the com- assets, owners’ equity, and sales. The numerator (top number)
pany is likely paying off long-term debt or returning contributed used in these examples is always the net income after taxes.
capital to investors. As in the case of Starbucks, if this amount is Common profitability ratios include profit margin, return on
positive, the company is either borrowing more money or rais- assets, and return on equity. The following examples are based
ing money from investors by selling more shares of stock. on the 2010 income statement and balance sheet for Starbucks,
as shown in Tables 14.4 and 14.6. Except where specified, all
data are expressed in millions of dollars.
RATIO ANALYSIS: The profit margin, computed by dividing net income by sales,
ANALYZING FINANCIAL shows the overall percentage profits earned by the company. It
is based solely upon data obtained from the income statement.
STATEMENTS The higher the profit margin, the better the cost controls within
the company and the higher the return on every dollar of rev-
The income statement shows a company’s profit or loss, while enue. Starbucks’ profit margin is calculated as follows:
the balance sheet itemizes the value of its assets, liabilities, and
Profit margin = Net income (Net earnings)

owners’ equity. Together, the two statements provide the means
to answer two critical questions: (1) How much did the firm
make or lose? and (2) How much is the firm presently worth
Sales (Total net revenues)
based on historical values found on the balance sheet? Ratio = $945.6
analysis, calculations that measure an organization’s finan- $10,707.4
cial health, brings the complex information from the income = 8.83%
statement and balance sheet into sharper focus so that manag-
ers, lenders, owners, and other interested parties can measure Thus, for every $1 in sales, Starbucks generated profits of 8.8
and compare the organization’s productivity, profitability, and cents.
financing mix with other similar entities.
Return on assets, net income divided by assets, shows how
As you know, a ratio is simply one number divided by another, with much income the firm produces for every dollar invested in
the result showing the relationship between the two numbers. Finan- assets. A company with a low return on assets is probably not
cial ratios are used to weigh and evaluate a firm’s performance. An using its assets very productively—a key managerial failing. For
absolute value such as earnings of $70,000 or accounts receivable its construction, the return on assets calculation requires data
of $200,000 almost never provides as much useful information as from both the income statement and the balance sheet.
a well-constructed ratio. Whether those numbers are good or bad
depends on their relation to other numbers. If a company earned
Return on assets = Net income (Net earnings)
$70,000 on $700,000 in sales (a 10 percent return), such an earnings Total assets
level might be quite satisfactory. The president of a company earn-
ing this same $70,000 on sales of $7 million (a 1 percent return),
= $945.6
however, should probably start looking for another job! $6385.9
Ratios by themselves are not very useful. It is the relationship of
= 14.81%
the calculated ratios to both prior organizational performance In the case of Starbucks, every $1 of assets generated a return of
and the performance of the organization’s “peers,” as well as its around 14.8 percent, or profits of around 14.81 cents per dollar.
[ “Profitability ratios measure how much operating income

or net income an organization is able to generate
relative to its assets, owners’ equity, and sales.”
]
return on asset utilization receivables inventory liquidity current ratio
equity net income ratios ratios that turnover sales turnover sales ratios ratios that current assets divided
divided by owners’ measure how well a divided by accounts divided by total inventory measure the speed with by current liabilities
equity; also called return firm uses its assets to receivable which a company can
on investment (ROI) generate each $1 of total asset turn its assets into cash
sales turnover sales to meet short-term debt
divided by total assets
Stockholders are always concerned with how much money Inventory turnover, sales divided by total inventory, indi-
they will make on their investment, and they frequently use the cates how many times a firm sells and replaces its inventory
return on equity ratio as one of their key performance yard- over the course of a year. A high inventory turnover ratio may
sticks. Return on equity (also called return on investment indicate great efficiency but may also suggest the possibility of
[ROI]), calculated by dividing net income by owners’ equity, lost sales due to insufficient stock levels. Starbucks’ inventory
shows how much income is generated by each $1 the owners turnover indicates that it replaced its inventory approximately
have invested in the firm. Obviously, a low return on equity 20 times last year, or almost twice a month.
means low stockholder returns and may indicate a need for
immediate managerial attention. Because some assets may have Inventory turnover
= Sales (Total net revenues)
been financed with debt not contributed by the owners, the
value of the owners’ equity is usually considerably lower than Inventory
the total value of the firm’s assets. Starbucks’ return on equity is
calculated as follows: = $10,707.4
$543.3
Return on equity = Net income
= 19.71X
Stockholders’ equity
= $945.6
Total asset turnover, sales divided by total assets, measures
$3,674.7 how well an organization uses all of its assets in creating sales. It
indicates whether a company is using its assets productively. Star-
= 25.73% bucks generated $1.68 in sales for every $1 in total corporate assets.
For every dollar invested by Starbucks stockholders, the com- Total asset turnover
pany earned around a 25.7 percent return, or 25.73 cents per
dollar invested. = Sales (Total net revenues)
Total assets
Asset Utilization Ratios $10,707.4
Asset utilization ratios measure how well a firm uses its
= $6,385.9
assets to generate each $1 of sales. Obviously, companies using = 1.68X
their assets more productively will have higher returns on assets
than their less efficient competitors. Similarly, managers can Liquidity Ratios
use asset utilization ratios to pinpoint areas of inefficiency in
Liquidity ratios compare current (short-term) assets to cur-
their operations. These ratios (receivables turnover, inventory
rent liabilities to indicate the speed with which a company can
turnover, and total asset turnover) relate balance sheet assets to
turn its assets into cash to meet debts as they fall due. High
sales, which are found on the income statement.
liquidity ratios may satisfy a creditor’s need for safety, but ratios
The receivables turnover, sales divided by accounts receiv- that are too high may indicate that the organization is not using
able, indicates how many times a firm collects its accounts its current assets efficiently. Liquidity ratios are generally best
receivable in one year. It also demonstrates how quickly a firm examined in conjunction with asset utilization ratios because
is able to collect payments on its credit sales. Obviously, no high turnover ratios imply that cash is flowing through an orga-
payments means no profits. Starbucks collected its receivables nization very quickly—a situation that dramatically reduces the
35 to 36 times per year. The reason the number is so high is that need for the type of reserves measured by liquidity ratios.
most of Starbucks’ sales are for cash and not credit.
The current ratio is calculated by dividing current assets by
current liabilities. Starbucks’s current ratio indicates that for
Receivables turnover every $1 of current liabilities, the firm had $1.55 of current assets
= Sales (Total net revenues) on hand. This number improved from previous years, and indi-
Receivables cates that Starbucks has increased its liquidity as it restructures
$10,707.4 its business. Although current liabilities increased from 2009
= to 2010, current assets also increased during this period, mak-
$302.7 ing for a much improved current ratio. Additionally, accounts
= 35.37X receivable has increased over the same time period.

quick ratio (acid debt utilization debt to total assets times interest earned per share data data
test) a stringent measure ratios ratios that ratio a ratio indicating how ratio operating income used by investors to compare
of liquidity that eliminates measure how much debt an much of the firm is financed divided by interest expense the performance of one
inventory organization is using relative by debt and how much by company with another on an
to other sources of capital, owners’ equity equal, per share basis
such as owners’ equity
Thus, for every $1 of Starbucks’ total assets, 42.3 percent is

Current ratio = Current assets financed with debt. The remaining 55 percent is provided by
Current liabilities owners’ equity.
$2,756.4
= $1,779.1 The times interest earned ratio, operating income divided
by interest expense, is a measure of the safety margin a com-
= 1.55X pany has with respect to the interest payments it must make
to its creditors. A low times interest earned ratio indicates
The quick ratio (also known as the acid test) is a far more that even a small decrease in earnings may lead the company
stringent measure of liquidity because it eliminates inventory, into financial straits. Because Starbucks has more interest
the least liquid current asset. It measures how well an organiza- income than interest expense, it would appear that their times
tion can meet its current obligations without resorting to the interest earned ratio is not able to be calculated by using the
sale of its inventory. In 2010, Starbucks had 1.24 cents invested income statement. However, in the statement of cash flows in
in current assets (after subtracting inventory) for every $1 of Table 14.7 on the second line from the bottom, we can see that
current liabilities, an increase over previous years. Starbucks paid $32.7 million in interest expense, an amount
that was covered nearly 43.4 times by income before interest
Quick ratio = Current assets − Inventory and taxes. A lender would probably not have to worry about
Current liabilities receiving interest payments.
$2,213.1
= $1,779.1 Time interest earned
= 1.24X = EBIT (Operating income)
Interest
$1,419.4
Debt Utilization Ratios = $32.7
Debt utilization ratios provide information about how much
debt an organization is using relative to other sources of capital, = 43.4X
such as owners’ equity. Because the use of debt carries an inter-
est charge that must be paid regularly regardless of profitability, Per Share Data
debt financing is much riskier than equity. Unforeseen nega- Investors may use per share data to compare the perfor-
tive events such as recessions affect heavily indebted firms to a mance of one company with another on an equal, or per share,
far greater extent than those financed exclusively with owners’ basis. Generally, the more shares of stock a company issues, the
equity. Because of this and other factors, the managers of most less income is available for each share.
firms tend to keep debt-to-asset levels below 50 percent. How-
Earnings per share is calculated by dividing net income
ever, firms in very stable and/or regulated industries, such as
or profit by the number of shares of stock outstanding. This
electric utilities, often are able to carry debt ratios well in excess
ratio is important because yearly changes in earnings per
of 50 percent with no ill effects.
share, in combination with other economywide factors, deter-
The debt to total assets ratio indicates how much of the mine a company’s overall stock price. When earnings go up,
firm is financed by debt and how much by owners’ equity. To so does a company’s stock price—and so does the wealth of its
find the value of Starbucks’ total debt, you must add current stockholders.
liabilities to long-term debt and other liabilities.
Diluted earnings per share
Debt to total assets Net income
=
= Debt (Total liabilities) Number of shares
Total assets outstanding (diluted)
$2,703.6 $945.6
= $6,385.9 = 764.2
= 42.3% = $1.24

earnings per
share net income
or profit divided by the
We can see from the income statement that Starbucks’ basic the introduction of new Starbucks number of stock shares
earnings per share increased from $0.53 in 2009 to $1.27 in products has helped Starbucks outstanding
2010. Notice that Starbucks lists diluted earnings per share, cal- recover from its lower earning
culated here, of $0.52 per share in 2009 and $1.24 per share in levels during the 2008–2009 reces- dividends per
2010. You can see from the income statement that diluted earn- sion. Its earnings per share has share the actual cash
ings per share include more shares than the basic calculation; increased from $0.52 in 2009 to received for each share
this is because diluted shares include potential shares that could $1.24 a year later. On the other owned
be issued due to the exercise of stock options or the conversion hand, McDonald’s has increased
of certain types of debt into common stock. Investors gener- its earnings per share from $1.93
ally pay more attention to diluted earnings per share than basic in 2007 to $4.58 in 2010. McDonald’s has also increased its
earnings per share. dividend over this time period from $1.50 per share to $2.26
per share, whereas Starbucks paid its first dividends in 2010
Dividends per share are paid by the corporation to the
after years of reinvesting in the company’s expansion and debt
stockholders for each share owned. The payment is made from
earnings after taxes by the corporation but is taxable income to
the stockholder. Thus, dividends result in double taxation: The T A B L E 1 4 . 8 Industry Analysis, Year Ending 2010
corporation pays tax once on its earnings, and the stockholder
Starbucks McDonald’s
pays tax a second time on his or her dividend income. Star-
bucks paid dividends of $171 million in 2010. For each share Profit margin 8.83% 20.55%
owned, Starbucks paid a 23-cent dividend. Return on assets 14.81% 15.47%
Return on equity 25.73% 33.80%
Dividents per share paid*
Receivables turnover 35.37X 20.41X
Dividents paid
= Inventory turnover 19.71X 219.05X
Number of shares
outstanding Total asset turnover 1.68X 0.75 X
Current ratio 1.55X 1.49 X
$171
= 746.2 Quick ratio 1.24X 1.46 X
= $0.23 Debt to total assets 42.3% 54.23%

*
Times interest earned 43.4 X 16.57X
The income statement shows $0.36 declared but not necessarily paid in 2010.
Diluted earnings per share $1.24 $4.58
Dividends per share paid $0.23 $2.26
Industry Analysis
We have used McDonald’s as a comparison to Starbucks because Source: Data calculated from 2010 annual reports.
there are no real national and international coffee houses that
compete with Starbucks on the same scale. While McDonald’s
is almost four times larger than Starbucks in terms of sales, they
both have a national and international presence and to some
extent compete for the consumer’s dollars. Table 14.8 shows
that McDonald’s dominates Starbucks in areas of profitability.
Since 2007, McDonald’s has doubled its profitability. Starbucks
stumbled somewhat during the recession years but has since
rebounded. Both companies have very little accounts receivable
relative to the size of their sales, and so the ratios are very high,
indicating a lot of cash sales and credit card sales. McDonald’s
pushes off much of its inventory holding costs on its suppliers,
and so has much less inventory per sales dollar compared with
Starbucks and, therefore, has a much higher inventory turn-
over ratio. Both have current ratios about the same, but because
McDonald’s has less inventory, its quick ratio is higher than
Starbucks. Fortunately for Starbucks, its inventory is highly liq-
uid and can be turned into cash quickly. The difference in the Many of Netflix’s financial ratios were higher than the industry average.
quick ratios is of little consequence to the financial analyst or However, after the company raised the price on one of its most popular
lender because both companies have high times interest earned rental plans, the value of its stock price fell significantly. This could
ratios. The return of Starbucks founder Howard Schultz and impact Netflix’s future financial ratios.

CERTIFIED FRAUD most effective means of catching a thief, An upturn in an employee’s fortunes may
revealing fraud three times as often as tra- point to fraud.
EXAMINERS REPORT ditional reviews and accounting checks and Fraud is not disappearing anytime soon.
ON FRAUDSTERS balances. Unfortunately, many employees In the meantime, it is costing U.S. com-
fear that if they reveal fraud, they will face panies median losses of anywhere from
reprisals from supervisors or fellow employ- $80,000 to $150,000. To keep fraud from
A recent survey reported bad news for
business owners. Despite regulations,
corporate scandals, and external controls,
ees. This is not totally unjustified; whistleblow-
ers at Enron, for example, were threatened
taking over, companies would be wise to
alter their cultures to provide employees
fraud is still lurking among businesses. In a with firing. Only 7.4 percent of companies with safe methods for reporting suspected
survey of 1,842 global fraud investigators, praise employees who come forward with fraud. Vigilant accounting is simply not
the Association of Certified Fraud Examin- information. enough to catch every fraudster.7
ers (ACFE) revealed that fraud remains dif- To curb fraud, therefore, managers must
ficult to spot. In fact, it can take almost two find ways to encourage employees to step Discussion Questions
years on average to recognize that fraud is forward. One way is to set up anonymous 1. Why do you think fraud is a significant
taking place. employee hotlines and to ask all employ- financial issue in most businesses?
Accounting controls alone are not reliable ees, no matter how senior, to submit to 2. What is the best way to prevent fraud?
for catching fraudulent behavior. Instead, it routine screenings and attend trainings. To
3. As a manager, how would you try to
is often up to employees to blow the whistle. be safe, employers should also keep an eye
detect fraud?
The ACFE states that “tip-offs” remain the out for lifestyle changes among employees.
reduction. Both companies are in good financial health, but the audit system failed with Lehman Brothers and many other
McDonald’s is winning the race for stockholder returns. One major financial firms during the 2008 crisis on Wall Street.
thing is for sure: If Starbucks could earn the same profit margin
Banks and other financial companies blamed much of the prob-
as McDonald’s, it would improve its other profitability ratios
lem on the accounting rule of mark-to-market, which was also
and its stock price.
used by Enron to make it look more profitable. This rule meant
that assets on the books have to be carried on the books at the
ACCOUNTING AND current market price. As the financial markets deteriorated, the
value of many assets (such as mortgages) could not be valued
THE IMPACT OF THE accurately. What happens when a market is so unhealthy that
it basically ceases to function? Is the asset worth zero? Because
FINANCIAL CRISIS the value of the assets held on their books determined a bank’s
capital adequacy ratios, the decline in value that resulted from
The financial crisis of 2007–2009 provided another example
using the mark-to-market accounting method made banks’
of failed accounting audits. Banks and other financial institu-
capital appear to shrink dramatically. Investors determined
tions often held assets off their books by manipulating their
that these banks were suddenly risky investments. The govern-
accounts. In 2010, the examiner for the Lehman Brothers’
ment determined that it had to step in and
bankruptcy found that the most common
allow banks to revalue assets. Many think
example of removing assets or liabilities
this was helpful in stemming the deteriora-
from the books was entering into what
tion of banks’ capital. Some accountants,
is called a “repurchase agreement.” In a
TEAM EXERCISE however, argued that the mark-to-market
repurchase agreement, assets are trans-
You can look at websites such as
rule creates a more honest balance sheet
ferred to another entity with the contrac-
Yahoo! Finance (http://finance.yahoo. and true value of a company’s worth. This
tual promise of buying them back at a set
com/), under the company’s “‘key sta- may be true under normal circumstances,
price. In the case of Lehman Brothers and
tistics’” link, to find many of its finan- where markets are not frozen and inves-
other companies, repurchase agreements
cial ratios, such as return on assets tors continue to trade and trust the finan-
were used as a method of “cooking the
and return on equity. Have each cial stability of their trading partners. These
books” that allowed them to manipulate member of your team look up a dif- issues will continue to be addressed by the
accounting statements so that their ratios ferent company, and explain why you government in future financial reform.
looked better than they actually were. If the think there are differences in the ratio
accountants, the SEC, and the bank regula- analysis for these two ratios among Banks were not the only institutions engag-
tors had been more careful, these types of the selected companies. ing in high-risk behavior. During the
transactions would have been discovered global financial crisis, it was revealed that
and corrected. The public discovered that Greece had also been engaging in deceptive

accounting practices, with the help of U.S. investment banks. To top this off, The New York Times reported that many states,
Greece was using financial techniques that hid massive amounts such as Illinois and California, seem to have the same problems
of debt from its public balance sheets. Eventually, the markets as Greece—debt overload. These states have “budgets that will
figured out that the country was up to its ears in debt and might not balance, accounting that masks debt, the use of deriva-
not be able to pay off its creditors. The European Union and tives to plug holes, and armies of retired public workers who
the International Monetary Fund came up with a plan to give are counting on benefits that are proving harder and harder to
Greece some credit relief, but tied to this was the message to pay.” Clearly, the financial crisis will have some lasting effects
“get your financial house in order.” that need clear accounting solutions.8 ■
SO YOU WANT TO BE // an Accountant /

D o you like numbers and finances? Are
you detail oriented, a perfectionist, and
highly accountable for your decisions? If so,
a good job. Accounting is a volatile discipline
affected by changes in legislative initiatives.
With corporate accounting policies chang-
Accountants are needed in the public
and the private sectors, in large and small
firms, in for-profit and not-for-profit organiza-
accounting may be a good field for you. If ing constantly and becoming more complex, tions. Accountants in firms are generally in
you are interested in accounting, there are accountants are needed to help keep a business charge of preparing and filing tax forms and
always job opportunities available no matter running smoothly and within the bounds of the financial reports. Public-sector accountants
the state of the economy. Accounting is one law. In fact, the number of jobs in the account- are responsible for checking the veracity of
of the most secure job options in business. Of ing and auditing field are expected to increase corporate and personal records in order to
course, becoming an accountant is not easy. 22 percent between 2008 and 2018, with more prepare tax filings. Basically, any organiza-
You will need at least a bachelor’s degree than 1.5 million jobs in the United States alone by tion that has to deal with money and/or taxes
in accounting to get a job, and many posi- 2018. Jobs in accounting tend to pay quite well, in some way or another will be in need of an
tions require additional training. Many states with the national average salary standing at just accountant, either for in-house service or
demand coursework beyond the 120 to 150 over $59,000 annually. If you go on to get your occasional contract work. Requirements for
credit hours collegiate programs require for master’s degree in accounting, expect to see an audits under the Sarbanes-Oxley Act and
an accounting degree. If you are really seri- even higher starting wage. In 2009, accountants rules from the Public Company Accounting
ous about getting into the accounting field, with a bachelor’s degree received an average Oversight Board are creating more jobs and
you will probably want to consider getting opening offer of $48,993, while employees with increased responsibility to maintain internal
your master’s in accounting and taking the master’s degrees were offered $49,786 start- controls and accounting ethics. The fact that
CPA exam. The field of accounting can be ing. Of course, your earnings could be higher or accounting rules and tax filings tend to be
complicated, and the extra training provided lower than these averages, depending on where complex virtually ensures that the demand for
through a master’s in accounting program will you work, your level of experience, the firm, and accountants will never decrease.9
prove invaluable when you go out looking for your particular position.

GET ONLINE
mhhe.com/FerrellM3e
and video

fifteen
rom Wall Street to Main Street,
money +
introduction
F both overseas and at home, money

is the one tool used to measure
personal and business income and the financial
wealth. Finance is the study of money:
how it’s made, how it’s lost, and how
it’s managed. This chapter introduces
system
you to the role of money and the finan-
cial system in the economy. Of course,
LEARNING OBJECTIVES
if you have a checking account, auto- LO1 Define money, its functions, and its
mobile insurance, a college loan, or a characteristics.
credit card, you already have personal LO2 Describe various types of money.
LO3 Specify how the Federal Reserve
experience with some key players in
Board manages the money supply
the financial world. and regulates the American banking
We begin our discussion with a system.
LO4 Compare and contrast commercial
definition of money and then explore
banks, savings and loan associa-
some of the many forms money may tions, credit unions, and mutual
take. Next, we examine the roles of savings banks.
LO5 Distinguish among nonbanking
the Federal Reserve Board and other
institutions such as insurance
major institutions in the financial sys- companies, pension funds, mutual
tem. Finally, we explore the future of funds, and finance companies.
LO6 Investigate the challenges ahead for
the finance industry and some of the
the banking industry.
changes likely to occur over the course
of the next several years.
CHAPTER 15 | Money and the Financial System 315

finance the study of
money; how it’s made,
how it’s lost, and how it’s
managed MONEY IN THE Functions of Money
No matter what a particular society uses for money, its primary
money anything
generally accepted in FINANCIAL purpose is to enable a person or organization to transform a
desire into an action. These desires may be for entertainment
exchange for goods and
services SYSTEM actions, such as party expenses; operating actions, such as pay-
ing for rent, utilities, or employees; investing actions, such as
Strictly defined, money, or cur- buying property or equipment; or financing actions, such as for
rency, is anything generally starting or growing a business. Money serves three important
accepted in exchange for goods and services. Materials as diverse functions: as a medium of exchange, a measure of value, and a
as salt, cattle, fish, rocks, shells, cloth, as well as precious metals store of value.
such as gold, silver, and copper have long been used by various
cultures as money. Most of these materials were limited-supply Medium of Exchange Before fiat money, the trade of
commodities that had their own value to society (for example, goods and services was accomplished through bartering—trading
salt can be used as a preservative and shells and metals as jew- one good or service for another of similar value. As any school-age
elry). The supply of these commodities therefore determined the child knows, bartering can become quite inefficient—particularly
supply of “money” in that society. The next step was the develop- in the case of complex, three-party transactions involving peanut
ment of “IOUs,” or slips of paper that could be exchanged for a butter sandwiches, baseball cards, and hair barrettes. There had
specified supply of the underlying commodity. “Gold” notes, for to be a simpler way, and that was to decide on a single item—
instance, could be exchanged for gold, and the money supply was money—that can be freely converted to any other good upon
tied to the amount of gold available. While paper money was first agreement between parties.
used in North America in 1685 (and even earlier in Europe), the
concept of fiat money—a paper money not readily convertible to Measure of Value As a measure of value, money serves
a precious metal such as gold—did not gain full acceptance until as a common standard or yardstick of the value of goods and
the Great Depression in the 1930s. The United States abandoned services. For example, $2 will buy a dozen large eggs and
its gold-backed currency standard largely in response to the $25,000 will buy a nice car in the United States. In Japan,
Great Depression and converted to a fiduciary, or fiat, monetary where the currency is known as the yen, these same transac-
system. In the United States, paper money is really a government tions would cost about 185 yen and 2.3 million yen, respec-
“note” or promise, worth the value specified on the note. tively. Money, then, is a common denominator that allows
No matter what a particular society uses for money,

its primary purpose is to enable a person or organization
to transform a desire into an action.
people to compare the different goods and services that can

be consumed on a particular income level. While a star athlete
and a “burger-flipper” are paid vastly different wages, each
uses money as a measure of the value of their yearly earnings
and purchases.
Store of Value As a store of value, money serves as a way

to accumulate wealth (buying power) until it is needed. For
example, a person making $500 per week who wants to buy a
$500 computer could save $50 per week for each of the next
10 weeks. Unfortunately, the value of stored money is directly
dependent on the health of the economy. If, due to rapid infla-
tion, all prices double in one year, then the purchasing power
value of the money “stuffed in the mattress” would fall by half.
For centuries people on the Micronesian island of Yap have used giant On the other hand, “mattress savings” buy more when prices
round stones, like the ones shown here, for money. The stones aren’t fall as they did for more than 52 months in Hong Kong between
moved, but their ownership can change. 1999 and 2005.

Characteristics of Money T A B L E 1 5 . 1 The Life Expectancy of Paper Currency
To be used as a medium of exchange, money must be accept- Denomination of Bill Life Expectancy (Years)
able, divisible, portable, stable in value, durable, and difficult to $1 1.8
counterfeit. $5 1.3
Acceptability To be effective, money must be readily $10 1.5

acceptable for the purchase of goods and services and for the $20 2.0
settlement of debts. Acceptability is probably the most impor- $50 4.6
tant characteristic of money: If people do not trust the value of $100 7.4
money, businesses will not accept it as a payment for goods and
Source: “How Currency Gets into Circulation”, Federal Reserve Bank of Bank
services, and consumers will have to find some other means of
of New York, www.newyorkfed.org/aboutthefed/fedpoint/fed01.html (accessed
paying for their purchases. March 31, 2010).
Divisibility Given the widespread use of quarters, dimes, nickels,

way all around town for about 20 months before being replaced
and pennies in the United States, it is no surprise that the principle
(see Table 15.1). Were the value of an old, faded bill to fall in line
of divisibility is an important one. With barter, the
with the deterioration of its appearance, the prin-
lack of divisibility often makes otherwise preferable
ciples of stability and universal acceptability would
trades impossible, as would be an attempt to trade
fail (but, no doubt, fewer bills would pass through
a steer for a loaf of bread. For money to serve effe-
the washer!). Although metal coins, due to their
cively as a measure of value, all items must be valued
much longer useful life, would appear to be an ideal
in terms of comparable units—dimes for a piece of
form of money, paper currency is far more porta-
bubble gum, quarters for laundry machines, and
ble than metal because of its light weight. Today,
dollars (or dollars and coins) for everything else.
coins are used primarily to provide divisibility.
Portability Clearly, for money to function as DID YOU KNOW? Difficulty to Counterfeit Finally, to
a medium of exchange, it must be easily moved
remain stable and enjoy universal acceptance, it
from one location to the next. Large colored Around 75 percent of almost goes without saying that money must be
rocks could be used as money, but you couldn’t counterfeit currency is very difficult to counterfeit—that is, to duplicate
carry them around in your wallet. Paper cur-
found and destroyed illegally. Every country takes steps to make coun-
rency and metal coins, on the other hand, are
before it ever reaches terfeiting difficult. Most use multicolored money,
capable of transferring vast purchasing power
the public. 2 and many use specially watermarked papers that
into small, easily carried (and hidden!) bundles.
are virtually impossible to duplicate. Counterfeit
Few Americans realize it, but more U.S. cur-
bills represent less than 0.03 percent of the cur-
rency is in circulation outside the United States
rency in circulation in the United States,3 but it is
than within. Currently, about $829 billion of U.S. currency is in
becoming increasingly easier for counterfeiters to print money
circulation, and the majority is held outside the United States.1
with just a modest inkjet printer. This illegal printing of money
is fueled by hundreds of people who often circulate only small
Stability Money must be stable and maintain its declared
amounts of counterfeit bills. To thwart the problem of counter-
face value. A $10 bill should purchase the same amount of
feiting, the U.S. Treasury Department redesigned the U.S. cur-
goods or services from one day to the next. The principle of sta-
rency, starting with the $20 bill in 2003, the $50 bill in 2004, the
bility allows people who wish to postpone purchases and save
$10 bill in 2006, the $5 bill in 2008, and the $100 bill in 2010. For
their money to do so without fear that it will decline in value. As
the first time, U.S. money includes subtle colors in addition to
mentioned earlier, money declines in value during periods of
inflation, when economic conditions cause prices to rise. Thus,
the same amount of money buys fewer and fewer goods and
services. In some countries, people spend their money as fast as
they can in order to keep it from losing any more of its value.
Instability destroys confidence in a nation’s money and its abil-
ity to store value and serve as an effective medium of exchange.
Ultimately, people faced with spiraling price increases avoid
the increasingly worthless paper money at all costs, storing all
of their savings in the form of real assets such as gold and land.
Durability Money must be durable. The crisp new dollar bills The U.S. government redesigns currency in order to stay ahead of
you trade at the music store for the hottest new CD will make their counterfeiters and protect the public.

checking account savings accounts money market certificates of credit cards means of
money stored in an account accounts with funds accounts accounts that deposit (CDs) savings access to preapproved lines
at a bank or other financial that usually cannot be offer higher interest rates accounts that guarantee a of credit granted by a bank
institution that can be with- withdrawn without advance than standard bank rates depositor a set interest rate or finance company
drawn without advance notice; also known as time but with greater restrictions over a specified interval as
notice; also called a demand deposits long as the funds are not
deposit withdrawn before the end of
the period—six months or
one year, for example
the traditional green, as well as enhanced security features, such already on deposit. Figure 15.2 explains the significance of the
as a watermark, security thread, and color-shifting ink.4 numbers found on a typical U.S. check. As legal instruments,
checks serve as a substitute for currency and coins and are pre-
Although counterfeiting is not as much of an issue with coins,
ferred for many transactions due to their lower risk of loss. If
metal coins have their own problems. The value of certain coins
you lose a $100 bill, anyone who finds or steals it can spend it.
is less than the money it costs to produce them. In 2006 the new
If you lose a blank check, however, the risk of catastrophic loss
Jefferson nickel was introduced, showing a profile of the nation’s
is quite low. Not only does your bank have a sample of your
third president. Due to the increased price of metals, it costs 5.79
signature on file to compare with a suspected forged signature,
cents to make the 5-cent piece.5 President Lincoln was the first
but you can render the check immediately worthless by means
president to appear on a coin when the Lincoln penny was intro-
of a stop-payment order at your bank.
duced in 1909. As Figure 15.1 indicates it costs more than a penny
to manufacture a penny, resulting in a call to discontinue it. There are several types of checking accounts, with different fea-
tures available for different monthly fee levels or specific mini-
Types of Money mum account balances. Some checking accounts earn interest
While paper money and coins are the most visible types of (a small percentage of the amount deposited in the account that
money, the combined value of all of the printed bills and all the bank pays to the depositor). One such interest-bearing check-
of the minted coins is actually rather insignificant when coming account is the NOW (Negotiable Order of Withdrawal) account
pared with the value of money kept in checking accounts, sav- offered by most financial institutions. The interest rate paid on
ings accounts, and other monetary forms. such accounts varies with the interest rates available in the econ-
omy but is typically quite low (ranging between 2 and 5 percent).
You probably have a checking account (also called a demand
deposit), money stored in an account at a bank or other finan- Savings accounts (also known as time deposits) are accounts
cial institution that can be withdrawn without advance notice. with funds that usually cannot be withdrawn without advance
One way to withdraw funds from your account is by writing a notice and/or have limits on the number of withdrawals per
check, a written order to a bank to pay the indicated individual period. While seldom enforced, the “fine print” governing most
or business the amount specified on the check from money savings accounts prohibits withdrawals without two or three days’
notice. Savings accounts are not generally
used for transactions or as a medium of
FIGURE 15.1
Cost to Produce a Penny exchange, but their funds can be moved
to a checking account or turned into cash.
$0.0179 Money market accounts are similar

$0.0180
to interest-bearing checking accounts,
$0.0160 but with more restrictions. Generally, in
exchange for slightly higher interest rates,
$0.0140 the owner of a money market account can
$0.0120 write only a limited number of checks each
U.S. Mint Cost
U.S. Mint Cost

month, and there may be a restriction on
$0.0100 the minimum amount of each check.
$0.0080 Trended Line
Certificates of deposit (CDs) are
$0.0060 $0.0080 savings accounts that guarantee a
depositor a set interest rate over a speci-
$0.0040 fied interval of time as long as the funds
$0.0020
are not withdrawn before the end of the
interval—six months, one year, or seven
$0.0000 years, for example. Money may be with-
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 drawn from these accounts prematurely
Source: “Cost to Make Penny and Nickel Rises for US Mint,” Coin Update News, January 10, 2011, http://news. only after paying a substantial penalty.
coinupdate.com/cost-to-make-penny-nickel-0619/ (accessed January 18, 2011). In general, the longer the term of the
FIGURE 15.2
A Check
XYZ Corporation No. 177

530 W. Adams June 23, 20 11
Chicago, IL 60606
70-1669/719
Pay to the Clearing number

order of Kristin Piotrowski $ 250.00 Bank number
Regional bank
Two hundred fifty and no/100 Dollars number
FIRST BANK OF CHICAGO
312/555-8400
1245 S. State St.
Chicago, IL 60607
Memo Temp secretarial
Clearing Bank Account Check This gets put on

number number number number when the check clears.
It represents the
Check sum
dollar amount,
(a number used to
in this case, $250.00.
verify that everything
is correct)
CD, the higher is the interest rate it earns. As with all interest Sears, and others—have their own branded credit cards. They
rates, the rate offered and fixed at the time the account is opened use credit rating agencies to check the credit of the cardholders
fluctuates according to economic conditions. and they generally make money on the finance charges.
Credit cards allow you to promise to pay at a later date by using In May 2009, President Obama signed the Credit CARD (Card
preapproved lines of credit granted by a bank or finance com- Accountability Responsibility and Disclosure) Act of 2009 into
pany. They are a popular substitute for cash payments because of law, primarily to regulate the practices of credit card compa-
their convenience, easy access to credit, and acceptance by mer- nies that were coming under attack by consumers during the
chants around the world. The institution that issues the credit card recession of 2007–2009. Without going into the details, the
guarantees payment of a credit charge to merchants and assumes law limited the ability of card issuers to raise interest rates,
responsibility for collecting the money from the cardholders. Card limited credit to young adults, gave people more time to pay
issuers charge a transaction fee to the merchants for
performing the credit check, guaranteeing the payment
and collecting the payment. The fee is typically between 2
and 5 percent, depending on the type of card. American
Express fees are usually higher than Visa and MasterCard.
The original American Express cards require full pay-
ment at the end of each month, but American Express
now offers credit cards similar to Visa, MasterCard,
and Discover that allow cardholders to make install-
ment payments and carry a maximum balance. There
is a minimum monthly payment with interest charged
on the remaining balance. Some people pay off their
credit cards monthly, while other make monthly pay-
ments. Charges for unpaid balances can run 18 per-
cent or higher at an annual rate, making credit card
debt one of the most expensive ways to borrow money.
Besides the major credit card companies, many stores— High interest rates on credit cards and the most recent recession have led the bulk of
Target, Saks Fifth Avenue, Macy’s, Bloomingdales, Americans to reduce credit card balances for the first time in years.

debit card a card that Federal Reserve monetary policy open market
looks like a credit card but Board an independent means by which the Fed operations decisions
works like a check; using it agency of the federal controls the amount of to buy or sell U.S. Treasury
results in a direct, immediate, government established money available in the bills (short-term debt issued
for the electronic
electronic payment from in 1913 to regulate the economy by the U.S. government) and transfer of funds
the cardholder’s checking nation’s banking and other investments in the throughout the
account to a merchant or financial industry open market world. Over the
third party past 20 years,
the rate at which
money turns over,
or changes hands,
bills, required that if there were various levels of interest rates has increased exponentially. Different cultures place unique
that the balances with the highest rate would be paid off first, values on saving, spending, borrowing, and investing. The com-
and made clearer due dates on billing cycles, along with several bination of this increased turnover rate and increasing interac-
other provisions. For college students, the most important part tions with people and organizations from other countries has
of the law is that young adults under the age of 21 will have to created a complex money system. First, we need to meet the
have an adult co-signer or show proof that they have enough guardian of this complex system.
income to handle the debt limit on the card.
This act is important to all companies and cardholders. There were
The Federal Reserve System
approximately 180 million credit cardholders in the United States The guardian of the American financial system is the Federal
in 2010, and the average cardholder has 3.5 cards. One study indi- Reserve Board, or “the Fed,” as it is commonly called, an inde-
cated that 41 percent of college students have credit cards, and 65 pendent agency of the federal government established in 1913 to
percent of them paid off their bills in full at the end of each month, regulate the nation’s banking and financial industry. The Federal
which is a higher rate than the general population.6 Reserve System is organized into 12 regions, each with a Federal
Reserve Bank that serves its defined area (Figure 15.3). All the Fed-
A debit card looks like a credit card but works like a check. eral Reserve banks except those in Boston and Philadelphia have
The use of a debit card results in a direct, immediate, electronic regional branches. The Cleveland Federal Reserve Bank, for exam-
payment from the cardholder’s checking account to a merchant ple, is responsible for branch offices in Pittsburgh and Cincinnati.
or other party. While they are convenient to carry and prof-
itable for banks, they lack credit features, offer no purchase The Federal Reserve Board is the chief economic policy arm of
“grace period,” and provide no hard “paper trail.” Debit cards the United States. Working with Congress and the president,
are gaining more acceptance with merchants, and consum- the Fed tries to create a positive economic environment capable
ers like debit cards because of the ease of getting cash from an of sustaining low inflation, high levels of employment, a balance
increasing number of ATMs. Financial institutions also want in international payments, and long-term economic growth. To
consumers to use debit cards because they reduce the number this end, the Federal Reserve Board has four major responsibili-
of teller transactions and check processing costs. Some cash ties: (1) to control the supply of money, or monetary policy; (2)
management accounts at retail brokers like Merrill Lynch offer to regulate banks and other financial institutions; (3) to manage
deferred debit cards. These act like a credit card but debit to the regional and national checking account procedures, or check
cash management account once a month. During that time, the clearing; and (4) to supervise the federal deposit insurance pro-
cash earns a money market return. grams of banks belonging to the Federal Reserve System.
Traveler’s checks, money orders, and cashier’s checks are other Monetary Policy The Fed controls the amount of money
common forms of “near money.” Although each is slightly dif- available in the economy through monetary policy. Without
ferent from the others, they all share a common characteristic: this intervention, the supply of and demand for money might
A financial institution, bank, credit company, or neighborhood not balance. This could result in either rapid price increases
currency exchange issues them in exchange for cash and guaran- (inflation) because of too much money or economic recession
tees that the purchased note will be honored and exchanged for and a slowdown of price increases (disinflation) because of
cash when it is presented to the institution making the guarantee. too little growth in the money supply. In very rare cases (the
depression of the 1930s) the United States has suffered from
deflation, where the actual purchasing power of the dollar has
THE AMERICAN increased as prices declined. To effectively control the supply
of money in the economy, the Fed must have a good idea of
FINANCIAL SYSTEM how much money is in circulation at any given time. This has
The U.S. financial system fuels our economy by storing money, become increasingly challenging because the global nature of
fostering investment opportunities, and making loans for our economy means that more and more U.S. dollars are circu-
new businesses and business expansion as well as for homes, lating overseas. Using several different measures of the money
cars, and college educations. This amazingly complex system supply, the Fed establishes specific growth targets that, presum-
includes banking institutions, nonbanking financial institu- ably, ensure a close balance between money supply and money
tions such as finance companies, and systems that provide demand. The Fed fine-tunes money growth by using four basic

FIGURE 15.3
Federal Reserve System
Seattle
1
Helena
Portland 9
Minneapolis 2 Boston
Detroit Buffalo
7
3 New York
12 Chicago Pittsburgh Philadelphia
Omaha Cleveland Baltimore
San Salt 10 4 Culpeper WASHINGTON
Lake St Louis
Francisco Denver Cincinnati
Kansas Richmond
City
City 8 Louisville
Los 5
Oklahoma Memphis Nashville
Angeles
City Charlotte
Little Rock Atlanta
11 Dallas Birmingham
El Paso San 6 Jacksonville
Antonio Houston
New
Alaska
Orleans
Miami
12
Hawaii
12
Boundaries of Federal Reserve Districts Federal Reserve Bank Cities

Boundaries of Federal Reserve Branch Territories Federal Reserve Branch Cities
Board of Governors of the Federal Reserve System Federal Reserve Bank Facility
T A B L E 1 5 . 2 Fed Tools for Regulating the Money Supply
Activity Effect on the Money Supply and the Economy

Buy government securities The money supply increases; economic activity increases.
Sell government securities The money supply decreases; economic activity slows down.
Raise discount rate Interest rates increase; the money supply decreases; economic activity slows down.
Lower discount rate Interest rates decrease; the money supply increases; economic activity increases.
Increase reserve requirements Banks make fewer loans; the money supply declines; economic activity slows down.
Decrease reserve requirements Banks make more loans; the money supply increases; economic activity increases.
Relax credit controls More people are encouraged to make major purchases, increasing economic activity.
Restrict credit controls People are discouraged from making major purchases, decreasing economic activity.
tools: open market operations, reserve requirements, the dis- The actual purchase or sale of the investments is performed by
count rate, and credit controls (see Table 15.2). There is gener- the New York Federal Reserve Bank. This monetary tool, the
ally a log of 6 to 18 months before the effect of these charges most commonly employed of all Fed operations, is performed
shows up in economic activity. almost daily in an effort to control the money supply.
Open market operations refer to decisions to buy or sell U.S. When the Fed buys securities, it writes a check on its own
Treasury bills (short-term debt issued by the U.S. government; account to the seller of the investments. When the seller of the
also called T-bills) and other investments in the open market. investments (usually a large bank) deposits the check, the Fed

One of the roles of the Federal Reserve is to use its policies to keep money flowing. Money is the lifeblood of the economy. If banks become too
protective of their funds and stop lending money, the economy can grind to a halt.
transfers the balance from the Federal Reserve account into Fed charges to loan money to any banking institution to meet
the seller’s account, thus increasing the supply of money in the reserve requirements. The Fed is the lender of last resort for
economy and, hopefully, fueling economic growth. The oppo- these banks. When a bank borrows from the Fed, it is said to
site occurs when the Fed sells investments. The buyer writes have borrowed at the “discount window,” and the interest rates
a check to the Federal Reserve, and when the funds are trans- charged there are often higher than those charged on loans of
ferred out of the purchaser’s account, the amount of money in comparable risk elsewhere in the economy. This added interest
circulation falls, slowing economic growth to a desired level. expense, when it exists, serves to discourage banks from bor-
rowing from the Fed.
The second major monetary policy tool is the reserve
requirement, the percentage of deposits that banking institu-
When the Fed wants to expand the money supply, it lowers the
tions must hold in reserve (“in the vault,” as it were). Funds so
discount rate to encourage borrowing. Conversely, when the Fed
held are not available for lending to busi-
wants to decrease the money supply, it raises
nesses and consumers. For example, a bank
the discount rate. The increases in inter-
holding $10 million in deposits, with a 10
est rates that occurred in the United States
percent reserve requirement, must have
reserves of $1 million. If the Fed were to
The Fed from 2003 through 2006 were the result of
more than 16 quarter-point (0.25 percent)
reduce the reserve requirement to, say, establishes and increases in the Fed discount rate. The pur-
5 percent, the bank would need to keep
pose was to keep inflation under control
only $500,000 in reserves. The bank could enforces banking and to raise rates to a more normal level as
then lend to customers the $500,000 dif-
ference between the old reserve level and rules that affect the economy recovered from the recession
of 2001. During the most recent recession,
the new lower reserve level, thus increasing
the supply of money. Because the reserve
monetary policy which started in 2007, the Fed lowered inter-
est rates to nearly zero in order to encourage
requirement has such a powerful effect on and the overall level borrowing. In an environment where credit
the money supply, the Fed does not change
markets were nearly frozen, the Fed utilized
it very often, relying instead on open mar- of the competition monetary policy to stimulate spending. Not
ket operations most of the time.
between different surprisingly, economists watch changes in
The third monetary policy tool, the this sensitive interest rate as an indicator of
discount rate, is the rate of interest the banks. the Fed’s monetary policy.

reserve discount rate the rate credit controls the commercial banks
requirement the of interest the Fed charges authority to establish and the largest and oldest of
percentage of deposits that to loan money to any enforce credit rules for all financial institutions,
The final tool in the
banking institutions must banking institution to meet financial institutions and relying mainly on checking
Fed’s arsenal of weap-
hold in reserve reserve requirements some private investors and savings accounts as
ons is credit con- sources of funds for loans to
trols—the authority to businesses and individuals
establish and enforce
credit rules for finan-
cial institutions and Depository Insurance The Fed is also responsible
some private investors. For example, the Fed can determine for supervising the federal insurance funds that protect the
how large a down payment individuals and businesses must deposits of member institutions. These insurance funds will be
make on credit purchases of expensive items such as automo- discussed in greater detail in the following section.
biles, and how much time they have to finish paying for the
purchases. By raising and lowering minimum down payment Banking Institutions
amounts and payment periods, the Fed can stimulate or dis- Banking institutions accept money deposits from and make
courage credit purchases of “big ticket” items. The Fed also loans to individual consumers and businesses. Some of the
has the authority to set the minimum down payment investors most important banking institutions include commercial
must use for the credit purchases of stock. Buying stock with banks, savings and loan associations, credit unions, and mutual
credit—“buying on margin”—is a popular investment strategy savings banks. Historically, these have all been separate institu-
among individual speculators. By altering the margin require- tions. However, new hybrid forms of banking institutions that
ment (currently set at 50 percent of the price of the purchased perform two or more of these functions have emerged over the
stocks), the Fed can effectively control the total amount of last two decades. The following all have one thing in common:
credit borrowing in the stock market. They are businesses whose objective is to earn money by man-
aging, safeguarding, and lending money to others. Their sales
Regulatory Functions The second major responsibility of revenues come from the fees and interest that they charge for
the Fed is to regulate banking institutions that are members of providing these financial services.
the Federal Reserve System. Accordingly, the Fed establishes and
enforces banking rules that affect monetary policy and the overall Commercial Banks The largest and oldest of all financial
level of the competition between different banks. It determines institutions are commercial banks, which perform a variety
which nonbanking activities, such as brokerage services, leasing, of financial services. They rely mainly on checking and savings
and insurance, are appropriate for banks and which should be accounts as their major source of funds and use only a portion
prohibited. The Fed also has the authority to approve or disap- of these deposits to make loans to businesses and individuals.
prove mergers between banks and the formation of bank holding Because it is unlikely that all the depositors of any one bank will
companies. In an effort to ensure that all rules are enforced and want to withdraw all of their funds at the same time, a bank can
that correct accounting procedures are being followed at mem- safely loan out a large percentage of its deposits.
ber banks, surprise bank examinations are conducted by bank
examiners each year.
Check Clearing The Federal Reserve pro-

vides national check processing on a huge scale.
Divisions of the Fed known as check clearing-
houses handle almost all the checks written
against a bank in one city and presented for
deposit to a bank in a second city. Any bank-
ing institution can present the checks it has
received from others around the country to its
regional Federal Reserve Bank. The Fed passes
the checks to the appropriate regional Federal
Reserve Bank, which then sends the checks to
the issuing bank for payment. With the advance
of electronic payment systems and the passage
of the Check Clearing for the 21st Century Act
(Check 21 Act), checks can now be processed in
a day. The Check 21 Act allows banks to clear
checks electronically by presenting an electronic
image of the check. This eliminates mail delays JPMorgan Chase is the second largest commercial bank in the United States behind Bank of
and time-consuming paper processing. America.

Today, banks are quite diversified and offer a number of ser- healthy banks ended up buying weak banks that were in trou-
vices. Commercial banks make loans for virtually any conceiv- ble. JPMorgan Chase bought Washington Mutual; Wells Fargo
able legal purpose, from vacations to cars, from homes to college bought Wachovia; PNC bought National City Bank; and Bank
educations. Banks in many states offer home equity loans, by of America bought Countrywide and Merrill Lynch. Most of
which home owners can borrow against the appraised value these purchases were made with financial help from the U.S.
of their already purchased homes. Banks also issue Visa and Treasury and Federal Reserve.
MasterCard credit cards and offer CDs and trusts (legal entities
set up to hold and manage assets for a beneficiary). Many banks Savings and Loan Associations Savings and loan
rent safe deposit boxes in bank vaults to customers who want associations (S&Ls), often called “thrifts,” are financial
to store jewelry, legal documents, artwork, and other valuables. institutions that primarily offer savings accounts and make
In 1999 Congress passed the Financial Services Moderniza- long-term loans for residential mortgages. A mortgage is a loan
tion Act, also known as the Gramm-Leach-Bliley Bill. This act made so that a business or individual can purchase real estate,
repealed the Glass Stegal Act, which was enacted in 1929 after typically a home; the real estate itself is pledged as a guarantee
the stock market crash and prohibited commercial banks from (called collateral) that the buyer will repay the loan. If the loan
being in the insurance and investment banking business. This is not repaid, the savings and loan has the right to repossess the
puts U.S. commercial banks on the same competitive footing property. Prior to the 1970s, S&Ls focused almost exclusively on
as European banks and provides a more level playing field for real estate lending and accepted only savings accounts. Today,
global banking competition. As commercial banks and invest- following years of regulatory changes, S&Ls compete directly
ment banks have merged, the financial landscape has changed. with commercial banks by offering many types of services.
Consolidation remains the norm in the U.S. banking industry. Savings and loans have gone through a metamorphosis since
For example, JPMorgan Chase completed a merger with Bank the early 1990s, after having almost collapsed in the 1980s.
One in 2004, making it the second largest bank in the United Today, many of the largest savings and loans have merged with
States behind Citigroup. JPMorgan was created through a commercial banks. This segment of the financial services indus-
merger with Chase Manhattan Bank and JPMorgan, and Bank try plays a diminished role in the mortgage lending market.
One acquired many Midwestern banks, with its biggest acqui-
sition being First Chicago Corp. The financial crisis and the Credit Unions A credit union is a financial institution
economic recession only accelerated the consolidation as large, owned and controlled by its depositors, who usually have a
[ “Banks are quite diversified and offer a number

of services.” ]
ARE CREDIT UNIONS cards, and car loans. For example, in May although credit unions did not require as
2010 credit unions charged an average 5.73 much of a government bailout as banks did,
A BETTER DEAL percent for a four-year new-car loan, while regulators did have to bail out the wholesale
THAN BANKS? banks charged an average of 6.98 percent. credit union sector. These downsides have
Some consumers also feel that credit led analysts to recommend that consumers
unions offer more quality services, such carefully investigate financial institutions,
I s it time to ditch the bank for the credit
union? After the most recent financial
crisis led to the closure of several banks,
as taking the time to help customers set
up financial plans. Additionally, most credit
be it bank or credit union, before investing.
However, for those consumers who con-
credit unions began looking better and unions offer free checking and lower pen- stantly get frustrated with their banks, credit
better. Credit unions have several advan- alty fees than banks. With 91.5 million mem- unions might be the way to go.7
tages over banks. Because they are non- bers, credit unions are becoming a popular
profit institutions, and therefore do not alternative to traditional banking. Discussion Questions
have to pay shares or executive salaries, Of course, credit unions have their 1. What are the advantages of credit unions
the money that credit unions earn goes downsides as well. Unlike banks, consum- over banks?
back to members in the form of dividends. ers must meet requirements to become 2. What are the disadvantages of credit
The lack of pressure to make a profit also members of credit unions. Banks also unions over banks?
allows credit unions to offer more attractive offer more diverse products and services 3. Given a choice, would you rather deal
rates on items like CDs, mortgages, credit than many credit unions do. Additionally, with a bank or a credit union?

savings and loan credit union a financial mutual savings Federal Deposit National Credit
associations (S&Ls) institution owned and banks financial Insurance Union Association
financial institutions that controlled by its depositors, institutions that are similar Corporation (NCUA) an agency that
primarily offer savings who usually have a common to savings and loan (FDIC) an insurance regulates and charters
accounts and make long- employer, profession, trade associations but, like credit fund established in 1933 credit unions and insures
term loans for residential group, or religion unions, are owned by their that insures individual bank their deposits through
mortgages; also called depositors accounts its National Credit Union
“thrifts” Insurance Fund
common employer, profession, trade group, or religion. The insolvency and failure during the S&L crisis of the 1980s.
Aggieland Credit Union in College Station, Texas, for exam- Now, the insurance functions once overseen by the FSLIC are
ple, provides banking services for faculty, employees, and cur- handled directly by the FDIC through its Savings Association
rent and former students of Texas A&M University. A savings Insurance Fund. The National Credit Union Association
account at a credit union is commonly referred to as a share (NCUA) regulates and charters credit unions and insures their
account, while a checking account is termed a share draft deposits through its National Credit Union Insurance Fund.
account. Because the credit union is tied to a common organi-
When they were originally established, Congress hoped that
zation, the members (depositors) are allowed to vote for direc-
these insurance funds would make people feel secure about
tors and share in the credit union’s profits in the form of higher
their savings so that they would not panic and withdraw their
interest rates on accounts and/or lower loan rates.
money when news of a bank failure was announced. The “bank
While credit unions were originally created to provide deposi- run” scene in the perennial Christmas movie It’s a Wonder-
tors with a short-term source of funds for low-interest con- ful Life, when dozens of Bailey Building and Loan depositors
sumer loans for items such as cars, home appliances, vacations, attempted to withdraw their money (only to have the reassur-
and college, today they offer a wide range of financial services. ing figure of Jimmy Stewart calm their fears), was not based on
Generally, the larger the credit union, the more sophisticated mere fiction. During the Great Depression, hundreds of banks
its financial service offerings will be. failed and their depositors lost everything. The fact that large
numbers of major financial institutions failed in the 1980s and
Mutual Savings Banks Mutual savings banks are 1990s—without a single major banking panic—underscores the
similar to savings and loan associations, but, like credit unions, effectiveness of the current insurance system. While the future
they are owned by their depositors. Among the oldest finan- may yet bring unfortunate surprises, most depositors go to sleep
cial institutions in the United States, they were originally estab- every night without worrying about the safety of their savings.
lished to provide a safe place for savings of particular groups
of people, such as fishermen. Found mostly in New England, Nonbanking Institutions
they are becoming more popular in the rest of the country as Nonbank financial institutions offer some financial services,
some S&Ls have converted to mutual savings banks to escape such as short-term loans or investment products, but do not
the stigma created by the widespread S&L failures in the 1980s. accept deposits. These include insurance companies, pension
funds, mutual funds, brokerage firms, nonfinancial firms,
Insurance for Banking Institutions The Federal and finance companies. Table 15.3 lists some other diversified
Deposit Insurance Corporation (FDIC), which insures financial services firms.
individual bank accounts, was established in 1933 to help
T A B L E 1 5 . 3 Diversified Financial Services Firms
stop bank failures throughout the country during the Great
Depression. Today, the FDIC insures personal accounts up to Revenues
Company
a maximum of $250,000 at nearly 8,000 FDIC member insti- (in Millions)
tutions.8 While most major banks are insured by the FDIC, General Electric $156,779.0
small institutions in some states may be insured by state insur-
International Assets Holding 43,604.4
ance funds or private insurance companies. Should a member
bank fail, its depositors can recover all of their funds, up to Freddie Mac 37,614.0
$250,000. Amounts over $250,000, while not legally covered Fannie Mae 29,065.0
by the insurance, are in fact usually covered because the Fed Marsh & McLennan 10,493.0
understands very well the enormous damage that would result Ameriprise Financial 7,946.0
to the financial system should these large depositors withdraw
Aon 7,595.0
their money. When the financial crisis occurred, the FDIC
was worried about people taking their money out of banks, so SLM 6,144.7
they increased the deposit insurance amount from $100,000 to H&R Block 4,213.4
$250,000. The amount is scheduled to revert back to $100,000 Source: “Industry: Diversified Financials,” Fortune 500 2010, Fortune, http://
on December 31, 2013. The Federal Savings and Loan Insur- money.cnn.com/magazines/fortune/fortune500/2010/industries/31/index.html
ance Corporation (FSLIC) insured thrift deposits prior to its (accessed January 19, 2011).

insurance companies pension funds
businesses that protect their managed investment pools set
clients against financial losses aside by individuals, corporations,
a fee, called a premium. Because insurance premiums flow
from certain specified risks unions, and some nonprofit
(death, accident, and theft, for organizations to provide
into the companies regularly, but major insurance losses can-
example) retirement income for members not be timed with great accuracy (though expected risks can
be assessed with considerable precision), insurance companies
generally have large amounts of excess funds. They typically
Diversified Firms Recently, a growing number of tradi- invest these or make long-term loans, particularly to businesses
tionally nonfinancial firms have moved onto the financial field. in the form of commercial real estate loans.
These firms include manufacturing organizations, such as Gen-
eral Motors and General Electric, that traditionally confined
Pension Funds Pension funds are managed invest-
ment pools set aside by individuals, corporations, unions, and
their financial activities to financing their customers’ purchases.
some nonprofit organizations to provide retirement income for
GE was once so successful in the financial arena that its credit
members. One type of pension fund is the individual retirement
subsidiary accounted for more than 40 percent of the compa-
account (IRA), which is established by individuals to provide for
ny’s revenues and earnings. Unfortunately, GE Capital became
their personal retirement needs. IRAs can be invested in a variety
a liability to GE during the financial crisis, and the stock price
fell from $42 per share to less than $8 per share. It is in the pro-
cess of recovery as GE cuts the size of its finance unit and writes
off billions of dollars in bad loans. Other nonfinancial firms
have been also been unsuccessful in their financial ventures.
Sears, the retail giant, once commanded an imposing financial
network composed of real estate (Coldwell Banker), credit card
(Discover Card), and brokerage (Dean Witter Reynolds) com-
panies, but losses of hundreds of millions of dollars forced Sears
to dismantle its network. The very prestigious brokerage firm
Morgan Stanley acquired Dean Witter Discover, thus creating
one of the largest investment firms in the country—in a league
with Smith Barney and Merrill Lynch. Perhaps the moral of the
story for firms like Sears is “stick to what you know.”
Insurance Companies Insurance companies are

businesses that protect their clients against financial losses
from certain specified risks (death, injury, disability, accident, State Farm Insurance allows users to input their information on its
fire, theft, and natural disasters, for example) in exchange for website to receive an auto insurance quote quickly and conveniently.
[ “A growing number of traditionally nonfinancial firms

have moved onto the financial field.” ]
THRUST FUND Jon Gosier, and Saul Garlick are doing just rack up tremendous debt or risk their homes
that. They’ve co-founded the Thrust Fund, to fund their ventures. Therefore, 3 to 6 per-
FOUNDERS an organization through which they are cent of future earnings may be the safer bet.
ENCOURAGE seeking investments of $300,000 to $600,000 Investors face risk as well. What happens if
in exchange for 3 to 6 percent of their future these three fail to earn much money in the
INVESTMENTS IN earnings. Is this idea feasible? Some fear the future? The fact that all three already run
THEMSELVES three entrepreneurs may be selling them- successful organizations may quell some
selves short by asking for too little, while concerns. Should they prosper, investors
I t takes a daring individual to gamble on

the uncertainty of one’s future earnings,
but young entrepreneurs Kjerstin Erickson,
others worry that receiving upfront fund-
ing may reduce the entrepreneurial drive.
On the other hand, many entrepreneurs
may net well beyond their initial invest-
ments. Only time will tell whether this new
type of investing will pay off.9

mutual fund an
investment company that
pools individual investor
of financial assets, from risky commodities such as oil or cocoa Brokerage Firms and Invest- dollars and invests them
to low-risk financial “staples” such as U.S. Treasury securities. in large numbers of well-
The choice is up to each person and is dictated solely by indi- ment Banks Brokerage firms
buy and sell stocks, bonds, and other diversified securities
vidual objectives and tolerance for risk. The interest earned by all
of these investments may be deferred tax-free until retirement. securities for their customers and brokerage firms
provide other financial services. firms that buy and sell
In 1997, Congress revised the IRA laws and created a Roth IRA. Larger brokerage firms like Merrill stocks, bonds, and
Although similar to a traditional IRA in that investors may Lynch, Charles Schwab, and Edward other securities for their
contribute $5,000 per year, the money in a Roth IRA is consid- Jones offer financial services unavail- customers and provide
ered an after-tax contribution. When the money is withdrawn able at their smaller competitors. other financial services
at retirement, no tax is paid on the distribution. The Roth IRA Merrill Lynch, for example, offers
investment banker
is beneficial to young people who can allow a long time for their the Merrill Lynch Cash Management
underwrites new issues of
money to compound and who may be able to have their parents Account (CMA), which pays inter- securities for corporations,
or grandparents fund the Roth IRA with gift money. est on deposits and allows clients to states, and municipalities
write checks, borrow money, and
Most major corporations provide some kind of pension plan for finance companies
withdraw cash much like a commer-
their employees. Many of these are established with bank trust businesses that offer short-
cial bank. The largest of the broker-
departments or life insurance companies. Money is deposited term loans at substantially
age firms (including Merrill Lynch)
in a separate account in the name of each individual employee, higher rates of interest than
have developed so many specialized
and when the employee retires, the total amount in the account banks
services that they may be considered
can be either withdrawn in one lump sum or taken as monthly
financial networks—organizations
cash payments over some defined time period (usually for the
capable of offering virtually all of the
remaining life of the retiree).
services traditionally associated with commercial banks.
Social Security, the largest pension fund, is publicly financed.
Most brokerage firms are really part financial conglomerates
The federal government collects Social Security funds from
that provide many different kinds of services besides buying and
payroll taxes paid by both employers and employees. The
selling securities for clients. For example, Merrill Lynch also is
Social Security Administration then takes these monies and
an investment banker, as is Morgan Stanley, Smith Barney, and
makes payments to those eligible to receive Social Security
Goldman Sachs. The investment banker underwrites new
benefits—individuals who are retired or disabled, and the
issues of securities for corporations, states, and municipalities
young children of deceased parents.
needed to raise money in the capital markets. The new issue
market is called a primary market because the sale of the securi-
Mutual Funds A mutual fund pools individual investor
ties is for the first time. After the first sale, the securities trade
dollars and invests them in large numbers of well-diversified
in the secondary markets by brokers. The investment banker
securities. Individual investors buy shares in a mutual fund in
advises on the price of the new securities and generally guaran-
the hope of earning a high rate of return and in much the same
tees the sale while overseeing the distribution of the securities
way as people buy shares of stock. Because of the large num-
through the selling brokerage houses. Investment bankers also
bers of people investing in any one mutual fund, the funds can
act as dealers who make markets in securities. They do this by
afford to invest in hundreds (if not thousands) of securities at
offering to sell the securities at an asked price (which is a higher
any one time, minimizing the risks of any single security that
rate) and buy the securities at a bid price (which is a lower
does not do well. Mutual funds provide professional financial
rate)—the difference in the two prices represents the profit for
management for people who lack the time and/or expertise
the dealer.
to invest in particular securities, such as government bonds.
While there are no hard-and-fast rules, investments in one or
more mutual funds are one way for people to plan for financial
Finance Companies Finance companies are busi-
nesses that offer short-term loans at substantially higher rates
independence at the time of retirement.
of interest than banks. Commercial finance companies make
A special type of mutual fund called a money market fund loans to businesses, requiring their borrowers to pledge assets
invests specifically in short-term debt securities issued by such as equipment, inventories, or unpaid accounts as collat-
governments and large corporations. Although they offer eral for the loans. Consumer finance companies make loans to
services such as check-writing privileges and reinvestment of individuals. Like commercial finance companies, these firms
interest income, money market funds differ from the money require some sort of personal collateral as security against the
market accounts offered by banks primarily in that the for- borrower’s possible inability to repay their loans. Because of
mer represent a pool of funds, while the latter are basically the high interest rates they charge and other factors, finance
specialized, individual checking accounts. Money market companies typically are the lender of last resort for individu-
funds usually offer slightly higher rates of interest than bank als and businesses whose credit limits have been exhausted
money market accounts. and/or those with poor credit ratings.

electronic funds automated teller automated
transfer (EFT) any machine (ATM) the clearinghouses
movement of funds by means most familiar form of (ACHs) a system that
of an electronic terminal, electronic banking, which permits payments such as
of automated clearinghouses in the United
telephone, computer, or dispenses cash, accepts deposits or withdrawals States is the federal government, with 99 per-
magnetic tape deposits, and allows to be made to and from a cent of federal government employees and
balance inquiries and cash bank account by magnetic 65 percent of the private workforce receiving
transfers from one account computer tape their pay via direct deposit. More than 82 per-
to another cent of all Social Security payments are made
through an ACH system.
The advantages of direct deposits to consum-
T A B L E 1 5 . 4 Facts about ATM Use ers include convenience, safety, and potential
• The first ATM was introduced in 1969. interest earnings. It is estimated that more than 4 mil-
lion paychecks are lost or stolen annually, and FBI
• 17 percent of Americans use ATMs as their primary banking method.
studies show that 2,000 fraudulent checks are cashed
• The United States has more than 425,000 ATMs. every day in the United States. Checks can never be
• More than 11.8 billion ATM transactions take place annually. lost or stolen with direct deposit. The benefits to busi-
• The top five ATM owners are Cardtronics, Payment Alliance, Bank of nesses include decreased check-processing expenses
America, JPMorgan Chase, and Wells Fargo. and increased employee productivity. Research shows
Source: Tyler Metzger, “ATM Use in the United States,” CreditCards.com, www.creditcards that businesses that use direct deposit can save more
.com/credit-card-news/atm-use-statistics-3372.php (accessed April 2, 2010). than $1.25 on each payroll check processed. Produc-
tivity could increase by $3 to $5 billion annually if all
employees were to use direct deposit rather than taking time
Electronic Banking away from work to deposit their payroll checks.
Since the advent of the computer age, a wide range of tech-
Some companies also use ACHs for dividend and interest pay-
nological innovations has made it possible to move money all
ments. Consumers can also use ACHs to make periodic (usu-
across the world electronically. Such “paperless” transactions
ally monthly) fixed payments to specific creditors without ever
have allowed financial institutions to reduce costs in what has
having to write a check or buy stamps. The estimated number
been, and continues to be, a virtual competitive battlefield.
of bills paid annually by consumers is 20 billion, and the total
Electronic funds transfer (EFT) is any movement of funds
number paid through ACHs is estimated at only 8.5 billion.
by means of an electronic terminal, telephone, computer, or
The average consumer who writes 10 to 15 checks each month
magnetic tape. Such transactions order a particular financial
would save $41 to $62 annually in postage alone.10
institution to subtract money from one account and add it to
another. The most commonly used forms of EFT are auto- Online Banking Many banking activities are now con-
mated teller machines, automated clearinghouses, and home ducted on a computer at home or at work, or through wire-
banking systems. less devices such as cell phones and PDAs anywhere there is a
wireless “hot point.” Consumers and small businesses can now
Automated Teller Machines Probably the most
make a bewildering array of financial transactions at home or
familiar form of electronic banking is the automated teller
machine (ATM), which dispenses cash, accepts deposits, and
allows balance inquiries and cash transfers from one account
to another. ATMs provide 24-hour banking services—both at
home (through a local bank) and far away (via worldwide ATM
networks such as Cirrus and Plus). Rapid growth, driven by
both strong consumer acceptance and lower transaction costs
for banks (about half the cost of teller transactions), has led to
the installation of hundreds of thousands of ATMs worldwide.
Table 15.4 presents some interesting statistics about ATMs.
Automated Clearinghouses
Automated clearinghouses (ACHs) permit payments
such as deposits or withdrawals to be made to and from a bank
account by magnetic computer tape. Most large U.S. employ-
ers, and many others worldwide, use ACHs to deposit their
employees’ paychecks directly to the employees’ bank accounts. Computers and handheld devices have made online banking extremely
While direct deposit is used by only 50 percent of U.S. work- convenient. However, hackers have stolen millions from banking
ers, nearly 100 percent of Japanese workers and more than customers by tricking them into visiting websites and downloading
90 percent of European workers utilize it. The largest user malicious software that gives the hackers access to their passwords.

on the go 24 hours a day. Functioning much like a vast network presentation are just a few of the areas where rapidly changing
of personal ATMs, companies like Google and Apple provide technology is causing the banking industry to change as well.
online banking services through mobile phones, allowing sub-
The premise that banks will get bigger over the next 10 years is
scribers to make sophisticated banking transactions, buy and
uncertain. During 2007–2008, the financial markets collapsed
sell stocks and bonds, and purchase products and airline tickets
under the weight of declining housing prices, subprime mort-
without ever leaving home or speaking to another human being.
gages (mortgages with low-quality borrowers), and risky secu-
Many banks allow customers to log directly into their accounts
rities backed by these subprime mortgages. Because the value
to check balances, transfer money between accounts, view their
of bank assets declined dramatically, most large banks like
account statements, and pay bills via home computer or other
CitiBank, Bank of America, and Wachovia had a shrinking cap-
Internet-enabled devices. Computer and advanced telecommu-
ital base. That is, the amount of debt in relation to their equity
nications technology have revolutionized world commerce; 25
was so high that they were below the minimum required capital
percent of adults list Internet banking as their preferred bank-
requirements. This was a financial environment where banks
ing method, making it the most popular banking
did not trust the counterparties to their loans
method in the United States.11
and asset-backed securities. In this environ-
ment, the markets ceased to function in an
Banking in the Future TEAM EXERCISE orderly fashion. To keep the banking sys-
and the Impact of the Mutual funds pool individual investor tem from total collapse, the U.S. Treasury
dollars and invest them in a number and the Federal Reserve created the TARP
Financial Crisis of different securities. Go to http:// program, an acronym for Troubled Asset
Rapid advances and innovations in tech- finance.yahoo.com/ and select some
Relief Program. This program allowed the
nology are challenging the banking indus- top-performing funds using criteria
Treasury to purchase up to $250 billion of
try and requiring it to change. As we said such as sector, style, or strategy.
Assume that your group has $100,000 senior preferred shares of bank securities.12
earlier, more and more banks, both large
and small, are offering electronic access to to invest in mutual funds. Select five Most of the big banks either needed to take
their financial services. ATM technology is funds in which to invest, representing the cash infusion from the U.S. Treasury
a balanced (varied industries, risk, etc.)
rapidly changing, with machines now dis- or were forced to sell preferred stock to the
portfolio, and defend your selections.
pensing more than just cash. Online finan- Treasury. The rationale from the govern-
cial services, ATM technology, and bill ment’s point of view was that it didn’t want
CONSUMER out of the hands of individuals. Instead of Banks are worried that the CFPB might
consumer products, however, the CFPB’s increase costs and inhibit their decision-
FINANCIAL authority involves financial products making authority to serve the market
PROTECTION BUREAU and services. The CFPB has rule-making effectively. Warren and her team admit the
authority and supervisory power over the bureau is merely in the beginning stages
TO UNDERTAKE credit market. Its goal is to make finan- of functionality, but over time they believe
FINANCIAL REFORM cial products and services easy to under- it will have a strong positive impact on
stand in terms of costs, risks, and product/ lenders and borrowers throughout the
service comparisons. It also aims to curtail credit world.13
F inancial products can be hard to com-
prehend. This inability to understand
the risks of financial products and lend-
unfair lending and credit card practices,
to check the safety of financial products Discussion Questions
ing practices contributed to the 2008–2009 before they are launched into the market, 1. Why was it considered necessary to cre-
financial meltdown. To try to prevent similar and to require changes to those financial ate the Consumer Financial Protection
problems in the future, the U.S. government products deemed to be too“dangerous” Bureau?
has formed the Consumer Financial Protec- or risky. According to Warren, the CFPB 2. Is there any danger that the Consumer
tion Bureau (CFPB). works proactively to supervise lenders by Financial Protection Bureau could abuse
The CFPB became a reality as a compo- regularly checking their books and working its decision-making authority and dam-
nent of the Dodd-Frank Act signed into law together with both the attorneys general age consumer access to some financial
in July 2010. Established by Harvard Law and the American people. When necessary, products?
Professor Elizabeth Warren, the bureau is the CFPB will step in to enforce new rules 3. Will the Consumer Financial Protection
designed to mimic the independent Con- on those not complying. Bureau be able to identify and deal with all
sumer Product Safety Commission, which Although the CFPB sounds like a good the financial products that are“dangerous”
aims to keep unsafe consumer products idea, critics point out potential problems. or“risky”?

to signal to the financial community which banks were strong disclose to regulators and over the documents that borrowers
and which ones were weak for fear that depositors would move must submit to be eligible for loans.14
massive amounts of money from weak banks to strong banks.
This phenomenon actually occurred several times and forced Lastly, the future of the structure of the banking system is in the
banks like Wachovia to be merged with Wells Fargo. hands of the U.S. Congress. In reaction to the financial melt-
down and severe recession, politicians are passing new finan-
During this period, the Federal Reserve took unprecedented
cial regulations that will limit the ability of banks to create this
actions that included buying up troubled assets from the banks
type of problem again. The greatest of these regulations to date
and lending money at the discount window to nonbanks such
is the Dodd-Frank Wall Street Reform and Consumer Protec-
as investment banks and brokers. The Fed also entered into the
tion Act passed in 2010. The purpose of the Dodd-Frank Act
financial markets by making markets in commercial paper and
is to reform the financial industry, end “too big to fail” busi-
other securities where the markets had ceased to function in
nesses, create greater transparency and accountability, and
an orderly fashion. Additionally, the Fed began to pay interest
protect consumers from deceptive or complex financial prod-
on reserves banks kept at the Fed and kept interest rates low
ucts. One of the agencies created by Dodd-Frank is the Con-
to stimulate the economy and to help the banks regain their
sumer Financial Protection Bureau, discussed in our boxed
health. Because banks make money by the spread between
feature. Dodd-Frank has 16 major provisions that cover nearly
their borrowing and lending rates, the Fed managed the spread
every aspect of the finance industry, including new agencies
between long- and short-term rates to generate a fairly large
to ensure financial stability; debit card fees; mortgage reform;
spread for the banks.
insurance; predatory lending; the Federal Reserve; and more.
The Federal Deposit Insurance Corp. also took action. The The legal appendix to Chapter 2 goes into further detail on
institution adopted rules that require banks to share the risks these new laws. Other financial reform proposals being dis-
of the securities they sell. Starting January 1, 2011, banks were cussed include placing limits on bank sizes and eliminating
required to hold 5 percent of securities on their books. The hope the Graham-Leach-Bliley Act, which did away with some
is that this will encourage banks to be more careful in screen- major consumer protections and contributed to the deregula-
ing their borrowers to prevent future financial meltdowns. The tion of the financial and banking industries. Only time will tell
FDIC also created new rules over what information banks must what is in store for the U.S. banking system. ■
SO YOU’RE INTERESTED // in Financial Systems or Banking /

Y ou think you might be interested in going
into finance or banking, but it is so hard to
tell when you are a full-time student. Classes
financial crimes ranging from fraud to money
laundering. The students get actual experi-
ence in forensic accounting and have the
to do some research to find them. To start,
talk to your program advisor and your pro-
fessors about opportunities. Also, you can
that seem interesting when you take them chance to see whether this is the right career check company websites where you think
might not translate into an interesting work path. On top of that, the program has saved you might like to work to see if they have any
experience after you graduate. A great way to the county an average of $20,000 annually on opportunities available. City, state, or fed-
see if you would excel at a career in finance consulting and accounting fees, not to men- eral government offices often provide stu-
is to get some experience in the industry. tion that detectives now have more time to dent internships as well. No matter where
Internships, whether they are paid or unpaid, take on larger caseloads. Michael Busby, a you end up interning, the real-life skills you
not only help you figure out what you might student who completed the program, spent pick up, as well as the résumé boost you
really want to do after you graduate but they his six months investigating a case in which get, will be helpful in finding a job after you
are also a great way to build up your résumé, the owner of a sewage treatment company graduate. When you graduate, commer-
put your learning to use, and start generating had embezzled a total of $1 million over the cial banks and other financial institutions
connections within the field. course of nine years. Busby noted that the offer major employment opportunities. In
For example, for the past four years, experience helped him gain an understand- 2008–2009, a major downturn in the financial
Pennsylvania’s Delaware County District ing about how different companies handle industry resulted in mergers, acquisitions,
Attorney’s Office has been accepting busi- their financial statements, as well as how and financial restructuring for many com-
ness students from Villanova University for accounting can be applied in forensics and panies. While the immediate result was a
a six-month internship. The students work law enforcement. decrease in job opportunities, as the indus-
in the economic-crime division, analyzing Internship opportunities are plentiful all try recovers, there will be many challenging
documents of people under investigation for over the country, although you may need job opportunities available.15

GET ONLINE
mhhe.com/FerrellM3e
and video

sixteen

financial management
+ securities markets
introduction
hile it’s certainly true that Next, we turn our attention to the man-
W money makes the world

go around, financial man-
agement is the discipline that makes
agement of short-term liabilities, the
sources of short-term funds used to
finance the business. Then, we discuss
the world turn more smoothly. Indeed, the management of long-term assets
without effective management of such as plants, equipment, and the use
assets, liabilities, and owners’ equity, of common stock (equity) and bonds
all business organizations are doomed (long-term liability) to finance these
to fail—regardless of the quality and long-term corporate assets. Finally, we
innovativeness of their products. look at the securities markets, where
Financial management is the field that stocks and bonds are traded.
addresses the issues of obtaining and
managing the funds and resources nec-
essary to run a business successfully. It
LEARNING OBJECTIVES
is not limited to business organizations:
LO1 Describe some common methods
All organizations, from the corner store of managing current assets.
to the local nonprofit art museum, from LO2 Identify some sources of short-term
financing (current liabilities).
giant corporations to county govern-
LO3 Summarize the importance of long-
ments, must manage their resources term assets and capital budgeting.
effectively and efficiently if they are to LO4 Specify how companies finance
their operations and manage fixed
achieve their objectives.
assets with long-term liabilities,
In this chapter, we look at both short- particularly bonds.
and long-term financial management. LO5 Discuss how corporations can use
equity financing by issuing stock
First, we discuss the management of through an investment banker.
short-term assets, which companies LO6 Describe the various securities
markets in the United States.
use to generate sales and conduct ordi-
nary day-to-day business operations.
CHAPTER 16 | Financial Management and Securities Markets 333

working capital transaction lockbox an address,
management the balances cash kept usually a commercial
managing of short-term on hand by a firm to pay bank, at which a company
assets and liabilities normal daily expenses, receives payments in order
Idle cash does not make money, and corporate
such as employee wages to speed collections from checking accounts typically do not earn inter-
and bills for supplies and customers est. As a result, astute money managers try
utilities to keep just enough cash on hand, called
transaction balances, to pay bills—such
as employee wages, supplies, and utilities—
as they fall due. To manage the firm’s cash
MANAGING CURRENT and ensure that enough cash flows through the organization
quickly and efficiently, companies try to speed up cash collec-
ASSETS AND LIABILITIES tions from customers.
Managing short-term assets and liabilities involves managing To facilitate collection, some companies have customers send
the current assets and liabilities on the balance sheet (dis- their payments to a lockbox, which is simply an address for
cussed in Chapter 14). Current assets are short-term receiving payments, instead of directly to the company’s main
resources such as cash, investments, accounts receivable, and address. The manager of the lockbox, usually a commercial
inventory. Current liabilities are short-term debts such as bank, collects payments directly from the lockbox several times
accounts payable, accrued salaries, accrued taxes, and short- a day and deposits them into the company’s bank account. The
term bank loans. We use the terms current and short term bank can then start clearing the checks and get the money into
interchangeably because short-term assets and liabilities are the company’s checking account much more quickly than if the
usually replaced by new assets and liabilities within three or payments had been submitted directly to the company. How-
four months, and always within a year. Managing short-term ever, there is no free lunch: The costs associated with lockbox
assets and liabilities is sometimes called working capital systems make them worthwhile only for those companies that
management because short-term assets and liabilities con- receive thousands of checks from customers each business day.
tinually flow through an organization and are thus said to be
“working.” Large firms with many stores or offices around the country,
such as HSBC Finance Corporation, formerly known as House-
hold International, frequently use electronic funds transfer to
Managing Current Assets speed up collections. HSBC Finance Corporation’s local offices
The chief goal of financial managers who focus on current deposit checks received each business day into their local banks
assets and liabilities is to maximize the return to the business on and, at the end of the day, HSBC Finance Corporation’s corpo-
cash, temporary investments of idle cash, accounts receivable, rate office initiates the transfer of all collected funds to its cen-
and inventory. tral bank for overnight investment. This technique is especially
attractive for major international companies, which face slow
Managing Cash A crucial element facing any financial
and sometimes uncertain physical delivery of payments and/or
manager is effectively managing the firm’s cash flow. Remem-
less-than-efficient check-clearing procedures.
ber that cash flow is the movement of money through an orga-
nization on a daily, weekly, monthly, or yearly basis. Ensuring More and more companies are now using electronic funds
that sufficient (but not excessive) funds are on hand to meet transfer systems to pay and collect bills online. Companies gen-
the company’s obligations is one of the single most important erally want to collect cash quickly but pay out cash slowly. When
facets of financial management. companies use electronic funds transfers between buyers and
MISSION MOTORS lithium-ion batteries with its own cooling and are pursuing licensing rather than doing
management technology to create electric their own manufacturing. The motorcycles
LICENSES THE power systems. In order to entice investors might also give it an edge over the 20 other
FASTEST E-BIKES TO to fund its electric power systems, Mission lithium-ion battery start-ups out there. Mis-
Motors plans to sell a limited number of its sion’s motorcycles have certainly gained
RAISE FUNDS $68,995 e-motorcycles, equipped with its attention, particularly after they achieved
battery system. an e-motorcycle record speed of 150 miles
W hat do software and motorcycles

have in common? They are both
licensed by Mission Motors. Mission Motors
Why motorcycles? The current finan-
cial environment is making it difficult for
per hour. To date, Mission has raised over
$3 million and may link up with China’s larg-
start-ups to acquire funding. For this rea- est motorcycle maker Zongshen Power
is a software company that combines son, companies such as Mission Motors Machinery.1

marketable
securities
temporary investment of
suppliers, the speed of collections and disbursements increases One of the most popular short- “extra” cash by organizations
to one day. Only with the use of checks can companies delay term investments for the larg- for up to one year in U.S.
the payment of cash by three or four days until the check is pre- est business organizations is Treasury bills, certificates of
sented to their bank and the cash leaves their account. commercial paper—a written deposit, commercial paper,
promise from one company to or eurodollar loans
Investing Idle Cash As companies sell products, they another to pay a specific amount of
generate cash on a daily basis, and sometimes cash comes in money. Because commercial paper Treasury bills
faster than it is needed to pay bills. Organizations often invest is backed only by the name and (T-bills) short-term
this “extra” cash, for periods as short as one day (overnight) debt obligations the U.S.
reputation of the issuing company,
or for as long as one year, until it is needed. Such temporary government sells to raise
sales of commercial paper are money
investments of cash are known as marketable securities. restricted to only the largest and
Examples include U.S. Treasury bills, certificates of deposit, most financially stable companies. commercial
commercial paper, and eurodollar deposits. Table 16.1 summa- As commercial paper is frequently certificates of
rizes a number of different marketable securities used by busi- bought and sold for durations of deposit (CDs)
nesses and some sample interest rates on these investments as as short as one business day, many certificates of deposit
of June 23, 2006, and April 15, 2011. The safety rankings are “players” in the market find them- issued by commercial
relative. While all of the listed securities are very low risk, the selves buying commercial paper banks and brokerage
U.S. government securities are the safest. You can see from the companies, available in
with excess cash on one day and
table that interest rates have declined during the two periods minimum amounts of
selling it to gain extra money the $100,000, which may be
presented. following day. traded prior to maturity
You may never see interest rates this low in your lifetime. The During 2007 and 2008, the com-
Fed used monetary policy to lower interest rates to stimulate commercial paper
mercial paper market simply a written promise from one
borrowing and investment during the severe recession of 2007– stopped functioning. Investors no company to another to pay
2009 and continued to maintain low rates into 2011 in order to longer trusted the IOUs of even a specific amount of money
stimulate employment and economic growth. the best companies. Companies
Many large companies invest idle cash in U.S. Treasury that had relied on commercial eurodollar market
bills (T-bills), which are short-term debt obligations the paper to fund short-term cash a market centered in
needs had to turn to the banks for London for trading U.S.
U.S. government sells to raise money. Issued weekly by the U.S.
dollars in foreign countries
Treasury, T-bills carry maturities of between one week to one borrowing. Those companies who
year. U.S. T-bills are generally considered to be the safest of all had existing lines of credit at their
investments and are called risk free because the U.S. govern- bank were able to draw on their
ment will not default on its debt. line of credit. Others were in a
tight spot. Eventually, the Federal Reserve entered the market
Commercial certificates of deposit (CDs) are issued by
to buy and sell commercial paper for its own portfolio. This is
commercial banks and brokerage companies. They are available
something the Fed was not in the habit of doing. But it rescued
in minimum amounts of $100,000 but are typically in units of $1
the market.
million for large corporations investing excess cash. Unlike con-
sumer CDs (discussed in Chapter 15), which must be held until Some companies invest idle cash in international markets such
maturity, commercial CDs may be traded prior to maturity. as the eurodollar market, a market for trading U.S. dollars in
Should a cash shortage occur, the organization can simply sell foreign countries. Because the eurodollar market was originally
the CD on the open market and obtain needed funds. developed by London banks, any dollar-denominated deposit
T A B L E 1 6 . 1 Short-Term Investment Possibilities for Idle Cash

Interest Rate
Type of Security Maturity Seller of Security 6/23/2006 4/15/2011 Safety Level
U.S. Treasury bills 90 days U.S. government 4.80% 0.06% Excellent
U.S. Treasury bills 180 days U.S. government 5.05 0.12 Excellent
Commercial paper 30 days Major corporations 5.14 0.16 Very good
Certificates of deposit 90 days U.S. commercial banks 5.40 0.23 Very good
Certificates of deposit 180 days U.S. commercial banks 5.43 0.32 Very good
Eurodollars 90 days European commercial banks 5.48 0.42 Very good
Source: “Selected Interest Rates,” Federal Reserve Statistical Release, April 18, 2011, www.federalreserve.gov/releases/h15/current (accessed April 20, 2011).

balance between the added advantages of early cash receipt
and the disadvantages of reduced profits is no simple matter.
Similarly, determining the optimal balance between the higher
sales likely to result from extending credit to customers with
less than sterling credit ratings and the higher bad-debt losses
likely to result from a more lenient credit policy is also chal-
lenging. Information on company credit ratings is provided
by local credit bureaus, national credit-rating agencies such as
Dun and Bradstreet, and industry trade groups.
Optimizing Inventory While the inventory that a firm

holds is controlled by both production needs and marketing
considerations, the financial manager has to coordinate inven-
tory purchases to manage cash flows. The object is to mini-
mize the firm’s investment in inventory without experiencing
production cutbacks as a result of critical materials shortfalls
or lost sales due to insufficient finished goods inventories.
Firms and individuals can buy and redeem T-bills and other government Every dollar invested in inventory is a dollar unavailable for
securities from the U.S. Department of the Treasury at www.
investment in some other area of the organization. Optimal
treasurydirect.com.
inventory levels are determined in large part by the method
of production. If a firm attempts to produce its goods just in
time to meet sales demand, the level of inventory will be rela-
in a non-U.S. bank is called a eurodollar deposit, regardless of tively low. If, on the other hand, the firm produces materials in
whether the issuing bank is actually located in Europe, South a constant, level pattern, inventory increases when sales
America, or anyplace else. For example, if you travel overseas decrease and decreases when sales increase. One way that com-
and deposit $1,000 in a German bank, you will have “created” panies are attempting to optimize inventory is through the use
a eurodollar deposit in the amount of $1,000. Because the U.S. of radio frequency identification (RFID) technology. Compa-
dollar is accepted by most countries for international trade, nies such as Walmart are attempting to better manage their
these dollar deposits can be used by international companies inventories by using RFID tags. An RFID tag, which contains
to settle their accounts. The market created for trading such a silicon chip and an antenna, allows a company to use radio
investments offers firms with extra dollars a chance to earn a waves to track and identify the products to which the tags are
slightly higher rate of return with just a little more risk than attached. These tags are primarily used to track inventory ship-
they would face by investing in U.S. Treasury bills. ments from the manufacturer to the buyer’s warehouses and
then to the individual stores.
Maximizing Accounts Receivable After cash and
marketable securities, the balance sheet lists accounts receiv- The automobile industry is an excellent example of an industry
able and inventory. Remember that accounts receivable is driven almost solely by inventory levels. Because it is inefficient
money owed to a business by credit customers. For example, to continually lay off workers in slow times and call them back
if you charge your Shell gasoline purchases, until you actually in better times, Ford, General Motors, and Chrysler try to set
pay for them with cash or a check, they represent an account and stick to quarterly production quotas. Automakers typically
receivable to Shell. Many businesses make the vast majority try to keep a 60-day supply of unsold cars. During particu-
of their sales on credit, so managing accounts receivable is an larly slow periods, however, it is not unusual for inventories to
important task. exceed 100 days of sales.
Each credit sale represents an account receivable for the com- Although less publicized, inventory shortages can be as much
pany, the terms of which typically require customers to pay the of a drag on potential profits as too much inventory. Not hav-
full amount due within 30, 60, or even 90 days from the date of ing an item on hand may send the customer to a competitor—
the sale. To encourage quick payment, some businesses offer forever. Complex computer inventory models are frequently
some of their customers discounts of between 1 to 2 percent employed to determine the optimum level of inventory a firm
if they pay off their balance within a specified period of time should hold to support a given level of sales. Such models can
(usually between 10 and 30 days). On the other hand, late pay- indicate how and when parts inventories should be ordered so
ment charges of between 1 and 1.5 percent serve to discourage that they are available exactly when required—and not a day
slow payers from sitting on their bills forever. The larger the before. Developing and maintaining such an intricate produc-
early payment discount offered, the faster customers will tend tion and inventory system is difficult, but it can often prove
to pay their accounts. Unfortunately, while discounts increase to be the difference between experiencing average profits and
cash flow, they also reduce profitability. Finding the right spectacular ones.

trade credit credit
extended by suppliers for
the purchase of their goods
Managing Current Liabilities terms of 2/10 net 30. By paying the and services
amount due within 10 days, you can
While having extra cash on hand is a delightful surprise, the
save 2 percent of $10,000, or $200. line of credit an
opposite situation—a temporary cash shortfall—can be a crisis.
Assume you place orders with Ajax arrangement by which
The good news is that there are several potential sources of
once per month and have 12 bills of a bank agrees to lend a
short-term funds. Suppliers often serve as an important source specified amount of money
$10,000 each per year. By taking the
through credit sales practices. Also, banks, finance companies, to an organization upon
discount every time, you will save
and other organizations offer short-term funds through loans request
12 times $200, or $2,400, per year.
and other business operations.
Now assume you are the financial secured loans loans
manager of Gigantic Corp., and backed by collateral that
Accounts Payable Remember from Chapter 14 that it has monthly payables of $100 the bank can claim if the
accounts payable is money an organization owes to suppli-
million per month. Two percent borrowers do not repay them
ers for goods and services. Just as accounts receivable must
of $100 million is $2 million per
be actively managed to ensure proper cash collections, so too
month. Failure to take advantage of
must accounts payable be managed to make the best use of this
such trade discounts can add up to
important liability.
large opportunity losses over the span of a year.
The most widely used source of short-term financing, and
therefore the most important account payable, is trade Bank Loans Virtually all organizations—large and small—
credit—credit extended by suppliers for the purchase of their obtain short-term funds for operations from banks. In most
goods and services. While varying in formality, depending on instances, the credit services granted these firms take the form
both the organizations involved and the value of the items pur- of a line of credit or fixed dollar loan. A line of credit is an
chased, most trade credit agreements offer discounts to organi- arrangement by which a bank agrees to lend a specified amount
zations that pay their bills early. A supplier, for example, may of money to the organization upon request—provided that
offer trade terms of “1/10 net 30,” meaning that the purchasing the bank has the required funds to make the loan. In general,
organization may take a 1 percent discount from the invoice a business line of credit is very similar to a consumer credit
amount if it makes payment by the 10th day after receiving the card, with the exception that the preset credit limit can amount
bill. Otherwise, the entire amount is due within 30 days. For to millions of dollars.
example, pretend that you are the financial manager in charge In addition to credit lines, banks also make secured loans—
of payables. You owe Ajax Company $10,000, and it offers trade loans backed by collateral that the bank can claim if the
Y COMBINATOR Graham offers something more valuable provide a superior service. These small
than a simple loan—an experienced eye, companies are often less expensive and
GIVES BOOST TO solid advice, and a positive and creative more flexible, making them better equipped
STARTUP COMPANIES environment. Y Combinator focuses on to do well in a recession. Although Graham
tech startups, with an emphasis on Web- takes a risk with each startup, graduates
based applications. Graham’s experience such as Scribd (which partnered with liter-
A lthough thousands of companies failed
during the most recent recession,
Y Combinator and the companies it assists
allows him to help direct, or redirect, found-
ers toward workable concepts attractive
ary giants and received over $12 million in
venture capital funding) and Omnisio (pur-
were among those thriving. Founder Paul to larger investors. His business motto is chased by Google for more than $15 million)
Graham (famous in tech circles for creat- “Make something people want.” Graham make it worthwhile. Some of the compa-
ing Viaweb—sold to Yahoo! for $49 million) also addresses running businesses, han- nies flourish—and when they do, Graham
launched Y Combinator in 2005. His method dling investors, and dealing with acquisi- makes a substantial profit.2
is somewhat like a school for startups, and tions. Y Combinator was rated number
eleven in BusinessWeek’s top angel Discussion Questions
his funding somewhat like financial aid.
Graham gathers entrepreneurs for three- investors. 1. Why has Y Combinator succeeded while
month periods, during which time he pro- Small businesses like those funded by many other firms in the financial industry
vides them with small loans (typically under Y Combinator are making some Fortune 500 have failed?
$20,000) to meet basic needs, allowing them companies nervous. For example, eBay, for 2. What are the risks involved in creating a
to focus on developing their fledgling com- all of its success, does not often update business like Y Combinator?
panies. In exchange, Y Combinator receives its auction system. This leaves room for a 3. What are the rewards for Graham in tak-
a 2 to 10 percent company stake. small startup to gain market share if it can ing a risk in small tech startups?

Because both businesses and individuals want to keep their financing costs to a minimum, when interest rates drop, their investment in assets tends
to increase.
borrowers do not repay the loans—and unsecured loans— of the market for commercial paper has dramatically reduced
loans backed only by the borrowers’ good reputation and previ- the importance of commercial banks as a source of short-term
ous credit rating. Both individuals and businesses build their loans. Today, most “prime” borrowers are actually small- and
credit rating from their history of borrowing and repaying bor- medium-sized businesses.
rowed funds on time and in full. The three national credit-rat-
ing services are Equifax, TransUnion, and Experian. A lack of The interest rates on commercial loans may be either fixed or
credit history or a poor credit history can make it difficult to get variable. A variable, or floating-rate, loan offers an advantage
loans from financial institutions. The principal is the amount when interest rates are falling but represents a distinct disad-
of money borrowed; interest is a percentage of the principal vantage when interest rates are rising. Between 1999 and 2004,
that the bank charges for use of its money. As we mentioned interest rates plummeted, and borrowers refinanced their loans
in Chapter 15, banks also pay depositors interest on savings with low-cost fixed-rate loans. Nowhere was this more visible
accounts and some checking accounts. Thus, banks charge bor- than in the U.S. mortgage markets, where homeowners lined
rowers interest for loans and pay interest to depositors for the up to refinance their high-percentage home mortgages with
use of their money. In addition, these loans may include origi- lower-cost loans, in some cases as low as 5 percent on a 30-year
nation fees. loan. These mortgage interest rates had returned to 6.5 percent
by mid-2006, but by the end of 2009 they had declined to less
One of the complaints from borrowers during the financial than 5.0 percent and were still hovering around 5 percent in
meltdown and recession was that banks weren’t willing to lend. spring of 2011. Individuals and corporations have the same
There were several causes. Banks were trying to rebuild their motivation: to minimize their borrowing costs.
capital, and they didn’t want to take the extra risk that lend-
ing offers in an economic recession. They were drowning in
bad debts and were not sure how future loan losses would affect
Nonbank Liabilities Banks are not the only source of
short-term funds for businesses. Indeed, virtually all financial
their capital. The banks’ lack of lending caused problems for
institutions, from insurance companies to pension funds, from
small businesses.
money market funds to finance companies, make short-term
The prime rate is the interest rate commercial banks charge loans to many organizations. The largest U.S. companies also
their best customers (usually large corporations) for short-term actively engage in borrowing money from the eurodollar and
loans. While for many years, loans at the prime rate repre- commercial paper markets. As noted earlier, both of these funds’
sented funds at the lowest possible cost, the rapid development sources are typically slightly less expensive than bank loans.

unsecured loans
loans backed only by the
borrowers’ good reputation
In some instances, businesses actually sell their accounts receiv- approach is leasing assets such as and previous credit rating
able to a finance company known as a factor, which gives the equipment, machines, and build-
selling organizations cash and assumes responsibility for col- ings. Leasing involves paying a prime rate the interest
lecting the accounts. For example, a factor might pay $60,000 fee for usage rather than owning rate that commercial banks
for receivables with a total face value of $100,000 (60 percent the asset. There are two kinds of charge their best customers
of the total). The factor profits if it can collect more than what leases: capital leases and operat- (usually large corporations)
it paid for the accounts. Because the selling organization’s cus- ing leases. A capital lease is a long- for short-term loans
tomers send their payments to a lockbox, they may have no term contract and shows up on the factor a finance
idea that a factor has bought their receivables. balance sheet as an asset and liabil- company to which
ity. The operating lease is a short- businesses sell their
Additional nonbank liabilities that must be efficiently
term cancelable lease and does accounts receivable—
managed to ensure maximum profitability are taxes owed
not show up on the balance sheet. usually for a percentage of
to the government and wages owed to employees. Clearly,
We’ll take a closer look at long- the total face value
businesses are responsible for many different types of taxes,
term financing in a moment, but
including federal, state, and local income taxes, property long-term (fixed)
first let’s address some issues asso-
taxes, mineral rights taxes, unemployment taxes, Social Secu- assets production
ciated with fixed assets, including
rity taxes, workers’ compensation taxes, excise taxes, and facilities (plants), offices,
capital budgeting, risk assessment, and equipment—all of
more. While the public tends to think that the only relevant
and the costs of financing fixed which are expected to last
taxes are on income and sales, many industries must pay
assets. for many years
other taxes that far exceed those levied against their income.
Taxes and employees’ wages represent debt obligations of the
firm, which the financial manager must plan to meet as they
Capital Budgeting capital budgeting
the process of analyzing
fall due. and Project the needs of the business
Selection and selecting the assets
One of the most important jobs that will maximize its value
MANAGING FIXED ASSETS performed by the financial man-
Up to this point, we have focused on the short-term aspects of ager is to decide what fixed assets,
financial management. While most business failures are the projects, and investments will earn profits for the firm beyond
result of poor short-term planning, successful ventures must the costs necessary to fund them. The process of analyzing the
also consider the long-term financial consequences of their needs of the business and selecting the assets that will maximize
All assets and projects must be continually reevaluated to

ensure their compatibility with the organization’s needs.
actions. Managing the long-term assets and liabilities and the

owners’ equity portion of the balance sheet is important for the
long-term health of the business.
Long-term (fixed) assets are expected to last for many
years—production facilities (plants), offices, equipment, heavy
machinery, furniture, automobiles, and so on. In today’s
fast-paced world, companies need the most technologically
advanced, modern facilities and equipment they can afford.
Automobile, oil refining, and transportation companies are
dependent on fixed assets.
Modern and high-tech equipment carry high price tags, and
the financial arrangements required to support these invest- Although pharmaceutical manufacturers may want to undertake many
ments are by no means trivial. Leasing is just one approach to projects, the costs involved require them to use capital budgeting to
financing. Obtaining major long-term financing can be chal- determine which projects will lead to the greatest profits. The company
lenging for even the most profitable organizations. For less suc- Allergan used capital budgeting to determine the potential profitability
cessful firms, such challenges can prove nearly impossible. One of the eye medication Restasis.

its value is called capital budgeting, and the capital budget England would be much less risky than a decision to build one
is the amount of money budgeted for investment in such long- in the Middle East, for example.
term assets. But capital budgeting does not end with the selec-
tion and purchase of a particular piece of land, equipment, or The longer a project or asset is expected to last, the greater its
major investment. All assets and projects must be continually potential risk because it is hard to predict whether a piece of
reevaluated to ensure their compatibility with the organization’s equipment will wear out or become obsolete in 5 or 10 years.
needs. Financial executives believe most budgeting activities are Predicting cash flows one year down the road is difficult, but
occasionally or frequently unrealistic or irrelevant. If a particular projecting them over the span of a 10-year project is a gamble.
asset does not live up to expectations, then management must The level of a project’s risk is also affected by the stability and
determine why and take necessary corrective action. Budgeting competitive nature of the marketplace and the world economy
is not an exact process, and managers must be flexible when new as a whole. IBM’s latest high-technology computer product is
information is available. far more likely to become obsolete overnight than is a similar
$10 million investment in a manufacturing plant. Dramatic
Assessing Risk changes in the marketplace are not uncommon. Indeed, uncer-
Every investment carries some risk. Figure 16.1 ranks potential tainty created by the rapid devaluation of Asian currencies in
investment projects according to estimated risk. When consid- the late 1990s wrecked a host of assumptions in literally hun-
ering investments overseas, risk assessments must include the dreds of projects worldwide. Financial managers must con-
political climate and economic stability of a region. The deci- stantly consider such issues when making long-term decisions
sion to introduce a product or build a manufacturing facility in about the purchase of fixed assets.
Pricing Long-Term
FIGURE 16.1 Money
Qualitative Assessment of Capital Budgeting Risk The ultimate profitability of any project
depends not only on accurate assump-
tions of how much cash it will generate,
Highest Risk
but also on its financing costs. Because
a business must pay interest on money
it borrows, the returns from any project
Introduce a New Product in must cover not only the costs of oper-
Foreign Markets (risk depends
on stability of country)
ating the project but also the interest
expenses for the debt used to finance
its construction. Unless an organization
can effectively cover all of its costs—both
Expand into a New Market financial and operating—it will eventu-
ally fail.
Clearly, only a limited supply of funds
Introduce a New Product in
a Familiar Area
is available for investment in any given
enterprise. The most efficient and prof-
itable companies can attract the lowest-
cost funds because they typically offer
Add to a Product Line reasonable financial returns at very low
relative risks. Newer and less prosperous
firms must pay higher costs to attract
capital because these companies tend
Buy New Equipment for
an Established Market to be quite risky. One of the strongest
motivations for companies to manage
their financial resources wisely is that
they will, over time, be able to reduce
Repair Old Machinery the costs of their funds and in so doing
increase their overall profitability.
In our free-enterprise economy, new firms
Lowest Risk tend to enter industries that offer the great-
est potential rewards for success. However,

long-term
liabilities debts that
will be repaid over a
as more and more companies enter an industry, competition could be won and lost in the space number of years, such as
intensifies, eventually driving profits down to average levels. The of an average-sized garage—have long-term loans and bond
digital music player market of the early 2000s provides an excellent long since passed into history. issues
example of the changes in profitability that typically accompany Personal computers have essen-
increasing competition. The sign of a successful capital budgeting tially become commodity items, bonds debt instruments
program is that the new products create higher than normal prof- and profit margins for companies that larger companies sell
its and drive sales and the stock price up. This has certainly been in this industry have shrunk as the to raise long-term funds
true for Apple. It introduced the first iPod in 2001, and after many market matures. With sales falling
enhancements it continued to sell 8.3 million iPods in 2007. Its and profits falling faster, Hewlett-
sales have grown from $6.2 billion in 2003 to $65.2 billion in 2010, Packard and Compaq merged to gain the economies of scale
while its earnings per share have increased from $0.10 per share to that saved money and created efficiencies.
$15.25 during the same time frame. From a low price of $6.36 per
share in 2003, its stocks rose to a high of $350 on April, 8, 2011.
Note that $1,000 invested in Apple at its low point in 2003 would be FINANCING WITH
worth approximately $55,000 on April, 8, 2011, at $350 per share.3
The success of the iPod and iTunes was followed up with the
LONG-TERM LIABILITIES
As we said earlier, long-term assets do not come cheaply, and
introduction of the iPhone in 2007. The iPhone was followed by
few companies have the cash on hand to open a new store across
the successful introduction of the iPad tablet in April 2010. The
town, build a new manufacturing facility, research and develop
combination of these products and the ease of synchronization
a new life-saving drug, or launch a new product worldwide.
with the iMac computers caused a complementary sales effect for
To develop such fixed assets, companies need to raise low-cost
Apple computers. Even with a well-planned capital budgeting
long-term funds to finance them. Two common choices for
program, it may be difficult for Apple to stay ahead of the com-
raising these funds are attracting new owners (equity financ-
petition because it is difficult to maintain market dominance in
ing), which we’ll look at in a moment, and taking on long-term
the consumer electronics industry for extended periods of time.
liabilities (debt financing), which we’ll look at now.
The same is true in the personal computer market. With
increasing competition, prices have fallen dramatically since Long-term liabilities are debts that will be repaid over a
the 1990s. Even Dell, with its low-cost products, has moved into number of years, such as long-term bank loans and bond issues.
other markets such as servers and televisions in order to main- These take many different forms, but in the end, the key word is
tain growth in a maturing market. Weaker companies have debt. Companies may raise money by borrowing it from com-
failed, leaving the most efficient producers/marketers scram- mercial banks or other financial institutions in the form of lines
bling for market share. The expanded market for personal com- of credit, short-term loans, or long-term loans. Many corpora-
puters dramatically reduced the financial returns generated by tions acquire debt by borrowing money from pension funds,
each dollar invested in productive assets. The “glory days” of mutual funds, or life-insurance funds.
the personal computer industry—the time in which fortunes Companies that rely too heavily on debt can get into serious
trouble should the economy falter; during these times, they may
not earn enough operating income to make the required interest
payments (remember the times-interest-earned ratio in Chap-
ter 14). In severe cases when the problem persists too long, credi-
tors will not restructure loans but will instead sue for the interest
and principal owed and force the company into bankruptcy.
Bonds: Corporate IOUs

Much long-term debt takes the form of bonds, which are debt
instruments that larger companies sell to raise long-term funds.
In essence, the buyers of bonds (bondholders) loan the issuer of
the bonds cash in exchange for regular interest payments until the
loan is repaid on or before the specified maturity date. The bond
itself is a certificate, much like an IOU, that represents the com-
pany’s debt to the bondholder. Bonds are issued by a wide vari-
ety of entities, including corporations; national, state, and local
governments; public utilities; and nonprofit corporations. Most
As a public corporation, one way in which Dell takes on long-term debt bondholders need not hold their bonds until maturity; rather, the
is in the form of bonds. The company sells bonds to raise long-term existence of active secondary markets of brokers and dealers allows
funds. for the quick and efficient transfer of bonds from owner to owner.

unsecured secured bonds bonds serial bonds a floating-rate bonds junk bonds a special
bonds debentures, or that are backed by specific sequence of small bond bonds with interest rates that type of high-interest-rate
bonds that are not backed by collateral that must be issues of progressively longer change with current interest bond that carries higher
specific collateral forfeited in the event that the maturity rates otherwise available in inherent risks
issuing firm defaults the economy
The bond contract, or indenture, specifies all of the terms of the Types of Bonds
agreement between the bondholders and the issuing organiza-
Not surprisingly, there are a great many different types of
tion. The indenture, which can run more than 100 pages, speci-
bonds. Most are unsecured bonds, meaning that they are
fies the basic terms of the bond, such as its face value, maturity
not backed by collateral; such bonds are termed debentures.
date, and the annual interest rate. Table 16.2 briefly explains
Secured bonds, on the other hand, are backed by specific
how to determine these and more things about a bond from
collateral that must be forfeited in the event that the issuing
a bond quote, as it might appear in The Financial Times. The
firm defaults. Whether secured or unsecured, bonds may be
face value of the bond, its initial sales price, is typically $1,000.
repaid in one lump sum or with many payments spread out
After this, however, the price of the bond on the open market
over a period of time. Serial bonds, which are different from
will fluctuate along with changes in the economy (particularly,
secured bonds, are actually a sequence of small bond issues of
changes in interest rates) and in the creditworthiness of the
progressively longer maturity. The firm pays off each of the
issuer. Bondholders receive the face value of the bond along
serial bonds as they mature. Floating-rate bonds do not
with the final interest payment on the maturity date. The annual
have fixed interest payments; instead, the interest rate changes
interest rate (often called the coupon rate) is the guaranteed
with current interest rates otherwise available in the economy.
percentage of face value that the company will pay to the bond
owner every year. For example, a $1,000 bond with a coupon In recent years, a special type of high-interest-rate bond has
rate of 7 percent would pay $70 per year in interest. In most attracted considerable attention (usually negative) in the financial
cases, bond indentures specify that interest payments be made press. High-interest bonds, or junk bonds as they are popularly
every six months. In the example above, the $70 annual pay- known, offer relatively high rates of interest because they have
ment would be divided into two semiannual payments of $35. higher inherent risks. Historically, junk bonds have been asso-
ciated with companies in poor financial health and/or startup
In addition to the terms of interest payments and maturity
firms with limited track records. In the mid-1980s, however,
date, the bond indenture typically covers other important top-
junk bonds became a very attractive method of financing corpo-
ics, such as repayment methods, interest payment dates, proce-
rate mergers; they remain popular today with many investors as
dures to be followed in case the organization fails to make the
a result of their very high relative interest rates. But higher risks
interest payments, conditions for the early repayment of the
are associated with those higher returns (upward of 12 percent
bonds, and any conditions requiring the pledging of assets as
per year in some cases) and the average investor would be well-
collateral.
advised to heed those famous words: Look before you leap!
T A B L E 1 6 . 2 Bonds—Global Investment Grade Quoted in US $
Spread vs.
30-Mar-10 Red Date a Couponb Sc Mc Fc Bid Priced Bid Yielde Govts.f
GE Capital 01/16 5.00 AA+ Aa3 AA– 103.7 4.01 1.56
AT&T 03/31 8.75 A A2 A 128.2 6.3 1.53
Wireless
Goldman 02/33 6.13 A A1 A+ 98.29 6.27 1.49
Sachs
a
Red Date—the month and year that the bond matures and must pay back the borrowed amount.
b
Coupon—the percentage in interest payment that the bond pays based on a $1,000 bond. For example, the GE Capital bond pays 5 percent on $1,000 or $50 per year
while the AT&T bond pays $87.50.
c
S-M-F—the ratings provided by the three major rating agenices: S (Standard and Poor’s), M (Moody’s), and F (Fitch). Using Standard and Poor’s as an example, a
rating of AAA would be the highest quality and lowest risk bond. Any bond in the A category is investment grade and considered high quality.
d
Bid Price—the price as a percentage of par value ($1,000) that investors are willing to pay for a bond. For example, the GE capital bond has a bid price of 103.69,
which would translate into 103% of $1,000 or a price of $1,036.90.
e
Bid Yield—the annual rate of return the investor would receive if he or she held the bond to maturity. For example, with the GE bond you would get $50 per year until
the bond matured in January 2016, and you would receive $1,000 par value at maturity. Because you paid $1,036.90, you would lose $36.90 on your investment. The
4.01 percent bid yield reflects both the income from the interest payment and the loss on the investment.
f
Spread vs. Govts.—represents the premium yield the corporate bond pays over a U.S. government bond of equal maturity. Because corporate bonds are riskier than
government bonds, an investor would expect the corporation to pay more than a risk-free government bond. In the case of GE Capital, the premium the company pays
is an extra 1.56 percent.
Source: The Financial Times, March 31, 2010, p. 23.

SHAREHOLDERS learned as CEO. With a personal stake in athletes, sports fishermen, and more. He
two-thirds of the voting shares and one- also views financial performance as the
ENJOY GROWTH AT fourth of the common stock, Stack wins or key to shareholder support. Of course,
DICK’S SPORTING loses significantly based on the company’s as with all companies, success hinges in
performance. Early on Stack led the com- part on events outside the company’s con-
GOODS pany on a path of rapid expansion, nearly trol. For example, Dick’s Sporting Goods
causing the company’s failure. When firms depends heavily on the seasons, which can
W hat began in 1948 as a small bait

and tackle shop is now the multi-
billion-dollar national sporting goods chain
expand too rapidly, this creates financial
pressure as expenses become greater
be unpredictable. However, Stack is driven
and determined to control all in his power,
than revenue. Today Stack grows the steering Dick’s Sporting Goods toward con-
Dick’s Sporting Goods. Founded by Rich- company slowly, focusing on regional cus- tinued success for shareholders.4
ard Stack with $300 from his grandmother’s tomers throughout its over 400 stores. For
cookie jar, the company is currently run by example, the company pays attention to Discussion Questions
second-generation Ed Stack (CEO). Annual each region’s seasons to ensure that prod- 1. How has Dick’s Sporting Goods grown to
revenues in 2010 soared beyond the $4 bil- ucts are stocked at exactly the right times. be so financially successful?
lion mark, landing the company on the For- This allows products to quickly leave the 2. Why does too rapid growth of a company
tune 500. Since the company’s public debut shelves, thereby increasing revenue. Stack cause a stress on finances?
in 2002, share value has increased over also focuses heavily on customer experi-
600 percent. Analysts continue to predict 3. What could be some financial chal-
ence in an effort to create repeat custom-
growth for the company. lenges in growing Dick’s Sporting Goods
ers willing to pay Dick’s prices.
Such growth may be attributed in part to 800 stores?
With an eye toward 800 stores, Stack
to Ed Stack and the lessons that he has is building relationships with professional
A second means of long-term financing is through equity.
FINANCING WITH stock quote, as it might appear in The Wall Street Journal or on
the NASDAQ website.
OWNERS’ EQUITY Preferred stock was defined in Chapter 14 as corporate owner-

ship that gives the stockholder preference in the distribution
A second means of long-term financing is through equity.
Remember from Chapter 14 that owners’ equity refers to the of the company’s profits but not the voting and control rights
owners’ investment in an organization. Sole proprietors and accorded to common stockholders. Thus, the primary advan-
partners own all or a part of their businesses outright, and their tage of owning preferred stock is that it is a safer investment
equity includes the money and assets they have brought into than common stock.
their ventures. Corporate owners, on the other hand, own stock
or shares of their companies, which they hope will provide
them with a return on their investment. Stockholders’ equity
includes common stock, preferred stock, and retained earnings.
Common stock (introduced in Chapter 4) is the single most
important source of capital for most new companies. On the
balance sheet, the common stock account is separated into two
basic parts—common stock at par and capital in excess of par.
The par value of a stock is simply the dollar amount printed
on the stock certificate and has no relation to actual market
value—the price at which the common stock is currently trad-
ing. The difference between a stock’s par value and its offering
price is called capital in excess of par. Except in the case of some
very low-priced stocks, the capital in excess of par account is
significantly larger than the par value account. Table 16.3
briefly explains how to gather important information from a A McGraw-Hill stock certificate.

retained earnings
earnings after expenses and
taxes that are reinvested in
the assets of the firm and
All businesses exist to earn profits funds and are, in fact, the only long-term funds that the com-
belong to the owners in the for their owners. Without the pos- pany can generate internally.
form of equity sibility of profit, there can be no
incentive to risk investors’ capital When the board of directors distributes some of a corporation’s
and succeed. When a corporation profits to the owners, it issues them as cash dividend payments.
has profits left over after paying all But not all firms pay dividends. Many fast-growing firms retain
of its expenses and taxes, it has the choice of retaining all or a all of their earnings because they can earn high rates of return
portion of its earnings and/or paying them out to its sharehold- on the earnings they reinvest. Companies with fewer growth
ers in the form of dividends. Retained earnings are rein- opportunities typically pay out large proportions of their earn-
vested in the assets of the firm and belong to the owners in the ings in the form of dividends, thereby allowing their stock-
form of equity. Retained earnings are an important source of holders to reinvest their dividend payments in higher-growth
T A B L E 1 6 . 3 A Basic Stock Quote
1 2 3 4 5 6 7 8
Stock Price 52 Week
High Low Stock Symbol Dividend Yield (%) Volume Close Net Change
92.49 60.89 Nike NKE 1.24 1.50% 1,517,318 83.71 –0.35
44.90 19.00 Skechers USA SKX 0.00 0.00 426,524 21.28 –0.47
27.37 15.07 Timberland TBL 0.00 0.00 580,105 27.20 +0.31
33.00 23.51 Wolverine Worldwide WWW 0.44 1.40% 89,870 31.35 –0.31
1. The 52-week high and low—the highest and lowest prices, respectively, paid for the stock in the last year; for Nike stock, the highest was $92.49 and the lowest
price, $60.89.
2. Stock—the name of the issuing company. When followed by the letters “pf,” the stock is a preferred stock.
3. Symbol—the ticker tape symbol for the stock; NKE.
4. Dividend—the annual cash dividend paid to stockholders; Nike paid a dividend of $1.24 per share of stock outstanding.
5. Dividend yield—the dividend return on one share of common stock; 1.50 percent.
6. Volume—the number of shares traded on this day; Nike, 1,517,318
7. Close—Nike’s last sale of the day was for $83.71.
8. Net Change—the difference between the previous day’s close and the close on the day being reported; Nike was down $0.35.
Source: Yahoo! Finance, http://finance.yahoo.com/q?s (accessed January 19, 2011).
T A B L E 1 6 . 4 Estimated Common Stock Price-Earnings Ratios and Dividends for Selected
Price per Dividend per Dividend Earnings per Price Earnings

Ticker Symbol Company Name Share Share Yield Share (*) Ratio P/E
AEO American Eagle $14.50 $0.44 3.10% $ 0.54 26.73
AXP American Express 45.19 0.72 1.60 3.06 14.71
AAPL Apple 342.34 0.00 0.00 15.15 22.59
CPB Campbell Soup 34.82 1.16 3.30 2.36 14.73
DIS Disney 39.11 0.40 1.00 2.03 19.28
F Ford 18.12 0.00 0.00 1.89 9.60
HOG Harley-Davidson 36.17 0.40 1.10 –0.10 N/A (**)
HD Home Depot 35.64 0.95 2.60 $1.85 19.26
MCD McDonald’s 75.25 2.44 3.30 $4.53 16.61
PG Procter & Gamble 65.52 1.93 2.90 $4.06 16.09
LUV Southwest Airlines 12.92 0.02 0.10 0.59 21.93
SBUX Starbucks 33.02 0.52 1.60 1.24 26.63
*
Earnings per share are for the latest 12-month period and do not necessarily match year-end numbers.
**
N/A—not applicable because of negative earnings.
Source: http://finance.yahoo.com/q?s (accessed January 19, 2011).

dividend yield the
dividend per share divided
by the stock price
companies. Table 16.4 presents a sample of companies and the shopping” banking centers. When
dividend each paid on a single share of stock. As shown in the Pixar merged with Disney, both primary market the
table, when the dividend is divided by the price the result is companies used investment bank- market where firms raise
the dividend yield. The dividend yield is the cash return as a ers to help them value the transac- financial capital
percentage of the price but does not reflect the total return an tion. Each firm wanted an outside
investor earns on the individual stock. If the dividend yield is opinion about what it was worth secondary
markets stock
3.2 percent on Campbell Soup and the stock price increases by to the other. Sometimes mergers
exchanges and over-the-
10 percent from $34.92 to $38.41, then the total return would fall apart because the companies counter markets where
be 13.2 percent. It is not clear that stocks with high dividend cannot agree on the price each investors can trade their
yields will be preferred by investors to those with little or no company is worth or the structure securities with others
dividends. Most large companies pay their stockholders divi- of management after the merger.
dends on a quarterly basis. The advising investment banker, investment banking
the sale of stocks and
working with management, often
bonds for corporations
INVESTMENT BANKING irons out these details. Of course,
investment bankers do not pro- securities markets
A company that needs more money to expand or take advantage vide these services for free. They the mechanism for buying
of opportunities may be able to obtain financing by issuing usually charge a fee of between and selling securities
stock. The first-time sale of stocks and bonds directly to the pub- 1 and 1.5 percent of the transac-
lic is called a new issue. Companies that already have stocks or tion. A $20 billion
bonds outstanding may offer a new issue of stock merger can generate between $200 and $300
to raise additional funds for specific projects. million in investment banking fees. The merger
When a company offers its stock to the public for mania of the late 1990s allowed top investment
the very first time, it is said to be “going public,” bankers to earn huge sums. Unfortunately, this
and the sale is called an initial public offering. type of fee income is dependent on healthy stock
New issues of stocks and bonds are sold directly to markets, which seem to stimulate the merger
the public and to institutions in what is known as fever among corporate executives.
the primary market—the market where firms
raise financial capital. The primary market dif-
fers from secondary markets, which are stock DID YOU KNOW? THE SECURITIES
exchanges and over-the-counter markets where
investors can trade their securities with other
If you bought one MARKETS
investors rather than the company that issued
share of Microsoft Securities markets provide a mechanism for
stock when the buying and selling securities. They make it pos-
the stock or bonds. Primary market transactions
company went public sible for owners to sell their stocks and bonds to
actually raise cash for the issuing corporations,
other investors. Thus, in the broadest sense, stocks
while secondary market transactions do not. in 1986, it would be
and bonds markets may be thought of as provid-
Investment banking, the sale of stocks and worth almost $8,000 ers of liquidity—the ability to turn security hold-
bonds for corporations, helps such companies today, after allowing ings into cash quickly and at minimal expense and
raise funds by matching people and institutions for stock splits and effort. Without liquid securities markets, many
who have money to invest with corporations in adjustments.5 potential investors would sit on the sidelines rather
need of resources to exploit new opportunities. than invest their hard-earned savings in securi-
Corporations usually employ an investment ties. Indeed, the ability to sell securities at well-
banking firm to help sell their securities in the primary mar- established market prices is one of the very pillars of the capitalistic
ket. An investment banker helps firms establish appropriate society that has developed over the years in the United States.
offering prices for their securities. In addition, the investment
Unlike the primary market, in which corporations sell stocks
banker takes care of the myriad details and securities regula-
directly to the public, secondary markets permit the trading of
tions involved in any sale of securities to the public.
previously issued securities. There are many different secondary
Just as large corporations such as IBM and Microsoft have a markets for both stocks and bonds. If you want to purchase 100
client relationship with a law firm and an accounting firm, shares of Google common stock, for example, you must purchase
they also have a client relationship with an investment bank- this stock from another investor or institution. It is the active buy-
ing firm. An investment banking firm such as Merrill Lynch, ing and selling by many thousands of investors that establishes
Goldman Sachs, or Morgan Stanley Smith Barney can provide the prices of all financial securities. Secondary market trades may
advice about financing plans, dividend policy, or stock repur- take place on organized exchanges or in what is known as the
chases, as well as advice on mergers and acquisitions. Many over-the-counter market. Many brokerage houses exist to help
now offer additional banking services, making them “one-stop investors with financial decisions, and many offer their services

over-the-counter
(OTC) market a
network of dealers all
through the Internet. One such and NASDAQ became publicly traded companies. They were
over the country linked by
computers, telephones, and
broker is Charles Schwab. Its site previously not-for-profit organizations but are now for-profit
Teletype machines offers a wealth of information and companies. Additionally, both exchanges bought or merged
provides educational material to with electronic exchanges, the NYSE with Archipelago and the
individual investors. NASDAQ with Instinet. Electronic trading is faster and less
expensive than floor trading (where brokers meet to transact
Stock Markets business) and now accounts for most of the stock trading done
Stock markets exist around the world in New York, Tokyo, Lon- worldwide.
don, Frankfort, Paris, and other world locations. The two big-
In an attempt to expand their markets, NASDAQ acquired the
gest stock markets in the United States are the New York Stock
OMX, a Nordic stock exchange headquartered in Sweden, and
Exchange (NYSE) and the NASDAQ market. The American Stock
the New York Stock Exchange merged with Euronext, a large
Exchange is now part of the New York Exchange, and NASDAQ
European electronic exchange that trades options and futures
bought both the Boston and Philadelphia regional exchanges. The
contracts as well as common stock. Both the NYSE and NAS-
Chicago Stock Exchange still exists as a regional exchange, but it has
DAQ have expanded their reach, their product line, and their
a difficult time justifying its existence as a stand-alone exchange.
ability to trade around the world. What we are witnessing is the
Exchanges used to be divided into organized exchanges and globalization of the world’s financial markets.
over-the-counter markets, but during the last several years, dra-
Traditionally, the NASDAQ market has been an electronic
matic changes have occurred in the markets. Both the NYSE
market, and many of the large technology companies such as
Microsoft, Oracle, and Apple trade on the NASDAQ market.
The NASDAQ operates through dealers who buy and sell com-
mon stock (inventory) for their own accounts. The NYSE has
traditionally been a floor-traded market, where brokers meet at
trading posts on the floor of the New York Stock Exchange to
buy and sell common stock. The brokers act as agents for their
clients and do not own their own inventory. This traditional
division between the two markets is becoming less significant
as the exchanges become electronic.
The Over-the-Counter Market

Unlike the organized exchanges, the over-the-counter (OTC)
market is a network of dealers all over the country linked by
computers, telephones, and Teletype machines. It has no cen-
tral location. Today, the OTC market consists of small stocks,
illiquid bank stocks, penny stocks, and companies whose stocks
trade on the “pink sheets.” Once NASDAQ was classified as an
exchange by the SEC, it was no longer part of the OTC market.
Further, because most corporate bonds and all U.S. securities
are traded over the counter, the OTC market regularly accounts
for the largest total dollar value of all of the secondary markets.
Measuring Market Performance

Investors, especially professional money managers, want to
know how well their investments are performing relative to
the market as a whole. Financial managers also need to know
how their companies’ securities are performing when com-
pared with their competitors’. Thus, performance measures—
averages and indexes—are very important to many different
people. They not only indicate the performance of a particu-
lar securities market but also provide a measure of the overall
health of the economy.
Indexes and averages are used to measure stock prices. An
index compares current stock prices with those in a specified
The New York Stock Exchange is the world’s biggest stock exchange in base period, such as 1944, 1967, or 1977. An average is the
terms of market capitalization. average of certain stock prices. The averages used are usually

[ “Many investors follow the activity of the Dow Jones
Industrial Average to see whether the stock market has
gone up or down.”
]
not simple calculations, however. Some stock market averages Dow Jones Industrial Average hit 7,461. The markets stabilized
(such as the Standard & Poor’s Composite Index) are weighted and the economy kept growing; investors were euphoric when
averages, where the weights employed are the total market val- the Dow Jones Industrial Average hit an all time high of 14,198
ues of each stock in the index (in this case 500). The Dow Jones in October 2007. However, once the housing bubble burst, the
Industrial Average is a price-weighted average. Regardless of economy and the stock market went into a free fall. The Dow
how they are constructed, all market averages of stocks move Jones Industrial Average bottomed out at 6,470 in March 2009.
together closely over time. The market entered a period of wild fluctuations, and by April
2010, it hit a new high for the year of 10,975 and continued
Many investors follow the activity of the Dow Jones Industrial
up to 12,453 by April 20, 2011. Perhaps this roller coaster ride
Average to see whether the stock market has gone up or down.
indicates why some people are afraid to enter the market and
Table 16.5 lists the 30 companies that currently make up the
buy common stocks. If you look at the long-term trend and
Dow. Although these companies are only a small fraction of
long-term returns in common stocks, they far outdistance
the total number of companies listed on the New York Stock
bonds and government securities. When you are young, you
Exchange, because of their size they account for about 25 per-
should be playing the long-term trends, and as you get older
cent of the total value of the NYSE.
your investments should become more conservative.
The numbers listed in an index or average that tracks the per-
Recognizing financial bubbles can be difficult. It is too easy to
formance of a stock market are expressed not as dollars but as
get caught up in the enthusiasm that accompanies rising mar-
a number on a fixed scale. If you know, for example, that the
kets. Knowing what something is worth in economic terms is
Dow Jones Industrial Average climbed from 860 in August
the test of true value. During the housing bubble, banks made
1982 to a high of 11,497 at the beginning of 2000, you can see
loans to subprime borrowers to buy houses. (Remember that
clearly that the value of the Dow Jones Average increased more
the prime rate is the rate for the highest quality borrowers and
than 10 times in this 19-year period, making it one of the high-
subprime loans are generally made to those who do not qual-
est rate of return periods in the history of the stock market.
ify for regular ones.) As more money poured into the hous-
Unfortunately, prosperity did not last long once the Internet ing market, the obvious supply and demand relationship from
bubble burst. Technology stocks and new Internet companies economics would indicate that housing prices would rise. As
were responsible for the huge increase in stock prices. Even prices rose, speculators entered the real estate market trying
companies with few sales and no earnings were selling at prices to make a fast buck. States such as Florida, Arizona, Nevada,
that were totally unreasonable. It is always easier to realize that and California were the favorite speculative spots and the
a bubble existed after it has popped. By September 2002, the states with the largest decline in house prices. To make matters
worse, banks had created the home equity
loan years ago so that borrowers could take
T A B L E 1 6 . 5 The 30 Stocks in the Dow Jones Industrial Average out a second mortgage against their house
3M Co DuPont McDonald’s and deduct the interest payment for tax
purposes. Many homeowners no longer
Alcoa Inc. ExxonMobil Merck
thought about paying off their mortgages
American Express Co General Electric Microsoft but instead used the increase in the price of
AT&T Inc. Hewlett-Packard Pfizer their houses to borrow more money. This
Bank of America Home Depot Procter & Gamble behavior was unsustainable.
Boeing Intel Travelers Companies The bankers engaged in risky financial
Caterpiller IBM United Technologies behavior packaged up billions of dollars of
Chevron Johnson & Johnson Verizon mortgages into securitized assets. In other
words, an investor could buy a pool of
Cisco Systems JPMorgan Chase Walmart
assets and collect the interest income and
Coca-Cola Kraft Foods Walt Disney eventually get a payment at the end of the
Source: “Dow Jones Industrial Average,” Yahoo! Finance, http://finance.yahoo.com/q/cp?s=^DJI life of the product. This technique allowed
(accessed April 20, 2011). banks to make a mortgage, collect a fee,

FIGURE 16.2 to borrow in the first place.
The defaults caused housing
Long-Term Performance of Stock Market and Dow Jones Industrial Average (^DJI)
prices to fall, and some people
who had home equity loans
no longer had any equity left
12.50K in their house. Some hom-
eowners owed the bank more
12K than the house was worth,
and they started walking away
11.50K from their mortgages. As the
11K
same time, investors realized
that the mortgage-backed
securities they owned were
2010 2011 Feb Mar Apr May Jun Jul Aug Sep Oct Nov probably not worth what they
thought they were worth, and
Source: “Dow Jones Industrial Average,” Yahoo! Finance, http://finance.yahoo.com/charts?s=%5EDJI#symbol=%
5Edji;range=20010402,20110401;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logsc prices of these assets plum-
ale=off;source=; (accessed April 21, 2011). meted. Banks and other finan-
cial service firms that had
package the mortgage, and collect another fee. These securi- these assets on their books suffered a double whammy. They had
tized mortgages were sold to the market as asset-backed securi- loan losses and losses on mortgage-backed securities that another
ties with a AAA credit rating off their books and replaced with division of the bank had bought for investment purposes. Soon,
cash to make more loans. In this case, when the bubble burst, it many banks were close to violating their capital requirement, and
had extremely severe consequences for the economy, workers, the U.S. Treasury and Federal Reserve stepped in—with the help
and investors. of funding from Congress—to make banks loans, buy securities
that were illiquid, and invest in the capital of the banks by buying
People defaulted on loans when they could no longer afford to
preferred stocks.
pay the mortgage. Many of these people shouldn’t have been able
SO YOU WANT TO WORK // in Financial Management or Securities /

T aking classes in financial and securities
management can provide many career
options, from managing a small firm’s
across finance and securities will be more
competitive than it has been in the past. How-
ever, this does not mean that there are no jobs.
little experience, this may result in a great
deal of frustration. On the other hand, by the
time you graduate, the job market for finance
accounts receivables to handling charitable All firms need financial analysts to determine majors could be in recovery and rebuilding with
giving for a multinational to investment bank- whether a project should be implemented, new employees. Uncertainty results in hiring
ing to stock brokerage. We have entered into when to issue stocks or bonds, or when to ini- freezes and layoffs, but leave firms lean and
a less certain period for finance and securi- tiate loans. These and other forward-looking ready to grow when the cycle turns around,
ties jobs, however. In the world of invest- questions such as how to invest excess cash resulting in hiring from the bottom up.
ment banking, the past few years have been must be addressed by financial managers. Many different industries require people
especially challenging. Tens of thousands of Economic uncertainty in the financial and with finance skills. So do not despair if you
employees from Wall Street firms have lost securities market has made for more difficulty have a difficult time finding a job in exactly the
their jobs. This phenomenon is not confined to in finding the most desirable jobs. right firm. Most students switch companies
New York City either, leaving the industry with Why this sudden downturn in financial a number of times over the course of their
a lot fewer jobs around the country. This type industry prospects? A lot of these job cuts careers. Many organizations require individu-
of phenomenon is not isolated to the finance came in response to the subprime lending fall- als trained in forecasting, statistics, econom-
sector. In the early 2000s, the tech sector out and subsequent bank failures such as Bear ics, and finance. Even unlikely places like
experienced a similar downturn, from which it Stearns, which alone lost around 7,000 employ- museums, aquariums, and zoos need people
has subsequently largely recovered. Undoubt- ees. All of these people will be looking for new who are good at numbers. It may require some
edly, markets will bounce back and job cre- jobs in new organizations, increasing the com- creativity, but if you are committed to a career
ation in finance and securities will increase petitive level in a lot of different employment in finance, look to less obvious sources—not
again—but until that happens the atmosphere areas. For young jobseekers with relatively just the large financial firms.6

T A B L E 1 6 . 6 Top Companies: Best Investments The consensus of most economists is that through the actions
of the U.S. Treasury, and the Federal Reserve, the U.S. economy
1 Year Annual Rate %
escaped what might have been another depression equal to
Avis Budget Group $ 1,774.3 or worse than the depression of the 1930s. The recession of
Dana Holdings 1,364.9 2007–2009 lasted 18 months and was the longest recession
TRW Automotive Holdings 563.3 since the 1930s. Hundreds of banks went bankrupt during
Tenneco 501.0 2008–2009, and the Federal Deposit Insurance Corporation
closed these banks and reopened them as part of another
Rite Aid 387.1
healthy bank with no losses for the depositors. Most of the
Dillard’s 374.1 big banks have paid back their loans, but many of the smaller
Tenet Healthcare 368.7 banks still owe the Treasury money. Unemployment that
Unisys 353.6 had hit over 10.4 percent was down to 9.7 percent and the
Advanced Micro Devices 348.1 economy was growing again. Given that the stock market
is a leading indicator, it has been rising since the bottom in
Ford Motor 336.7
March 2009, and everyone—from investors to people relying
5 Years Annual Rate % (2004–2009) on pensions tied to the market—hopes we can eventually get
Apple $ 45.6 back to the 2007 high of more than 14,000 on the Dow Jones
Express Scripts 35.2 Industrial Average. Now you know why investing in the stock
Western Digital 32.4 market takes discipline, knowledge, and the willingness to
weather out economic storms. (See Figure 16.2.)
FMC Technologies 30.5
Mosaic 30.4 For investors to make sound financial decisions, it is impor-
tant that they stay in touch with business news, markets,
Flowserve 28.8
and indexes. Of course, business and investment magazines,
Precision Castparts 27.6 such as Bloomberg BusinessWeek, Fortune, and Money, offer
Google 26.3 this type of information. Many Internet sites, including the
Cameron International 25.5 CNN/Money, Business Wire, USA Today, other online news-
Monsanto 25.4 papers, and PR Newswire, offer this information as well. Many
sites offer searchable databases of information by topic, com-
10 Years Annual Rate % (1999–2009)
pany, or keyword. However investors choose to receive and
XTO Energy $ 43.0 review business news, doing so is a necessity in today’s mar-
Holly 34.2 ket. Table 16.6 provides information about total shareholder
Precision Castparts 33.0 return by company over the past 10 years. ■
World Fuel Services 31.9
DaVita 29.4
Consol Energy 29.0
Gilead Sciences 29.0
Reynolds American 28.4
Chesapeake Energy 28.0
EOG Resources 27.8
TEAM EXERCISE
Source: “Top Companies: Best Investments,” Fortune, http://money.cnn.com/ Compare and contrast financing with
magazines/fortune/fortune500/2010/performers/companies/bestinv/index.html long-term liabilities such as bonds
versus financing with owners’ equity,
typically retained earnings, common
stock, and preferred stock. Form
groups and suggest a good mix of
long-term liabilities and owners’ equity
for a new firm that makes wind tur-
bines for generating alternate energy
and would like to grow quickly.

GET ONLINE
mhhe.com/FerrellM3e
and video

notes
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CHAPTER 3 17. O’Reilly, “Global Logistics: New Tax Treaty Raises U.S. Stakes
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358 Notes
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smallbusiness/12guide.html (accessed November 18, 2009); p. S10; “Bartech Group Recognized by Eaton as Premier Sup-
www.facebook.com (accessed December 20, 2009); Kyle Aus- plier Award Winner,” Bartech Group Talent Solutions, March
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Your Business With Facebook,” The New York Times, Novem- 21, 2011).
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Huffington Post, February 7, 2011, www.huffingtonpost February 10, 2011, www.bloomberg.com/news/2011-02-10/
360 Notes
facebook-said-to-be-worth-60-billion-in-employee-offering.html 29. Harvard Business Review 60 (November–December 1982), p. 160.
(accessed March 21, 2011). 30. Kris Maher, “The Jungle,” The Wall Street Journal, May 29, 2001,
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17. Angeline Benoit and Elena Berton, “2nd UPDATE: PAI to Sell com/employment-articles/salary-after-taxes (accessed March 22,
Yoplait Stake to General Mills,” The Wall Street Journal, March 2011).
18, 2011, http://online.wsj.com/article/BT-CO-20110318- 33. Ibid.
705804.html (accessed March 21, 2011).
18. Joe Bel Bruno and Jessica Papini, “Morgan Stanley’s Gorman:
CHAPTER 7
No Bonus, but $9 Million Package,” The Wall Street Journal, 1. Mina Kimes, “What Admired Firms Don’t Have in Common,”
January 23, 2010, http://online.wsj.com/article/SB10001424 CNNMoney.com, March 6, 2009, http://money.cnn.com/2009/
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March 22, 2011). March 22, 2011).
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2001, p. 44. ness,” CNNMoney.com, February 2, 2010, http://money.cnn
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20. W. Garrison Jackson, “Multicultural Advertising,” Fortune, May
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5, 2008, p. S23.
3. “A New Future for Toms Shoes, Tweed Shire and Room to Read,”
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tric Car Company from San Carlos, California, Takes on What .com.au/2009/08/a-new-future-by-toms-shoes-tweed-shire-and-
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http://money.cnn.com/magazines/fortune/fortune500/2010/
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pp. 125–128; Johnny Cupcakes website, www.johnnycupcakes
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11. Ella Ide, “Italy Critics Trash McDonald’s Nationalist Food Bid,”
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Notes 361
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of Three Principle Operating Units,” PepsiCo Media, Novem-
CHAPTER 8
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New-Organizational-Structure-Names.html (accessed March Street Journal, April 16, 2010, p. B8; Stanley Reed & Rob-
22, 2011); “The PepsiCo Family,” PepsiCo, www.pepsico.com/ ert Tuttle, “Shell Aims for ‘New Nigeria’ as Qatari Plant Starts
Company/The-Pepsico-Family/PepsiCo-Americas-Beverages. (update 2),” Bloomberg Businessweek, March 4, 2010, www
html (accessed January 12, 2011). .businessweek.com/news/2010-03-04/shell-aims-for-new-nige-
ria-as-qatari-plant-starts-update1-.html (accessed June 9, 2010).
14. Jon R. Katzenbach and Douglas K. Smith, “The Discipline of
Teams,” Harvard Business Review 71 (March–April 1993), 19. 2. Rina Rapuano, “Check Please!,” The Washingtonian Blog, Feb-
ruary 18, 2010, www.washingtonian.com/blogarticles/restau-
15. Ibid. rants/bestbites/15008.html (accessed March 22, 2011).
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Stronger,” Inc., June 2008, p. 40; Joe Albanese, “Commo- The Free Press, 1999), pp. 86–96.
dore People,” Commodore Builders, www.commodorebuilders
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5. Bernard Wysocki, Jr., “To Fix Health Care, Hospitals Take
17. “How to Build a (Strong) Virtual Team,” CNNMoney.com,
Tips from the Factory Floor,” The Wall Street Journal, April 9,
http://money.cnn.com/2009/11/19/news/companies/ibm_
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woman-leadership-cars.html(accessed October 28, 2010); Carol www.nytimes.com/2010/07/11/business/11seattle.html?
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1, 2010, http://am.fix.blogs.cnn.com/2010/06/01/fords-green-
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12. “IFR Statistics Report Optimistic about Robotics Industry
23. Richard S. Wellins, William C. Byham, and Jeanne M. Wilson,
Growth in 2011-12,” Robotics & Automation Society, June
Empowered Teams: Creating Self-Directed Work Groups That
18, 2010, www.ieee-ras.org/news/236/IFR-Statistics-report-
Improve Quality, Productivity, and Participation (San Francisco:
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24. Matt Krumrie, “Are Meetings a Waste of Time? Survey Says
13. Gina Kolata, “Results Unproven, Robotic Surgery Wins Con-
Yes,” Minneapolis Workplace Examiner, May 12, 2009, www
verts,” The New York Times, February 13, 2010, www
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.nytimes.com/2010/02/14/health/14robot.html?pagewanted=1
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25. “Top 10 Ideas: Making the Most of Your Corporate Intranet,”
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15. Bryan Walsh, “Why Green Is the New Red, White and Blue,”
26. “Corporate America vs. Workers: Companies Do More with
Time, April 28, 2008, p. 53.
Fewer Employees,” NY Daily News, November 5, 2009, www
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362 Notes
19. John Edwards, “Orange Seeks Agent,” Inbound Logistics, Google Jobs, www.google.com/support/jobs/bin/static.py?page=
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21. Trader Joe’s website, www.traderjoes.com (accessed October 2, formance Solutions, December 10, 2008, www.super-solutions
2010); Beth Kowitt, “Inside the Secret World of Trader Joe’s- .com/CostofAbsenteeism.asp (accessed March 11, 2010).
Full Version,” Fortune, August 23, 2010, http://money.cnn 5. “Careers,” Nikebiz.com, www.nikebiz.com/careers/benefits/other/
.com/2010/08/20/news/companies/inside_trader_joes_full_ whq_campus.html (accessed February 9, 2010).
version.fortune/index.htm#joe (accessed October 1, 2010); 6. “CEO Compensation,” Forbes, April 28, 2010, www.forbes.
“2010 World’s Most Ethical Companies,” Ethisphere, 2010, com/lists/2010/12/boss-10_CEO-Compensation_Rank
http://ethisphere.com/wme2010 (accessed October 1, 2010). .html (accessed January 12, 2011).
22. Bob Daniell, John Tracy, and Simon Kaye, “Made in China: 7. Charisse Jones, “Great Work. Now Hit the Road—on Us,” USA
Perspectives on the Global Manufacturing Giant,” Inbound Today, May 12, 2010, pp. 1B–2B; V. Dion Haynes, “Washington-
Logistics, March 2008, pp. 46–49. Baltimore Benefits Survey: Part-Timers Getting More Perks,”
23. Scott McCartney, “The Big Guys Finish Last in 2010 Airline The Washington Post, June 8, 2010, www.washingtonpost.com/
Rankings,” USA Today, January 13, 2011, pp. D1, D4. wp-dyn/content/article/2010/06/07/AR2010060704513.html
24. Susan Carey, “Airlines Play Up Improvements in On-Time Per- (accessed June 10, 2010); Kim Covert, “Travel Perks One Way to
formance,” The Wall Street Journal, February 10, 2010, p. B6. Keep Employees Engaged,” The Vancouver Sun, April 27, 2010,
www.vancouversun.com/life/Travel+perks+keep+employees+
25. “Seven U.S. Organizations Honored with the 2010 Bald- engaged/2956071/story.html (accessed June 10, 2010);
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27. K.W., “The Dog Lover,” Inc., October 2010, pp. 68–70; vice Survey,” L.L. Bean News, February 21, 2008, www
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31. “Employment Opportunities,” Careers in Supply Chain Manage- sion,” Ethics Resource Center, p. 33.
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CHAPTER 9 2010.
1. Elaine Appleton Grant, “Next Health: Better Office Health 14. Geoff Colvin, “Ursula Burns launches Xerox into the future,”
Through Employee’s Diet,” FastCompany, June 2010, CNNMoney.com, April 22, 2010, http://money.cnn.com/
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(accessed July 10, 2010); www.thefullyield.com (accessed July htm (accessed October 7, 2010); Ella L. J. Edmondson Bell,
11, 2010); “The Grocery Cart: Essential in the Fight Against PhD, “Ursula Burns: Managing With Heart and Some Soul,”
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a Lifestyle of Healthier Choices,” The Boston Globe, February wit_b_498944.html (accessed June 10, 2010); Adam Bryant,
10, 2010, www.boston.com/lifestyle/food/articles/2010/02/10/ “Xerox’s New Chief Tries to Redefine Its Culture,” The New York
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2. Dan Heath and Chip Heath, “Business Advice from Van Halen,” to Be CEO for Fortune 500 Company,” nydailynews.com, May
Fast Company, March 1, 2010, www.fastcompany.com/ 23, 2009, www.nydailynews.com/money/2009/05/23/2009-
magazine/143/made-to-stick-thetelltale-brown-mampm.html 05-23_1st_black_woman_xerox_ceo.html (accessed June 14,
(accessed March 11, 2010). 2009); Jenny A. DiColo, “With Ursula Burns As CEO, Xerox Gets
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Notes 363
“An Historic Succession at Xerox,” BusinessWeek, June 8, 7. Joseph Daniel McCool, “Diversity Picture Rings Hollow,”
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aviors,” Wake Forest University Baptist Medical Center, Today, December 15, 2010, p. 1A.
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1, 2006, p. B1.
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Wage,” kvia.com, December 22, 2009, www.connectamarillo
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Year,” The Wall Street Journal, March 25, 2010, http://online Management & Strategy, June 19, 2007, http://productstrategy.
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CHAPTER 13 20. A.C. Nielsen, “Global Faces and Networked Places: A Nielsen
Report on Social Networking’s New Global Footprint,” March 2009,
1. This material in this chapter is reserved for use in the authors’
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other textbooks and teaching materials.
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2. Brad Stone and Bruce Einhorn, “Baidu China,” Bloomberg
21. “Couldn’t Stop the Spread of the Conversation in Reactions
Businessweek, November 15–21, 2010, pp. 60–67; Loretta
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tus,” The New York Times, April 15, 2010, www.nytimes
Fast Company, December 2009/January 2010, p. 77;
.com/2010/04/16/technology/16twitter.html (accessed April
Brad Stone, “Ads Posted on Facebook Strike Some as Off-
13, 2011).
Key,” The New York Times, March 3, 2010, www.nytimes
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Upcoming Location Feature,” AdvertisingAge, May 6, 2010, 59. Suzanne Vranica, “Tweeting to Sell Cars,” The Wall Street Jour-
http://adage.com/digital/article?article_id=143742 (accessed nal, November 15, 2010, p. B12.
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Mix of Tweets,” Sfgate, April 14, 2010, http://articles.sfgate ter,” Time, October 22, 2009, www.time.com/time/business/
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tweets-biz-stone (accessed April 13, 2011); “Hello World,”
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book to Submit Consumer Complaints,” Chicago Tribune, April 62. “Real Cars Drive into Second Life,” CNNMoney.com, November
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technomix/foxs-twitter-tv-overlays-tweet-their-way-epic-failure May 6, 2010).
(accessed April 13, 2011); “Twitter Snags over 100 Million
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2010, http://economictimes.indiatimes.com/infotech/internet/ ber 12, 2007, CNN.com, www.cnn.com/2007/TECH/11/12/
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New Households,” Mobile Marketer, January 30, 2009, www.
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April 13, 2011).
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book Contest,” Facebook, www.facebook.com/note.php?note_ .com/2011-03-28/tech/qr.codes.marketing_1_qr-smartphone-
id=201261566562422 (accessed April 12, 2011). users-symbian?_s=PM:TECH (accessed April 11, 2011).
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April 13, 2011); www.facebook.com/pages/Hansens- 69. Ibid., pp. 41–42.
Cakes/171578118691 (accessed April 13, 2011).
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Public to Do Good,” The New York Times, January 31, 2010, 72. Melissa Harris, “Viewpoints Network Snags Client, Enhances Its
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Conduit,” Marketing News, March 15, 2011, p. 12. plan-venture-capitalists (accessed April 13, 2011); Michael
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Networking Websites,” eBizMBA, April 2011, www.ebizmba
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2011). p. 70.
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(accessed April 11, 2011). USA Today, February 24, 2010, p. 1B; www.bloomenergy.com
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Today, January 13, 2011, pp. 1B–2B; “Details of 100 Mil- Space? Adobe Plants Fuel Cells,” The New York Times, Septem-
lion Facebook Users Published Online,” MSNBC.com, July 29, ber 28, 2010, www.usatoday.com/tech/news/2010-02-24-fuel-
2010, www.msnbc.msn.com/id/38463013/ns/technology_and_ cell_N.htm (accessed October 13, 2010).
science/?GT1=43001 (accessed July 29, 2010); Julia Angwin 7. Marie Leone, “Something Wicked This Way Comes,” CFO Mag-
and Steve Stecklow, “‘Scrapers’ Dig Deep for Data on Web,” The azine, June 2010, pp. 14–15; Sarah E. Needleman, “Busi-
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78. Quentin Hardy, “In Mark We Trust,” Forbes, October 11, Journal, March 11, 2010, http://online.wsj.com/article/SB10
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Corporate Fraud Than Regulators, Study Finds,” dallasnews,
‘Do-Not-Track’ in Browers,” The Wall Street Journal, March 31,
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3. Ibid.
Their Own Words,” Daily Finance, March 21, 2010, www.
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370 Notes
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April 26, 2011). September 20, 2010); Paul Graham, “A New Venture Ani-
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15, 2010).
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Notes 371
photo credits
FRONTMATTER CHAPTER 8
Page v: © Alex Slobodkin/iStockphoto; vi (t): © Dan Tero/iStockphoto, Pages 158–159: © Monty Rakusen/Getty Images/DAL; 162: © Alexi Boitsov/
(b): © Kadir Barcin/iStockphoto; vii: © fanelie rosier/iStockphoto; viii (t): Bloomberg via Getty Images; 163: © Jonathan Nackstrand/AFP/Getty Images;
© Joe Belanger/iStockphoto, (b): © TommL/iStockphoto; ix: © Tomislav 166: © Christof Stache/AFP/Getty Images; 168: © Susan Van Etten/PhotoEdit
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index
Advertising campaigns, 258

A Advocate Good Samaritan Hospital, 175
Abbot Laboratories Inc., 24 Aetna, 219
Abry Partners, LLC, 93 Affirmative action programs, 220
Absolute advantage, 62 Aflac, 35
Abusive behavior, 27–28 African Americans, 104, 218
Accenture, 173, 219 Age Discrimination in Employment Act, 205
Accessibility, 269 Agency, 51–52
Accessible Home Health Care, 113 Agents, 51
Accessory equipment, 245 Aggieland Credit Union, 325
Accountability, 56, 146 Agricultural economy, 15
Accountants AIG, 17
career options for, 311 Air pollution, 39
private, 291 AirTran, 175, 249
public, 290–291 Air transport, 256
Accounting. See also Financial statement analysis; Financial statements Alaska Airlines, 175, 249
bookkeeping vs., 291 Albanese, Joe, 151, 362
double-entry bookkeeping and, 294, 295 Albertson’s supermarkets, 253
explanation of, 290, 295 Alcoa, Inc., 347
external uses for, 293–294 Alcon, 98
financial crisis of 2007–2008 and, 310–311 Allergan, 339
forensic, 291 Alliances, 78–79
internal uses for, 292–293 Allstate, 278
managerial, 292 Alsop, Ronald, 353
scandals in, 17, 18 Alternative dispute resolution methods, 47–48
Accounting cycle, 296 Alternative energy, 40
Accounting equation, 295 Aluminum Company of America, 17
Accounting firms, 290, 291 Always Best Care Senior Services, 113
Accounts payable, 304, 337 Amazon.com, 11, 62, 104, 131, 152, 178, 228, 253, 268,
Accounts receivable, 301, 336, 339 270–271, 282
Accrued expenses, 304 AMC network, 260
Ace Hardware, 97–98 American Airlines, 174, 175, 249
Acer, 70 American Baby, 106
Acid rain, 39 American Bar Association, 91
Acid test, 308 American Civil Liberties Union (ACLU), 155
ACNielsen, 233, 244, 368 American Customer Satisfaction Index, 249
Acquisitions American Eagle, 344
explanation of, 98 American Express Co., 25, 42, 95, 219, 319, 344, 347
negative aspects of, 98, 101 American Indians. See Native Americans
trends in, 99 American International Group (AIG), 9, 17, 24, 92
Active Corps of Executives (ACE), 113 American Lung Association, 93
Adam Bryant, 363 American McCafe, 244
Adco Medical Supplies, Inc., 89 American Red Cross, 93
Addressability, 268 American Solar Energy Society, 34, 43
Adecco, 164 America Online, Inc. (AOL), 55, 99, 115, 285
Adkerson, Richard C., 127 Ameriprise Financial, 325
Administrative law, 46 Amos, Daniel P., 136, 137
Administrative managers, 128–129 Anago Cleaning Systems, 113
Adobe Systems, 294 Analytical skills, 130, 131
Adolph Coors, Inc., 93 Anderson, Henry R., 293
Advanced Micro Devices (AMD), 29–30, 349 Anderson, Jenny, 353
Advertisers, list of top ten, 258 Andruss, Paula, 366
Advertising Angwin, Julia, 370
career options in, 263 Anheuser-Busch, 261
explanation of, 258 Animal rights, 34
false and misleading, 30–31 Anjali Cordeiro, 365, 366
influence of, 260 Annual reports, 293
on Internet, 55 Ante, Spencer, 371
media for, 258–259 Anti-Cyber Squatting Consumer Protection Act (1999), 284
online, 259 Antitrust Improvements Act (1976), 54
publicity vs., 260 AOL, 115, 285
recruitment, 201 Aon, 325
375
Appellate court, 47 electronic, 328–330
Apple, 11, 19, 29, 42–43, 51, 70, 85, 89, 94, 104, 117, 131, financial crisis of 2007–2008 and, 329–330, 347–349
166, 194, 227, 246, 247, 255–256, 269, 270, 276, 280, function of, 323
329, 341, 344, 349 future outlook for, 330
Applications, job, 202–203 insurance for, 325
Apps, 280 investment, 327, 345
ARAMARK, 35 lending practices of, 291
Arbitration, 47–48, 216, 217 loans from, 337–339
Arbitron, 233 mutual savings, 325
Archer Daniels Midland (ADM), 95 online, 328–329
Archipelago, 346 savings and loan associations, 324
Areddy, James T., 352, 357 Bank loans, 337–339
Arthur Andersen, 17 Bank of America, 92, 99, 219, 323–324, 329, 347
Articles of partnership, 87, 88 Bank One, 99, 324
Ashland Oil, 123 Bankruptcy, 52–53
Asian Americans, 218 Bans, Lauren, 366
Asia-Pacific Economic Cooperation (APEC), 73–75 Barclays Bank, 78
Assets Barclays Wealth International, 78
current, 301, 334–336 Bardelline, Jonathan, 359
explanation of, 295 Barer, Sol J, 127
fixed, 339 Barfield, John, 360
Asset utilization ratios, 307 Barilla, 282
Association of Certified Fraud Examiners (ACFE), 310 Barksfield, Rupert, 282
Association of Privacy Professionals, 126 Barrett, Larry, 355, 370
AstraZeneca, 35 Barrett Jackson Auction Company, 35
Athlete’s Foot, 69 Barris, Mike, 367
AT&T, 26, 66, 92, 99, 121, 131, 149, 193, 194, 247, 258, 342, 347 Bartech Group, 124
Attitude, 235 Bartering, 112, 316
Audi, 259 BASF, 79
Audited statements, 293 Bassett, Abigail, 368
Austin Energy, 41 Bastien, Stephen, 364
Author’s Guild, 53 Batter Blaster, 246
Autocratic leaders, 130–131 Bauerlein, Valerie, 366
Automated clearinghouses (ACHs), 328 BBBOnline, 249
Automated teller machines (ATMs), 328 BDO Sideman, 270
Automatic Data Processing, 219 Bear Stearns, 17, 99
Automobiles. See Motor vehicles Beattie, Alan, 354
Averages, 346–347 Beaudin, Guy, 99
Avis Budget Group, 349 Bebo, 274
Avon, 42, 84, 149, 224 Behavioristic variables, 231
Behavior modification, 192
B BellSouth Corporation, 99
Benefits, employee, 213–214. See also Compensation
B. Braun Medical, Inc., 24 Benjamin Moore & Co., 269, 270
Babcock, Pamela, 365 Ben & Jerry’s, 17, 77
Babies ‘R’ Us, 106 Bennett, Drake, 368
Baby boomers, 114 Bennett, Julie, 356
Back, Aaron, 368 Bennett, N. Kane, 358
Backaler, Joel, 356 Benoit, Angeline, 361
Badenhausen, Kurt, 364 Berfield, Susan, 366
Baidu, 267–268, 285–286 Berkman, Leslie, 367
Baird, Kurtz & Dodson (BKD), 89 Berkshire Hathaway, 91, 92, 131
Baker, Bill, 46 Bernoff, Josh, 281, 368–370
Baker, Marcia, 46 Berry, Leonard L., 362
Balance of payments, 65 Berton, Elena, 361
Balance of trade, 64–65 Best Buy, 5, 35, 37, 107, 175, 256, 270, 279
Balance sheets Better Business Bureau (BBB), 284
assets on, 301 Betty Crocker, 232
examples of, 302, 303 Bezos, Jeff, 131, 152, 368
explanation of, 301 Bianco, Anthony, 353
liabilities on, 301, 304 Bieber, Justin, 246
owners’ equity on, 304 Big Boy, 69
Baldwin, Clare, 358 Big Society Bank, 110
Banking/banking institutions Bikram Yoga, 106
career options in, 330 Bing, 279
commercial, 323–324 Bing-Twitter, 279
credit unions, 324–325 Bio-plastics, 39
376 index
Bitner, Mary Jo, 362 green, 19, 34–35, 43
Blakely, Lindsay, 359 people and activities of, 5
Blankfein, Lloyd, 131 reasons to study, 7
Block, Sandra, 353 scandals in, 17–18
Blogs, 274–275 Business analysis, 243
Bloom Energy, 294 Business.com, 96
Bloomingdales, 319 Business ethics. See also Ethical issues; Ethics; Social responsibility
Blue Cross Blue Shield of Florida, 219 decision making related to, 31
Bluewolf, Inc., 188 explanation of, 24
Bly, Laura, 356 legislation related to, 24, 33, 37
BMW, 251 making improvements in, 31–34
Board of directors, 93–94 recognizing issues in, 26–31
Bob’s Red Mill, 96 role of, 25–26
Body language, 69 Business law. See also Legal environment; Legislation/regulations
Boeing, 27, 28, 95, 153, 185, 275, 347 affecting business practices, 53, 54, 56–58
Bold, Ben, 368 affecting Internet, 55
Bolthouse Farms, 255 bankruptcy law, 52–53
Bonasia, J., 356 contract law, 50–51
Bonds, 341–342 courts and, 47–48
Bonus Building Care, 113 dispute resolution and, 47–48
Bonuses, 212. See also Compensation explanation of, 46
Bookkeeping, 291 law of agency, 51–52
Boston Consulting Group, 196 law of torts and fraud, 50
Bourne, Joel K., Jr., 354, 360 property law, 52
Bowling Green State University, 280 regulatory administrative agencies and, 48–49
Boycotts, 216 sources of, 46
Boyd, Danah M., 368 Business ownership
Brand mark, 247 cooperative as form of, 97–98
Brands/branding, 247–248 corporation as form of, 90–97
Brant, John, 359 for entrepreneurs, 100, 111
Brat, Ilan, 357, 359 joint venture as form of, 97
Breach of contract, 51 limited liability company as form of, 97
Breeding, John, 243 partnership form of, 87–90
Brennan, Joe, 357 S corporation as form of, 97
Bribes, 28, 29 sole proprietorship form of, 84–87
Brin, Sergey, 88, 104 trends in, 98–101
Brinton, William F., 354 Business plans, 111
British Airways, 146 Business products. See also Products
British Petroleum (BP), 17, 32, 79, 122, 304 explanation of, 244, 245
Brokerage firms, 327 supply chain management and, 255
Brown, Gordon, 354 Business Software Alliance, 286
Brown, Paul, 360 BusinessWeek, 188, 337, 349
Brown, Susan, 106 Business Wire, 349
Brozyna, Christine, 359 Bustillo, Miguel, 361, 368
Bruno, Joe Bel, 361 Buying, 224–225
Bryant, Adam, 363 Buying behavior
Buchanan, Leigh, 360, 362 explanation of, 235
Budget, 292 insights into, 237
Budget deficit, 14 psychological variables of, 235
Buffett, Warren, 131, 358 social variables of, 236–237
Bullying, 28, 29 Buzz marketing, 260–261
Bureau of Consumer Protection, 37–38 Byham, William C., 362
Bureau of Labor Statistics, 13 Byrnes, Nanette, 364
Burger King, 98, 164, 277 Byron, Ellen, 356
Burgerville, 203
Burlingham, Bo, 361
Burns, Ursula, 192, 363, 364
C
Burrows, Peter, 366 Cablevision, 7
Business. See also International business; Small businesses Cadbury, 99
careers in, 19 Cadbury, Sir Adrian, 354
digital media use for, 270–271 Caldwell, James C., 293
economic foundations of, 7–15 Callahan, David, 25, 191, 353
ethics and social responsibility in, 17–19 (See also Business ethics; Calogera, Stephen, 362
Ethical issues) Calvey, Mark, 355
explanation of, 4 Camden Property Trust, 196
free-enterprise system and, 10, 17 Cameron International, 349
goal of, 4–5 Camia, Catalina, 353
index 377
Campbell Soup Co., 5–6, 42, 121, 140, 145–146, 159, 344–345 Chappell, Bill, 366
Camusio, Zeke, 368 Charles Schwab Corp., 166, 270, 327, 346
Canada, 71–73 Chartering the corporation, 91
CAN-SPAM Act of 2004, 55 Chase Manhattan Bank, 324
Capacity, 165–166 Chávez, Hugo, 9, 69
Capell, Kerry, 359 Chazan, Guy, 362
Capital budgeting, 339–340 Check clearing, 323
Capitalism, 9 Checking accounts, 318, 319
Capital One, 219 Chenault, Kenneth I., 95
Card Accountability Responsibility and Disclosure Act of 2009, Chesapeake Energy, 127, 349
319–320 Chevrolet, 4, 169, 248
Cardinal Health, 92 Chevron Corp., 40, 79, 92, 347
CareerBuilder.com, 193, 202 Chicago Bulls, 252, 273
Career options Chicago Cubs, 28
in accounting, 311 Chicago Stock Exchange, 346
in business ethics and social responsibility, 19, 43 Chief executive officer (CEO), 93–94, 126, 127, 185
in digital marketing, 287 Chief financial officer (CFO), 126
in financial management or securities, 348 Chief operations officer (COO), 126
in financial systems or banking, 330 Chief privacy officer (CPO), 126
in global business, 80 Child care facilities, 37
in human resource management, 195, 220 Children’s Online Privacy Protection Act (2000), 54, 55, 284
in management, 137 China
in managing organizational culture, 155 economic reform in, 73–74
in marketing, 239, 263 film industry in, 78
in operations management, 178 intellectual property issues and, 67, 285–286
in small businesses, 116 pollution in, 74, 238
Carey, Susan, 363 private businesses in, 103
Cargill, 91, 120 trade deficit with, 64
Caring Transitions, 113 China Mobile, 247
Carl’s Jr., 98 China National Petroleum, 79
Carnegie, Andrew, 17 Chiquita, 41
Carrefour, 78, 253 Chmielewski, Dawn C., 369
Carrie Sloan, 365 Choudhury, Bikram, 106
Carroll, A.B., 34 Chouinard, Yvon, 12
Carroll, Archie B., 353, 354, 363 Christie, Rebecca, 357
Cartels, 68, 69 Chrysler, 52, 92, 209, 260, 336
Carter, Majora, 41, 355 Chu, Kathy, 357
Cartridge World, 77 CIBERS (Centers for International Business Education and
Carty, Sharon Silk, 358 Research), 80
Casacchia, Chris, 365 Circuit City, 52
Casey, Nicholas, 356 Cirque du Soleil, 87
Cash flow Cirrus, 328
explanation of, 292, 293 Cisco Systems, 17, 57, 115, 219, 347
management of, 334–335 CitiBank, 329
statement of, 304–306 Citigroup, 9, 25, 92, 131, 136, 291, 324
Castro, Fidel, 9 City of Boston, 182
Castro, Raul, 9 Civil law, 46
Catan, Thomas, 353 Civil Rights Act of 1964, Title VII, 205
Caterpillar, 35, 146, 347 CKE Restaurants, 98
Catherine Rampell, 364 Clarke, Liz, 352
Cauchon, Dennis, 364 Clarkston Consulting, 208–209
CBS, 105 Classical theory of motivation, 184–185
C corporations, 91 Classroom training, 206–207
Celestial Seasonings, 121, 142–143 Clayton Act (1914), 53, 54
Celgene, 127 CleanNet USA, Inc., 113
Celler-Kauver Act (1950), 54 Cleveland Federal Reserve Bank, 320
Center for American Progress, 169 Clifford, Stephanie, 361
Centralized organization, 147 Climate change, 34, 39, 238
Century 21, 207 Clorox Green Works, 249
Certificates of deposit (CDs), 318–319 CNN, 61, 280
Certified management accountants (CMAs), 291 CNN/Money, 92, 115, 206, 349
Certified public accountants (CPAs), 290 Coach, Inc., 75, 136
Chafkin, Max, 358, 365, 370 Coalition for Environmentally Responsible Economies (CERES), 38
Chang, Bao, 356 Coca-Cola Company, 42, 52, 61, 69, 76, 80, 88, 131, 146, 219,
Chao, Loretta, 368 242–243, 247, 249, 251, 347
Chapman, Cameron, 368 Codes of ethics, 32–33. See also Business ethics; Ethical issues
378 index
Cohn, D’Vera, 360 Consideration, 51
Coldwell Bank, 326 Consol Energy, 349
Colgate-Palmolive Co., 79, 127, 219, 228, 245 Constitution, U.S., 46
Collateral, 112 Construction Industry Ethics and Compliance Initiative, 33
Collective bargaining, 214, 215 Consumer Financial Protection Bureau (CFPB), 58, 329, 330
Colorado Rockies, 141 Consumer Goods Pricing Act (1975), 54
Columbia University, 140 Consumerism, 37–38
Colvin, Geoff, 363, 364 Consumer products. See also Products
Comcast Corporation, 99 explanation of, 244
Comerica, 219 supply chain management and, 254–255
Commercial banks, 323–324 Consumer Product Safety Commission (CPSC), 48, 49
Commercial certificates of deposit (CDs), 225 Consumer relations, 37–38
Commercialization, 244 ConsumerReports.org, 249
Commercial paper, 335 Consumers
Commission, 210–212. See also Compensation buying behavior of, 235–237
Committees, 152 right to be informed, 37
Commodore Builders, 151 use of digital media to reach, 280–282
Common law, 46 Continental, 175, 231, 249
Common stock, 94–95 Contingency plans, 122–123
Common Threads, 12 Contract law, 50–51
Communication. See also Digital marketing; Digital media; Information Contract manufacturing, 77
technology (IT) Contracts, 50, 51
diagonal, 154 Contractual capacity, 51
downward, 154 Control, 269–270
electronic, 155 Controlling, 124–125
ethical issues related to, 30–31 Controlling the Assault of Non-Solicited Pornography and Marketing Act
formal, 153–154 (CAN-SPAM), 284
horizontal, 154 Convenience products, 245
informal channels of, 154–155 Converse Inc., 122
marketing strategy and, 228–229 Cooper, Petra, 111
monitoring, 155 Cooperatives (co-ops), 97–98
in organizations, 153–155 Coors, 170
upward, 154 Copeland, Michael V., 368
Communism, 8–9 Copyrights, 52, 55, 67. See also Intellectual property
Community relations, 42–43 Corcoran, Barbara, 10
Compaq, 341 Cordarounds.com, 164
Comparative advantage, 63 Cordeiro, Anjali, 365, 366
Compensation Cordoba, Jose De, 356
benefits as, 213–214 Core Commerce, 114
for chief executive officers, 126, 127, 185 Corporate charter, 91
financial, 211–213 Corporate citizenship, 34
for managers, 137 Corporate culture. See Organizational culture
overview of, 211 Corporate raiders, 98
performance and, 185 Corporations
for women, 205–206 advantages of, 95–96
Competition creation of, 91
ethical issues related to, 29 disadvantages of, 96–97
explanation of, 11 elements of, 93–95
monopolistic, 11 explanation of, 84, 85, 90–91
nature of, 11–12 lists of largest, 79, 92
pure, 11 S corporations, 84, 91, 97
Component parts, 245 types of, 91–93
Compressed workweek, 194 Corpus Christi, City of, 145, 150
Com-Psych Corporation, 203 Corruption Perceptions Index, 29
Compulsory arbitration, 216 Costco, 211, 251
Computer-assisted design (CAD), 167 Costello, Carol, 362
Computer-assisted manufacturing (CAM), 167 Cost of goods sold, 298
Computer-integrated manufacturing (CIM), 168 Cost-of-living escalator clause (COLA), 215
Computer Matching and Privacy Protection Act (1988), 284 Council of Better Business Bureaus, 284
Computer Security Act (1987), 284 Counterfeit money, 317–318
Compuware Gomez, 176 Countertrade agreements, 74, 75
Conceptual skills, 130, 131 Countrywide Financial, 24, 25, 52, 99, 324
Conciliation, 216, 217 Coupon Mom, 261
Conflict of interest, 28–29, 32 Coupons, 261
Connectivity, 269 Court system, 47, 48
ConocoPhillips, 92 Covert, Kim, 363
index 379
CowPots, 111 Debt to total assets ratio, 308
Cox, Taylor H., Jr., 365 Debt utilization ratios, 308
Cox Communications, 219 DeCarlo, Scott, 358
Cravens, David W., 360 Decentralized organization, 147–148
Cray, 255 Decision making
Crayola, 229 about ethical issues, 31
Credit CARD (Card Accountability Responsibility and Disclosure) managerial, 129, 133
Act of 2009, 319–320 in partnerships, 89
Credit cards, 318–320 steps in, 133–135
Credit controls, 323 Deener, Will, 370
Credit ratings, 338 Deepwater Horizon Oil Spill Trust, 32
Credit unions, 324–325 Deflation, 13
Crisis management plans, 122–123 Delancey Street Foundation, 110
Croak, Robert, 246 DeLay, Tom, 26
Crockett, Roger O., 364 Delegation of authority, 146–147
Crosby, Philip B., 363 Dell, Kristina, 354
Crowdsourcing, 282 Dell, Michael, 104
crowdspring.com, 282 Dell Computers, 17, 29, 42–43, 70, 85, 104, 110, 165, 167–168,
Cuba, 67–69 226, 242, 341
Cuizon, Gwendolyn, 366 Deloitte, 219
Culp, H. Lawrence, Jr., 127, 185 Deloitte & Touche, 30, 290
Cultural diversity. See also Diversity; Workforce diversity Deloitte Touche Tohmatsu, 290
benefits of, 219–220 Delta Airlines, 99, 146, 174, 175, 231, 249
ethics and, 27 Delta Marine Industries, 165
international business and, 69 Demand, 10
Culture, 237. See also Organizational culture Demand curve, 10
Cummins, 219 Demand deposit, 318
Currency. See Money Democratic leaders, 130
Current assets Democratic Republic of the Congo, 69
explanation of, 301 Demographics, 231
management of, 334–336 Demographic trends, 114–115
Current liabilities Demos, Telis, 360
explanation of, 301, 304 Departmentalization
management of, 337–339 customer, 146
Current ratio, 307–308 explanation of, 143–144
Customer departmentalization, 146 functional, 144–145
Customer relations, 228–229 geographical, 146
Customer service, 120 product, 145–146
Customization, 165 Department of Commerce, U.S., 17, 80
Cutler, Kim-Mai, 371 Department of Energy, U.S., 41
Cybersquatters, 55 Department of Justice, U.S., 25, 53, 284
Cyworld, 274 Department of Labor, Bureau of Labor Statistics, U.S.,
206, 214
Depository insurance, 323
D Depreciation, 298, 299
Depression, 14
Daewoo, 73 Deutsche Post, 9
Dalhousie University, 121 Devaluation, 66
Danaher Corporation, 127, 185 DHB Industries, 94
Dana Holdings, 349 Diagonal communication, 154
Dancing Bull, 224 Dick’s Sporting Goods, 343
Daniell, Bob, 363 DiColo, Jenny A., 364
Daniels, Bill, 7, 352 DigiSynd, 278
Daniels College of Business, 7 Digital Artists Agency (DAA), 86
Danone, 182 Digital economy, 16
Data, 233–234 Digital marketing. See also Internet
Davey, Monica, 354 career options in, 287
Davis Polk & Wardwell LLP, 88 explanation of, 268
DaVita, 349 growth and benefits of, 268–269
Day care, 37 identity theft and, 284–285
Dean, Cornelia, 354 intellectual property and, 285–286
Dean Witter Reynolds, 326 privacy and, 283–284
Deardorff, Julie, 367 Digital media. See also Internet
De Beers, 251 blogs and wikis, 274–275
De Beers Consolidated Mines, Ltd., 62 business uses of, 270–271
Debit cards, 320 control of employee use of, 271
Debt financing, 111–112 explanation of, 268
380 index
function of, 268–270 Doug Stewart, 364
gathering consumer information with, 282–283 Dow Chemical Co., 140
marketing impact of, 286 Dow Corning Corporation, 35
marketing mix and, 271, 273–274 Dow Jones, 97
mobile marketing and, 280 Dow Jones Industrial Average, 347–348
photo sharing, 276 Downsizing, 123–124
podcasting, 276–277 Downward communication, 154
reaching consumers through, 280–282 Doyle, Alison, 369
social networks, 277–279 Doyle, Mona, 367
video sharing, 275–276 Dr Pepper, 17
virtual worlds, 279–287 Dreamworks Animation SKG, 196
Digital Millennium Copyright Act (DMCA) (1996), 54, 284 Drug testing, 204
Dillard’s, 349 Dugas, Christine, 367
Dinner: Impossible, 205 Duke, Mike, 131
Directing, 124 Dumaine, Brian, 371
Direct investment, 79 Dumping, 68, 69
Dirty Jobs, 189 Duncan, Geoff, 355
Discount prices, 252 Dunkin’ Donuts, 112, 275
Discount rate, 322 DuPont, 40–41, 347
Discover Card, 319, 326 Durban Amendment, 58
Discrimination, 205–206 Durbin, Dick, 355
Disney, 344–345 Dyan Machan, 365
Disneyland/DisneyWorld, 140 Dyson, 11
Dispute resolution Dyson, James, 105–106
methods of, 47–48
for unionized employees, 215–216
Distribution
E
digital marketing and, 271, 273 Eaglesham, Jean, 355
exclusive, 256 Earle, John, 147
explanation of, 232, 233 Earnings per share, 308–309
intensive, 255–256 Easter Seals, 42
marketing channels and, 252–255 Eastman Kodak, 51, 98
marketing strategy and, 257 Eaton, 124
physical, 256–257 Eaton, Kit, 369
selective, 256 Eaton, Leslie, 366
Distribution managers, 263 eBay, 80, 85, 95, 116, 162, 268, 278, 294, 337
Diversified firms, 326 Economic contraction, 12–13
Diversity. See also Cultural diversity; Workforce diversity Economic development, 66
affirmative action and, 220 Economic expansion, 12
benefits of, 219–220 Economic order quantity (EOQ) model, 170, 171
characteristics of, 217 Economics, 8
explanation of, 217 Economic systems
importance of, 126–127, 216–217 capitalism as, 9
international business and, 69 communism as, 8–9
population data and, 217–219 comparison of, 8
recruiting for, 127 explanation of, 8
top companies for, 219 mixed, 9
workforce, 216–220 socialism as, 9
Diversity, Inc., 218, 219 Economy
Diversity Pipeline Alliance, 5 agricultural, 15
Dividends, 91, 94, 301 digital, 16
Dividends per share, 309 evaluation of, 15
Dividend yield, 345 history of U.S., 15–16
Dizik, Alina, 361 international comparisons of, 15
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010), manufacturing, 16
24, 33, 54, 57, 58 marketing, 16
Doherty, Dermot, 359 measurement of, 14–15
Dolan, Matthew, 354 role of entrepreneur in, 17
Dollar General Stores, 92 role of government in, 17
Dollar Tree, Inc., 237 role of small business in, 104–106, 115–116
Domino’s Pizza, 50 service, 16
Dooren, Jennifer Corbett, 353 Eddie Bauer, 52
Dorney, Maureen, 355 Edison, Thomas, 17
Dorsey, Jack, 115 Edward Jones, 327
DOT Air Travel Consumer Report, 175 Edwards, John, 327, 363
Double-entry bookkeeping, 294, 295 Einhorn, Bruce, 368, 370
Douglas McGregor, 363 Electrolux, 69
index 381
Electronic Communications Privacy Act (1986), 284 response to, 40–42, 238
Electronic funds transfer (EFT), 328 as social responsibility, 34, 38–40
Eli Lilly, 193 Environmental protection, 37–38
Elks Clubs, 93 Environmental Protection Agency (EPA), 39, 48, 49, 116, 169
Elliot, Stuart, 369 EOG Resources, 349
Elliott, Hannah, 366 Equal Employment Opportunity Commission (EEOC), 48, 205
Ellis, David, 371 Equal opportunity, 37
Ellis, Sean, 371 Equal Pay Act, 205
Ellison, Lawrence J., 126, 127 Equifax, 338
Ellison, Nicole B., 368 Equilibrium price, 11
Elmore, Rico, 108 Equity financing, 111
El Nasser, Haya, 352 Equity theory, 191
Embargo, 68 Erickson, Kjerstin, 326
Employee assistance programs (EAPs), 213 Ernst & Young, 19, 219, 290
Employees. See also Workforce Erupt-a-Cake, 153
flexible scheduling for, 37 Estée Lauder, 226
misuse of company resources by, 27, 30 Esteem needs, 186–187
morale of, 183 Esterl, Mike, 365
motivation of, 182–183, 191–196 (See also Motivation; Motivation Ethical issues. See also Business ethics; Social responsibility
strategies; Motivation theories) abusive and intimidating behavior as, 27–28
older, 205 in business, 17–18, 25–26
recruitment and selection of, 201–206 in business relationships, 31
responsibilities of, 5 in communications, 30–31
retention of, 184 conflict of interest as, 28–29, 32
social responsibility toward, 37 decision making about, 31
substance abuse by, 204 explanation of, 26
turnover of, 208–210 fairness and honesty as, 29–30
work-at-home, 212 in international business, 66–67
Employee stock ownership plans (ESOPs), 96, 97, 212–213 making improvements to avoid, 31–33, 56–58
Employee testing misuse of company resources as, 27, 30
discriminatory, 205 plagiarism as, 31
explanation of, 203–204 recognition of, 26–27
Emporio Armani, 64 Ethics. See also Business ethics; Social responsibility
Encyclopedia Britannica, 275 codes of, 32–33
Endo, Nobuhiro, 78 decision making related to, 31
Energizer Bunny, 258 legislation related to, 24, 33, 37
Energy Star, 238 personal, 24, 32
Engardio, Pete, 357 recognizing issues in, 26–31
Engel & Völkers, 77 role of, 25–26
Enron, 17–18, 24, 291, 310 Ethics officers, 33, 43
Entrepreneur, 113 Ethics programs, 33, 43
Entrepreneurs Ethics Resource Center, 27, 191
career options for, 116 Ethisphere, 171
digital media use by, 287 Ethisphere Institute, 35
explanation of, 17 Etter, Lauren, 354
microlending to, 89 Eukanuba, 235
role of, 17 Eurocopter, 72
social, 110 Eurodollar market, 335–336
traits of, 108 European Financial Stability Facility (EFSF), 73
Entrepreneurship. See also Small businesses European Union Directive (1998), 284
advantages of, 107–108 European Union (EU), 68, 73, 75
approaches to starting, 110–114 Euro zone, 73
disadvantages of, 108–110 Evangelista, Benny, 369
explanation of, 104 Evans, Heidi, 364
future outlook for, 114–116 Ewalt, David M., 358
mobile food trucks as, 16 Exchange controls, 68
role in U.S. economy, 104–106 Exchange rates, 66
trends in, 103 Exchange relationship, 224
Environmental issues. See also Green businesses; Sustainability Exclusive distribution, 256
alternative energy and, 40 Expectancy theory, 191
animal rights as, 34 Expedia.com, 273
careers related to, 43 Expenses, 298–299
community relations and, 42–43 Experian, 338
marketing strategies and, 238 Export agent, 76
pollution as, 39–40, 238 Exporting. See also Trade; Trade barriers
recycling and, 40–42 explanation of, 63–64
related to product production and distribution, 5 getting involved in, 75–76
382 index
Express Scripts, 349 Financial crisis of 2007–2008, 310–311, 329–330, 335, 338,
Express warranty, 49 347–349. See also Great Recession of 2007–2009
Extrinsic reward, 183–184 Financial Executives International, 57
ExxonMobil, 79, 92, 96, 347 Financial management
career options in, 348
F of current assets, 334–336
of current liabilities, 337–339
Facebook, 16, 80, 107, 114, 126, 159, 164, 232, 234, 246, 266, financing with long-term liabilities and, 342–343
268–269, 272–274, 277–278, 281–285, 287 financing with owners’ equity as, 343–345
FAC Food Service Logistics, 170 of fixed assets, 339–341
Facilities function of, 333
layout of, 167 investment banking and, 345
location of, 166–167 Financial managers, 128
technology and, 167–168 Financial resources, 111
Factor, 339 Financial Stability Oversight Council, 58
Factories, 16 Financial statement analysis
Fairlamb, David, 357 asset utilization ratios and, 307
Fairness, 29–30 debt utilization ratios and, 308
Fair Packaging and Labeling Act (1966), 54 explanation of, 306
Faith Keenan, 366 industry analysis and, 309–310
Family Dollar, 237 liquidity ratios and, 307–308
Family roles, 69–70 per share data and, 308–309
Fannie Mae, 92, 325 profitability ratios and, 306–307
FARELOGIX, 280 Financial statements. See also Accounting
Fatheadz, 108 balance sheet and, 301–304
Federal Aviation Administration (FAA), 48 explanation of, 293, 296
Federal Bureau of Investigation (FBI), 30, 291, 328 income statement and, 298–301
Federal Communications Commission (FCC), 48 statement of cash flow and, 304–306
Federal Deposit Insurance Corporation (FDIC), 285, 325, users of, 293–294
330, 349 Financial system
Federal Energy Regulatory Commission (FERC), 48 banking institutions and, 323–325
Federal Highway Administration (FHA), 48 electronic banking and, 328–329
Federal Reserve Banks, 317, 320–323, 329, 330, 348, 349 Federal Reserve System and, 320–323
Federal Reserve Board (Fed), 17, 315, 320, 330 financial crisis of 2007–2008 and, 329–330, 335
Federal Reserve System legislation related to, 56–58
check clearing and, 323 money in, 316–320
depository insurance and, 323 nonbanking institutions and, 325–328
explanation of, 320 The Financial Times, 342
financial crisis of 2007–2008 and, 322, 329, 330, 349 Financing
monetary policy of, 320–323 debt, 111–112
regulatory functions of, 323 equity, 111
Federal Savings and Loan Insurance Corporation (FSLIC), 325 explanation of, 225
Federal Sentencing Guidelines for Organizations (FSGO), 56 Finnigan, Annie, 361
Federal Trade Commission Act (1914), 9, 54 First Chicago Corp., 324
Federal Trade Commission (FTC), 9, 29, 30, 37–38, 48–49, 257, First-line managers, 125, 127–128
279, 283–285 Firtel, 89
consumer protections and, 37–38 Fixed assets, 339
creation of, 9 Fixed-position layout, 166, 167
Intel and, 29–30 FlexFuel, 169
privacy issues and, 284 Flexibility, 108
responsibilities of, 48–49 Flexible manufacturing, 168
Federal Trademark Dilution Act (1995), 54, 55 Flexible scheduling, 37, 193–194
FedEx, 17, 163, 242 Flextime, 37, 193
Females. See Women Flickr, 4, 276
Ferrell, Linda, 57, 352–354, 358, 359 Floating-rate bonds, 342
Ferrell, O. C., 29, 57, 152, 253, 254, 352–354, 358, 359, Flowserve, 349
363, 365 FMC Technologies, 349
Fiat money, 316 Food and Drug Administration (FDA), 31, 48, 49
Fidelity Investments, 163 Food Network, 16, 136, 204–205
Field, Abigail, 370 Food trucks, 16
Field, Anthony, 352 Forbes, 92, 127, 195, 250
Fifth Town Artisan Cheese, 111 Ford, Henry, 16–17, 143
Finance Ford Motor Company, 35, 37, 79, 89, 91, 92, 117, 120, 128, 143, 149,
career options in, 330 151, 163, 219, 224, 229, 236, 248, 274, 278, 336, 344, 349
explanation of, 6–7 Forensic accounting, 291
Finance companies, 327 Forest, Stephanie Anderson, 343
Financial Accounting Standards Board, 290 The Forest Trust, 272
index 383
Formal communication, 153–154 Gerdes, Lindsey, 353
Forrester Research, 281 Gertz, Emily, 352
Fortune, 42, 77, 92, 129, 131, 195, 202, 270, 275, 325, 337 Ghassemi, Adam, 364
Fortune 500 companies, 40, 42, 77, 192, 195, 202, 211, 270, Gifts, 27
275, 278, 294, 337, 343, 349 Gilbreth, Frank, 184–185
Fowler, Geoffrey A., 352, 368 Gilbreth, Lillian, 184–185
Fraedrich, John, 57, 353, 354, 358, 359 Gilead Sciences, 127, 349
France, Brian, 5, 92 Gillette, 26, 248
France, William, 92 Giorgio Armani, 64
Franchisees, 69, 76–77, 112–113, 122 Givebacks, 215
Franchisers, 77, 112 Glasser, Josh, 355
Franchising Glaxo Wellcome Plc., 99
advantages and disadvantages of, 113 Glee, 27
explanation of, 76–77, 112–113 The Global Fund, 43
list of top, 77 Globalization. See also International business; Trade
Fraud, 50, 56, 285, 310 challenges related to, 80
Frazier, Mya, 366, 370 property rights and, 52
Freddie Mac, 92, 325 strategy for, 79–80
Fred L. Turner Training Center, 207 Global strategy, 79–80
Fredrix, Emily, 367 Global warming, 34, 39, 238
Free-enterprise system, 10, 17. See also Capitalism Goals, 121
Free-market system, 9 Gogoi, Pallavi, 361
Freeport Copper, 127 Gold, Russell, 354, 359
Free-rein leaders, 130 Goldman, David, 353
Freescale, 29 Goldman, Seth, 88
Freese and Nichols, Inc., 107, 175 Goldman Sachs, 131, 327, 342, 345
French, Clarissa, 358 Gold Violin, 114
Freund, Ben, 111 Goods, tangible, 162–163
Freund, Matthew, 111 Google, 17, 19, 35, 53, 55, 80, 85, 104, 128, 131, 147, 164, 183,
Friends of TOMS, 141 196, 213, 240, 247, 250, 258, 260, 267–268, 276–277,
Friendster, 281 284, 286, 329, 337, 345, 349
Fringe, 27 Gorman, James P., 126
Frito-Lay, 124, 146, 226 Gosier, Jon, 326
The Full Yield, 182 Goudreau, Jenna, 362
Functional departmentalization, 144–145 Government
Futterman, Matthew, 365 organizational structure in, 142
regulation of business, 85–86, 89
G role in economy, 17
Goya Foods, 236
Galante, Joseph, 366 Graduate Management Admission Council, 210
Galeries Lafayette, 226 Graham, Jefferson, 369
Galvin, John, 354 Graham, Paul, 337, 371
The Gap, 35, 43, 233 Grameen, 110
Garlick, Saul, 326, 371 Granite Construction, 33
Gates, Bill, 17, 104 Grant, Elaine Appleton, 363
Gatewood, Robert, 152 Grapevine, 154–155
Gatorade, 26 Great Recession of 2007–2009, 14, 19, 188, 261, 292, 322,
Gauthier, Daniel, 87 338, 349. See also Financial crisis of 2007–2008
GE Capital, 326 Greece, 73, 310–311
Geek Squad, 107, 175 Green, Jeff, 367
Gender. See Women Green businesses, 19, 34–35, 43. See also Environmental issues;
General Agreement on Tariffs and Trade (GATT), 70–71 Sustainability
General Electric Capital, 326, 342 Green Car Vision Award, 243
General Electric (GE), 35, 90–92, 117, 120–121, 131, 132, 147, GreenChoice, 41
216, 227, 247, 325–326, 347 Greenhouse gases, 74, 238. See also Global warming; Pollution
General Foods, 193 Greenpeace, 272
General Mills, 35, 91, 126, 127, 219, 257 Green products, 34, 257
General Motors (GM), 9, 64, 92, 124, 128, 146, 159, 169, 247, 258, Greenwashing, 41, 257
276, 279, 326, 336 Greer, Peter, 358
Generation Y, 114 Gross, Doug, 352
Generic products, 248 Gross, Grant, 355
GeniusRocket.com, 269 Gross domestic product (GDP), 14
Gentle Giant Movers, 120 Gross income or profit, 298
Geographical departmentalization, 146 Grossman, Anna Jane, 365
Geographic variables, 231 Groups, 151–152. See also Teams
George, Jennifer M., 129 Grover, Ronald, 358
384 index
Guess, Inc., 75 Hookway, James, 357
Guitar Syndicate, Inc., 114 Hoover, Kent, 358
Gulf Oil, 17 Horizontal communication, 154
Gulfstream, 72 Horovitz, Bruce, 352, 354, 356, 365–369
Gunther, Marc, 371 Hostile takeover, 98–99, 101
Guynn, Jessica, 366 Household International, 334
Gwendolyn Cuizon, 366 Housing bubble, 347–348
Howarth, Brad, 367
H H&R Block, 279, 325
HSBC Finance Corporation, 334
H. J. Heinz, 123 HSBC–North America, 219
Habitat for Humanity, 161 Huang, Jen-Hsun, 127
Haiti, 69 Huffington, Arianna, 115, 360
Hamburger University, 207 Huffington Post, 115
Hampton Inn, 225 Hult, M., 360
Handshake deal, 50 Hulu, 270, 275
Hansen Cakes, 278 Human relations
Hardees, 98 explanation of, 182
Hardy, Quentin, 370 nature of, 182–184
Harley-Davidson, 171, 344 skills in, 132
Harrington, Jeff, 354 Human resources management (HRM)
Harris, Andrew, 99 career options in, 195, 220
Harris, Gardiner, 354 compensation function of, 211–214
Harris, Melissa, 370 explanation of, 128, 200
Hart, Jay, 358 planning strategies for, 200–201
Hartline, Michael D., 363 recruiting function of, 201–202, 205–206
Harvard Law School, 280, 329 selection function of, 202–206
Hawthorne studies, 185–186 unionized employees and, 214–216
Hawthorne Works Plant, 185–186 workforce development function of, 206–210
Haynes, Judie, 70 workforce diversity and, 216–220
Haynes, V. Dion, 363 Hummer SUVs, 247
Health Care Service Corp., 219 Humphreys, Jeffrey M., 230
Health Source Chiropractic and Progressive Rehab, 113 Hunsinger, Dana, 359
Heath, Chip, 363 Hutton, Keith A, 127
Heath, Dan, 363 Hyatt Hotels, 163, 193
Heath, Nick, 357 Hygiene factors (Herzberg), 187–188
Heathfield, Susan M., 130, 184, 185 Hyman, Mike, 370
Hebrew National, 260 Hyundai, 70, 248
Heinz Ketchup, 46, 75 Hyves, 274
Hellmich, Nanci, 360
Herrin, Jessica, 84
Hershey, Milton, 17
I
Hershey Company, 17, 134 Iams, 235
Hershey Foods, 177 IBM, 29, 79, 117, 127, 131, 140, 147, 167, 171, 173, 193, 219,
Herzberg, Frederick, 187–188, 192, 200, 211 247–248, 255, 275, 340, 345, 347
Hewlett-Packard (HP), 35, 70, 85, 92, 131, 160, 171, 231, 341, 347 Ide, Ella, 362
High technology, 107 Ideas
Hilton Hotels, 280 development of, 243
Hispanics explanation of, 231
population data for, 114, 218 screening new, 243–244
as small-business owners, 104 Identity theft, 284–285
Hisrich, Robert D., 359 Ihlwan, Moon, 366
Hodges, Jane, 361 IKEA, 35, 253
Hoffman, Dan, 140 Implied warranty, 49–50
Holahan, Catherine, 355 Importing. See also Trade; Trade barriers
Holden, Betsy, 127 explanation of, 64, 65
Holiday Inn, 17, 77 getting involved in, 75–76
Holly, 349 Import tariff, 67
Holmes, David, 132 Inc., 113
Holmes, Elizabeth, 357 Income statements
Home, working from, 212 examples of, 299, 300
Home Depot, 5, 38, 41, 105, 344, 347 expenses on, 298–299
Honda, 70, 248 explanation of, 298, 300–301
Honest Tea, 88 net income on, 299–300
Honesty, 29–30 revenue on, 298
Honeywell, 72 temporary nature of, 300
index 385
Independence, 108 trade agreements, alliances, and organizations and, 70–75
Index, 346–347 trade and, 62–65
India, 105, 238 trade barriers and, 65–69
Individual retirement accounts (IRAs), 326–327 International Business Machines (IBM), 92
Industrialized nations, 66 International Franchise Association, 113
Industrial Revolution, 15–16 International Monetary Fund (IMF), 15, 73–75, 311
Industrial services, 245 International Organization for Standardization (ISO), 176–177
Industrias Añaños, 251 International Paper, 35
Industry analysis, 309–310 Internet. See also Digital marketing; Digital media
Indy Racing League, 5 advertising on, 55, 259
Inflation, 12 consumer grouping by use of, 281–282
Infomercials, 259–260 costs of using, 270
Informal communication, 154–155 identity theft and, 284–285
Information management, 129 impact of, 267, 268
Information technology (IT). See also Internet; Technology intellectual property and copyrights and, 55, 285–286
dynamic nature of, 267 legal and regulatory issues related to, 55
identity theft and, 284–285 marketing research on, 234–235
intellectual property and copyrights and, 55, 285–286 privacy issues related to, 283–284
management of, 80 social networking on, 202
privacy and, 283–284 volume of traffic on, 17
Information technology (IT) managers, 128 Internships, 201–202
Infosys Technologies, 173 Interstate Commerce Commission (ICC), 48
Infrastructure, 66 Interviews, job, 203
Initial public offering (IPO), 92, 345 Intimidating behavior, 27–28
Inn at Little Washington, 161–162 Intrapreneurs, 117
Innovation, 105–106 Intrinsic reward, 183
Inputs Inventory, 170, 336
explanation of, 160, 161 Inventory control, 170–171, 336
uniformity of, 163 Inventory management, 170–172
Inside directors, 94 Inventory turnover, 307
Insourcing, 77 Investment banking, 327, 345
Inspection, 177 Iran, 69
Instinet, 346 Irani, Ray R., 127
Institute of Food Technologists Student Association, 153 Iraq, 69
Insurance companies, 326 Ireland, 73
Integrated marketing communications, 258 Irvine, Robert, 204–205
Intel Corporation, 18, 29–30, 121, 131, 140, 164, 347 Irwin, Richard D., 152
Intellectual property Isidore, Chris, 358
explanation of, 52 ISO 9000, 176, 177
international business and, 67 ISO 14000, 176, 177
Internet and, 55, 285–286 ISO 9002 certification, 177
patent infringement and, 51 Istithmar World, 87
Intensive distribution, 255–256
Interactive Data Corporation, 212
Interactivity, 269
J
Intercontinental Hotels Group, 77 Jackson, W. Garrison, 127, 361
Intermediaries, 252 Jaguar, 79
Intermittent organizations, 166 Jana, Reena, 355
Internal Revenue Service (IRS), 147, 291 Jannarone, John, 352
International Assets Holding, 325 Jan-Pro Franchising International, Inc., 113
International Association of Outsourcing Professionals, 173 Japan
International Association of Privacy Professionals, 126 employee motivation in, 195
International Bank for Reconstruction and Development. See World gift-giving in, 27
Bank trade with, 69
International business. See also Globalization Japan Post Holdings, 79
career options in, 79 Jayson, Sharon, 365
developing strategies for, 79–80 JCPenney, 147, 219, 253
economic barriers and, 65–66 J.D. Power and Associates, 174, 175
entrepreneurship and, 103 JelloPuddingFace.com, 223
ethical, legal and political barriers and, 66–69 Jenkins, Matt, 357
explanation of, 62 JetBlue Airways, 162, 175, 249, 279
managing challenges of, 80 Jiffy Lube, 112, 280
methods to get involved in, 75–79 Job analysis, 200
overview of, 61 Job applications, 202–203
social and cultural barriers and, 69–70 Job description, 200
technological barriers and, 70 Job design, 192–195
386 index
Job enlargement, 193 Kogi, 261
Job enrichment, 193 Kolata, Gina, 362
Job rotation, 192–193 Komando, Kim, 362
Jobs, Steve, 104, 131 Komatsu, 61
Job sharing, 37, 194 Konrad, Alex, 367
Job specification, 200–201 Konya, Rebecca, 363
John Deere, 16, 68 Korte, Gregory, 352
Johnny Cupcakes, 147 Koskey, Andrea, 366
Johnson, Lyndon B., 220 Kostova, Tatiana, 363
Johnson & Johnson (J&J), 123, 131, 219, 258, 270, 347 Kotter, John P., 135
Joint ventures, 78–79, 97 Kozlowski, Dennis, 18
Jonas brothers, 228 KPMG, 219, 290
Jones, Ashby, 355 Kraft Foods, 99, 105, 127, 219, 247, 258, 282, 347
Jones, Charisse, 363, 366 Krauss, Michael, 370
Jones, Gareth R., 129 Kroc, Ray, 105
Jones, Thomas M., 354 Kroger, 42, 122, 148, 253
Josephson, Michael, 353 Krumrie, Matt, 362
Journal, 296 Kuehn, Kurt, 292
JPMorgan Chase, 92, 99, 219, 323–324, 347 Kumon, 77
Junk bonds, 342 Kutcher, Ashton, 225
Jurisdiction, 47
Just-in-time (JIT) inventory management, 170–172
Juvenile Diabetes Research, 42
L
Labeling, 249
K Labor contracts, 214, 215
Labor unions
Kagan, Aaron, 363 collective bargaining and, 214, 215
Kaiser Permanente, 219 dispute resolution and, 215–216
Kamerick, Megan, 363 explanation of, 214
Kane, Joseph Nathan, 359 membership in, 214–215
Kansas City Chiefs, 5 Ladders.com, 201
Kao, 35 Lady Gaga, 36
Kaplan, David, 359 Laissez-faire capitalism, 9
Karabell, Zachary, 368 Laliberte, Guy, 87
Karmin, Craig, 352 Landers, Mary, 355
Kasindorf, Martin, 50 Land pollution, 39–40
Katzenbach, Jon R., 362 Land Rover, 79
Kaye, Simon, 363 Lanham Act (1946), 54
Keenan, Faith, 362, 366 La Posta, 9
Kele & Co. Jewelers, 211 Larkin, Catherine, 360
Kellogg Company, 6, 248 Laskawy, Tom, 367
Kelly, Tim, 356 Latinos/Latinas. See Hispanics
Kennedy, John F., 37 Lattman, Peter, 353
Kent, Muhtar, 131 Lauder, Estée, 226
Kessler, Sarah, 371 Lavenda, David, 109
KFC, 55, 63, 252, 279 Law. See also Business law; Legal environment; Legal issues;
Khermouch, Gerry, 367 Legislation/regulations
Kiernan, Paul, 357 affecting business practices, 53, 54, 56–58
Kim, Hyejin, 368 affecting international business, 67–69
Kim, Jane J., 371 civil, 46
Kimberly Clark, 261 criminal, 46
Kimes, Mina, 361 sources of, 46
Kindle, 270 Lawsuits, 46–47
Kindler, Jeffrey, 140 Lawton, Christopher, 363
King, Stephen, 187 Layoffs, 209. See also Downsizing
King Arthur Flour, 210 Leadership
Kirks, Kurt T., 363 explanation of, 129
Kiva.org, 89 styles of, 130–131
Kiviat, Barbara, 353 tips for successful, 130
Klaassen, Abbey, 367 Learning, 235
Kleenex, 247 Leasing, 339
Klein, Julie, 371 Ledgers, 296
Knight, Dana, 359 LeDoux, Chris, 86
Knight, Matthew, 354 Legal environment. See also Business law; Legislation/regulations
K&N Management, 107, 175 business law and, 46
Kodak, 42, 51 court system and, 47
index 387
Legal environment—Cont. LinkedIn, 136, 202, 234, 269, 273, 277–278, 282
dispute resolution and, 46–49 Linthicum, Kate, 352
Internet and, 55 Lionell LLC, 122
law of agency and, 51–52 Lionsgate, 93
law of bankruptcy and, 52–53 Liquidity ratios, 307–308
law of contracts and, 50–51 Little Man Ice Cream, 252
law of property and, 52 Littman, Todd, 354
law of torts and fraud and, 50 L.L.Bean, 188, 225
regulatory administrative agencies and, 48–49 Loans, bank, 337–338
responsible business conduct and, 53, 54, 56–58 Lockbox, 334
sources of law and, 46 Lockheed Martin, 98
Uniform Commercial Code and, 49–50 Lockouts, 216
Legal issues. See also Legislation/regulations Loden, Marilyn, 217, 365
related to digital marketing, 283–286 Lombardi, David, 86
related to international trade, 66–69 Long-term assets, 339
related to Internet, 55, 283–284 Long-term liabilities, 341–342
related to recruiting and selecting employees, 205–206 Lorber, Laura, 364
Legality, 51 L’Oreal, 258
LegalZoom.com, 96 Louis-Charles, Andy, 371
Legendary Pictures, 78 Lowell, Francis Cabot, 16
Legislation/regulations. See also Business law; specific laws and Luhnow, David, 367
regulations Lynch, David J., 355, 357
affecting business practices, 53–55 Lynnyang, Jia, 362
employment, 205, 220 Lyons, John, 357
environmental, 39, 40
ethics and social responsibility, 24, 33, 37
privacy, 283–284
M
LEGO, 230 M·A·C AIDS Fund, 36
Lehman Brothers, 18, 52, 310 MacArthur, Kate, 368
Lennar Corporation, 25 Machan, Dyan, 365
Lenovo, 70, 72, 341 Mackey, Robert, 354
Leone, Marie, 370 MacMillan, Douglas, 361
Leonhardt, David, 354 Macsai, Dan, 369
Less-developed countries (LDCs), 66 Macy’s, 142, 253, 256, 319
Leveraged buyout (LBO), 100 Mad Men, 260
Levi’s, 17 MAF-Carrefour, 78
Levi Strauss & Company, 104 Magnuson-Mass Warranty (FTC) Act (1975), 54
Lewis, Al, 353 Maher, Kris, 361
Lewis, Sage, 369 Mahoney, Sarah, 367
LG, 282 Majid al Futaim (MAF), 78
LG Electronics, 51 Majora Carter Group LLC, 41
Li, Charlene, 281, 368–370 Major equipment, 245
Liabilities Malcolm Baldrige National Quality Award, 107, 174–175
of corporations, 95 Male, Bianca, 368
current, 301, 304, 337–339 Malik, Om, 371
explanation of, 295 Maltby, Emily, 366
long-term, 341–342 Management
nonbank, 338–339 areas of, 128–129
of partnerships, 89–90 career options in, 137
product, 50 controlling function of, 124–125
of sole proprietorships, 86 directing function of, 124
Liberto, Jennifer, 371 explanation of, 5–6, 120
Liberty Tax Service, 113 functions of, 31, 120–123
Licensee, 76 levels of, 125–127
Licensing, 76, 77 organizing function of, 123
Licensor, 76 planning function of, 120–123
LifeSpring, 114 reality of, 135–136
Light, Joe, 361 staffing function of, 123–124
Limited liability company (LLC), 84, 97 Managerial accounting, 292
Limited partnerships, 87. See also Partnerships Managers
Lin, Cynthia, 371 administrative, 128–129
Lincoln, Abraham, 318 analytical skills of, 131
Lindblad, Cristina, 357 background of, 132–133
Line-and-staff structure, 149–150 compensation for, 137
Line of credit, 112, 337 conceptual skills of, 131
Line structure, 149 decision-making role of, 133–135
388 index
explanation of, 120 explanation of, 225, 233
financial, 128 online, 234–235
first-line, 125 primary data and, 233–234
human relations skills of, 132 secondary data and, 234
human resources, 128 Marketing strategy
informational technology, 128 environmental issues and, 238
leadership skills for, 129–131 explanation of, 229
marketing, 128 market mix development and, 231–233
middle, 125 role of distribution in, 257
production and operations, 128 target market selection and, 229–231
recruitment of, 132–133 Market orientation, 227–229
roles of, 129 Market segmentation
skills needed by, 129–132 approaches to, 230–231
small-business, 113–114 bases for, 231
technical expertise of, 131 explanation of, 229
top, 125–127 promotional positioning and, 263
Manufacturer, 163 Market segments, 229–230
Manufacturer brands, 248 Marketside groceries, 133
Manufacturing Marks, Vic, 353
computer-assisted, 167 Marlboro, 247
computer-integrated, 167, 168 Marquet, Christopher T., 205, 364
explanation of, 160 Marquis Jet, 228
flexible, 168 Marriot International, 219
small businesses in, 107 Mars, 91–93, 134, 227, 230
Manufacturing economy, 16 Mars, Forrest, Sr., 91, 93
Maquiladoras, 72 Mars, Inc., 230
Maremont, Mark, 371 Marsh & McLennan, 325
Market Mars-Wrigley, 134
explanation of, 229 Martha’s Pastries, 232
primary, 327, 345 Martin, Jennifer, 360
secondary, 327, 345 Martin, John C., 127
target, 229–231 Martin, Timothy W., 361
Marketable securities, 335 Martin Marietta, 98
Marketing. See also Digital marketing Marvel Comics, 246
buying behavior and, 235–237 Marx, Karl, 8
buzz, 260–261 Maslow, Abraham, 186–188, 200
career options in, 239, 263 Maslow’s hierarchy of needs, 186–187
creating value with, 225–226 Master budget, 292
environment for, 237–238 MasterCard, 25, 319, 324
exchange relationship in, 224 Material-requirements planning (MRP), 172
explanation of, 6, 224 Materials handling, 257
functions of, 224–225 Matlack, Carole, 356, 357
mobile, 280 Matrix structure, 150–151
niche, 231 Matsushita, 79
Marketing channels Mattel, 85, 247, 252
for business products, 255 Mattioli, Dana, 355
for consumer products, 254–255 Mayo, Elton, 185, 186
explanation of, 252–254 Maytag, 193
supply chain management and, 254 Mazi, Tu, 153
Marketing concept McCarthy, Caroline, 368
evolution of, 227–229 McCarthy, Michael, 353
explanation of, 226–227 McCartney, Scott, 175, 249, 363, 367
Marketing economy, 16 McClendon, Aubrey K., 127
Marketing information system, 233 McCool, Joseph Daniel, 364
Marketing managers, 128, 263 McCracken, Jeff, 358
Marketing mix McDonald, Bob, 228, 365
digital media and, 271–273 McDonald, Robert A., 5, 131
distribution and, 232, 252–257 McDonald’s, 17, 52, 61–62, 69, 77, 79, 104–106, 140, 147–148, 164,
explanation of, 231, 242 170, 174, 206, 208, 244, 247, 252, 309–310, 344, 347
price and, 232, 250–252 McGinn, Daniel, 360
product and, 231–232, 242–250 McGinty, Tom, 354
promotion and, 232–233, 257–263 McGovern, Tim, 86
social networks and, 273–274 McGrane, Victoria, 371
Marketing research McGraw-Hill, 344
career options in, 239 McGraw-Hill Ryerson Publishing, 111
digital media and, 270, 282–283 McGregor, Douglas, 188–190, 363
index 389
McGregor, Jena, 360, 363 Money
McGwire, Mark, 26 characteristics of, 317–318
McKay, Dawn Rosenberg, 209 explanation of, 316
McKesson, 92 functions of, 316
McKinsey Global Institute (MGI), 169 pricing long-term, 340–341
McNeil Laboratories, 123 types of, 318–320
McQueen, M. P., 355 Money, 349
Mediation, 47, 216, 217 Money market accounts, 318
MEDRAD, 175 Money market funds, 327
Medtronic, 139, 186 Monroe, Kent B., 367
Medvedev, Dmitry, 279 Monsanto, 219, 349
Mellon, Andrew, 17 Monster.com, 202
Mercedes-Benz, 259 Montgomery Country Public Schools, 175
Merchant, Brian, 355 Moody, Marie, 176, 363
Merchant Bank, 29 Moog, Matt, 282
Merck & Co., 219, 347 Moore, Bob, 96
Merger mania, 100 Moore, Charlee, 96
Mergers Morale, 183, 213
benefits of, 100–101 Morgan, J.P., 17
explanation of, 98 Morgan Stanley, 126, 326, 327
negative aspects of, 98, 101 Morgan Stanley Smith Barney, 345
trends in, 99 Mortgage industry, 18–19, 347–348
Merrill Lynch, 25, 52, 270, 320, 324, 326–327, 345 Mortgages, 112
Metacafe.com, 275 Mosaic, 349
MetLife, 219 Moscow, Ann Blackman, 356
Metzger, Tyler, 328, 371 Moses, Abigail, 357
Mexico, 67, 71–73 Motavelli, Jim, 367
MGM Entertainment, 92 Motivation
MGM Mirage, 219 employee benefits and, 213
Microlending, 89, 110 explanation of, 182, 235
Microsoft Corporation, 17, 42–43, 104, 186, 243, 247, 278, 279, Hawthorne studies of, 185–186
284, 345, 347 historical perspectives on, 184–186
Middle managers, 125, 127 Motivational factors (Herzberg), 187–188
Middlemen, 252 Motivation strategies
Mielewski, Debbie, 151 behavior modification as, 192
Mildenberg, David, 99 importance of, 184, 185, 195–196
Millennials, 114 job design as, 192–195
Miller, Claire Cain, 352, 369 Motivation theories
Miller, John W., 370 classical theory, 184–185
Miller, William, 33 equity theory, 191
Minkow, Barry, 25 expectancy theory, 191
Minorities. See also Cultural diversity; Diversity Herzberg’s two-factor theory, 187–188
African Americans, 104, 218 Maslow’s hierarchy of needs, 186–187
Asian Americans, 218 McGregor’s Theory X and Theory Y, 188–190
discrimination against, 205 Theory Z, 190–191
Hispanic, 104, 114, 218 Motorola, 43
Native American, 104–105, 218 Motor vehicles, 39, 336
as small-business owners, 104 Movado, 164
social responsibility issues and, 37 Mozilla, 284
in workforce, 205, 217–219 Mozilo, Angelo, 25
Mission, 121 MSNBC, 277
Mission Motors, 334 MTC, 55
Mitchell, Josh, 357 MTV, 61
Mitsubishi, 73, 79 Muller, Joann, 248
Mixed economies, 9 Mullin, Sheppard, 356
Mixi, 274 Multidivisional structure, 150
M5 Networks, 140 Multinational corporations (MNCs), 79
Mobile food trucks, 16 Multinational strategy, 79
Mobile marketing, 280 Multi-Pet Feeder, 282
Model Business Corporation Act, 91 Multisegment approach, 230–231
Modified capitalism, 9 Murphy, Andrea D., 358
Modular design, 165 Murphy, Richard McGill, 361
Moen, 164 Murphy Business & Financial Corp., 113
Mohammed, Rafi, 250 Murray, Sara, 355
Mona Doyle, 367 Muslims, 70
Monetary policy, 320–323 Musselwhite, Chris, 364
390 index
Mutual funds, 327 finance companies, 327
Mutual savings banks, 325 insurance companies, 326
Mycoskie, Blake, 140 mutual funds, 327
Myers-Briggs Type Indicator Test, 203–204 pension funds, 326–327
MySpace.com, 234, 269, 273, 277–278, 281, 282 Nonprofit corporations, 93
MyYearBook.com, 274 Nonprofit organizations, 4, 142
Nooyi, Indra, 35, 150, 354
N Nordstrom, 147
Norman, Jan, 365
Nair, Viraj, 371 Norris, Floyd, 359
Nakheel, 87 North American Free Trade Agreement (NAFTA), 70–73
Nalebuff, Barry, 88 North Korea, 69
NASCAR, 5, 92 Northrop Grumman Corp., 219
NASDAQ, 343, 346 Northwest Airlines, 99
Nassauer, Sarah, 370 Novak, David C., 127
Nathan’s Famous, 142 Novartis, 98
National Aeronautics and Space Administration (NASA), 93 Novartis Pharmaceuticals Corp., 219
National Alliance of Businessmen, 43 NOW (negotiable order of withdrawal) accounts, 318
National Association for Shoplifting Prevention, 253 NPR, 277
National Business Ethics Survey (NBES), 27, 31, 33 Nugget Market, 196
National City Bank, 324 Nutrition Labeling and Education Act (1990), 54
National Credit Union Association (NCUA), 325 Nvidia, 127
National Credit Union Insurance Fund, 325
National debt, 14–15
National Environmental Policy Act of 1969, 40 O
National Fluid Milk Processor Promotion Board, 6 Obama, Barack, 40, 57, 69, 72, 110, 276, 279, 319
National Football League (NFL), 216 Objectives, 121–122
National Fraud Center, 285 Occidental Petroleum, 127
National Institute of Standards and Technology (NIST), 284 Occupational Safety and Health Administration (OSHA), 37, 48
National Public Radio (NPR), 276 Ocean Spray, 97
Native Americans O’Connor, Sean, 246
population data for, 218 OfficeMax, 30
as small-business owners, 104–105 Office of Financial Research, 58
Natural disasters, 69 Office of Social Innovation and Civic Participation (OSICP), 110
The Nature Conservancy, 34 Offshoring, 77–78
Naturhouse, 77 Oglethorpe Power Corp., 97
Needleman, Sarah E., 360, 364, 370 Old National Bank, 121
Needles, Berlverd E., 293 Old Navy, 233
Neighborhood Markets, 133 Oligopoly, 11–12
Nestlé, 79, 98, 146, 175, 251, 272 Olive Garden, 230
Netapp, 196 Omnisio, 337
Netflix, 247, 271, 278, 282, 309 OMX, 346
Net income, 298–300 O’Neal, Shaquille, 7
Networking, 135 O’Neal, Stanley, 25
Neuger, James G., 357 1-800-Got-Junk, 112
Neutrogena, 256 Online advertising, 259
New Belgium Brewing, 41, 116, 168–169 Online banking, 328–329
Newberry, Jon, 365 On-the-job training, 206–207
New Orleans Saints, 163 Open market operations, 320, 321
Newsweek, 261 Operational plans, 122
New York Stock Exchange (NYSE), 346, 347 Operations, 160
Nextag, 269 Operations management (OM)
NFL, 5 career options in, 178
Niche marketing, 231 explanation of, 160
Nick’s Pizza & Pub, 130 quality management and, 160, 174–178
Nielsen Marketing Research, 271 in service businesses, 161–164
Nierenberg, Andrea, 135–136 supply chain and, 169–174
Nierenberg Group, Inc., 135 transformation process of, 160–161
Nike, 35, 147, 173, 184, 275, 344 Operations systems
Nikon, 274 operations processes design and, 165
Nissan, 228, 243, 248 planning capacity and, 165–166
Nokia, 164, 193 planning facilities and, 166–168
Nonbanking financial institutions product planning and, 164–165
brokerage firms and investment banks, 327 sustainability and manufacturing and, 168–169
diversified firms, 326 Oprah Winfrey Network (OWN), 105
explanation of, 325 Oracle, 115, 126, 127
index 391
Orange Sky Golden Harvest Entertainment, 78 Panasonic, 61
Oreck Clean Home Center, 113 Paper Mate, 39
O’Reilly, Joseph, 356 Papini, Jessica, 361
Organizational charts, 143 Paramount Pictures, 274
Organizational culture Partnership capital, 87
career options in managing, 155 Partnerships
explanation of, 140–141 advantages of, 88–89
Organizational layers, 148–149 articles of, 87, 88
Organizational structure disadvantages of, 89–90
departmentalization and, 143–146 explanation of, 84, 85, 87
development of, 142–143 taxation of, 90
explanation of, 139, 141–142 types of, 87
line, 149 Passal, Jeffrey, 360
line-and-staff, 149–150 Patagonia, 12, 35, 104, 168, 188
matrix, 150–151 Patents, 51, 52, 67. See also Intellectual property
multidivisional, 150 Pattison, Kermit, 360, 366
specialization and, 143 Paul, Franklin, 355
Organization of Petroleum Exporting Countries (OPEC), 69 Pay for performance, 185
Organizations PayPal, 285
assignment of responsibility in, 146–149 PayScale, 205, 285
centralized, 147 PBS, 277
communication in, 153–155 Pearl GTL (gas-to-liquids), 161
decentralized, 147–148 Pedigree, 92
list of ethically responsible, 35 Peiperl, Maury A., 364
list of most admired, 131 Penetration price, 251
nonprofit, 4, 142 Peninsula Shops, 232
role of groups and teams in, 151–153 Penn, Christopher S., 369
Organizing, 122 Pennzoil, 262
Orientation, 207 Pensacola, Florida, City Council of, 213
Orkut, 269, 274 Pension funds, 326–327
Orr, Deborah, 358 PepsiCo, 35, 61, 76, 150, 249, 251, 261, 278
O’Sullivan, Kate, 370 Perception, 235
O’Sullivan, Matt, 358 Performance appraisals, 207–208
Otellini, Paul, 18 Perrier, 259
O’Toole, Larry, 120 Per share data, 308–309
Ouchi, William, 190, 191 Personality, 235
Outback Steakhouse, 37 Personal property, 52
Outputs Personal selling, 260
explanation of, 160, 161 Personal space, 69
labor requirements to produce, 164 Perttila, Chris, 339
nature and consumption of, 163 Petco, 251
uniformity of, 163–164 Peters, Michael P., 359
Outside directors, 94 Peterson, Lisa J.B., 205, 364
Outsourcing Peterson, Molly, 360
explanation of, 77, 172 Petrecca, Laura, 353, 354, 358, 367, 369
list of top providers of, 173 Petry, Ashley, 338
Overberg, Paul, 352 Pets.com, 83
Overcentralization, 147 Pfizer, 99, 140, 258, 347
Overfelt, Maggie, 358 Pharmacia Corporation, 99
Overspecialization, 143 Photobucket, 276
Over-the counter (OTC) market, 345, 346 Photo sharing, 276
Owners’ equity Physical distribution, 256–257. See also Transportation
on balance sheet, 304 Physiological needs, 186
explanation of, 295 Piazza, Jo, 367
financing with, 343–345 Picasa Web Albums, 276
Oxi Fresh Franchising Co., 113 Pickens, T. Boone, 355
Picketing, 216
P Pidaparthy, Umika, 369
Pierce, Jon L., 363
Packaging, 248–249 Piercy, Nigel F., 363
Padgett, Tim, 356 Pinchott, Gifford, III, 360
Page, Jamie, 365 Pingdom, 274
Page, Larry, 88, 104 Pipelines, 256–257
PAI Partners, 126 Pita Pit, 77
Pakistan, 69 Pitney Bowes, 57
392 index
Pixar, 345 compensation and, 185
Pizza Hut, 61, 77, 113 digital media control and, 271
Plagiarism, 31 measurement of, 164
Planning Product layout, 166
controlling vs., 124–125 Product liability, 50
explanation of, 120 Product line, 245
as human resource function, 220–221 Product managers, 263
as management function, 120–123 Product mix, 245
material-requirements, 172 Products
Planning capacity, 165–166 branding of, 247–248
Plans, 122–123 business, 244
Plus, 328 classification of, 244–245
PNC, 324 consumer, 244
PNM, 166 departmentalization of, 145–146
Podcasts, 276–277 development of, 242–244
Points of Light Foundation, 188 digital marketing and, 271
Points of Light Institute, 121 distribution strategy for, 252–257
Poison pill, 98, 100 eco-friendly, 34, 257
Politics, international trade and, 69 ethnic, 114–115
Pollution explanation of, 4, 242
in China, 74, 238 generic, 248
responses to, 40–42 labeling of, 30–31, 249–250
trends in, 39–40 life-cycle of, 245–247
Polo Ralph Lauren, 237 marketing mix and, 242
Polygraph tests, 204 methods to identify, 247–250
Porsche, 128, 164, 230, 231 packaging of, 248–249
Pottery Barn Kids, 106 pricing strategy for, 250–252
Power of attorney, 51=52 promotion of, 257–263
Precision Castparts, 349 quality of, 249–250
Preferred stock, 94, 343 safety issues related to, 49
Preidt, Robert, 364 Profit
Priceline, 282 explanation of, 4, 34
Price skimming, 251 social responsibility and, 35
Prices/pricing Profitability ratios, 306–307
digital marketing and, 273 Profit margin, 306
discount, 252 Profit sharing, 212–213
explanation of, 232, 233, 250–251 Program Evaluation and Review Technique (PERT), 174
marketing mix and, 232 Project organization, 166, 167
of new products, 251–252 Project teams, 152, 153
penetration, 251 Promotion
psychological, 252 digital marketing and, 273
strategies for, 251–252 explanation of, 209, 232–233
PricewaterhouseCoopers, 219, 290 function of, 257–258
Pride, William M., 253, 254, 365 marketing mix and, 258–261
Primary data, 233–234 objectives of, 262–263
Primary markets, 327, 345 sales, 261
Prime rate, 338, 339 Promotional positioning, 263
Prince, Charles O., III, 25, 131 Promotion mix
Prince, Chuck, 361 advertising and, 258–260
Principal, 51 explanation of, 258
Print media, 258, 259 personal selling and, 260
Privacy issues, 283–284 publicity and, 260–261
Private accountants, 291 push vs. pull strategy and, 261–262
Private corporations, 91–93 sales promotion and, 261
Private court system, 48 Promotions (employee), 209
Private distributor brands, 248 Property law, 52
PR Newswire, 349 Propstra, George, 203
Processed materials, 245 Prudential Financial, 219
Process layout, 166, 167 Prudential Securities, 164
Procter & Gamble (P&G), 5, 62, 90, 95, 104, 131–132, 145, 169, 202, Psychographic variables, 231
219, 228, 230, 242, 244, 258, 268–270, 275, 278, 282, 344, 347 Psychological pricing, 252
Product-development teams, 152, 153 Public accountants, 290–291
Production, 160, 227 Public Company Accounting Oversight Board, 311
Production and operations management, 128, 159 Public corporations, 92, 93
Productivity Publicity, 260–261
index 393
Publix Super Markets, 92, 148 Reichert, Alan K., 355
Puck, Wolfgang, 17 Reid, Katie, 359
Pull strategy, 261–262 Repoport, Michael, 370
Purchasing, 169–170 Research in Motion (RIM), 67, 269, 280
Pure competition, 11 Reserve requirements, 322
Push strategy, 261–262 Responsibility, 146–147. See also Social responsibility
Retailers/retailing
Q explanation of, 252–253
general merchandise, 253
QantasLink, 79 jobs in, 263
Quaker, 246–247 marketing channels and, 253
Quality small-business owners as, 106
management of, 160, 174–178 RetailMeNot, 261
product, 249–250 Retained earnings, 344
standards for, 176–177 Retro Fitness, LLC, 113
Quality-assurance teams, 152, 153 Return on assets, 306–307
Quality circles, 191. See also Quality-assurance teams Return on equity, 307
Quality control, 175–176 Reuters Group, 123
Quasi-public corporations, 93 Revenue, 298
Quick ratio, 308 Rewards
Quittner, Josh, 368, 371 extrinsic, 183–184
Quotas, 68 intrinsic, 183
QZone, 274 time off as, 188
Reynolds, Dean, 343
R Reynolds, Kim, 361
Reynolds American, 349
Radio frequency identification (RFID) technology, 336 Rhodes, Ryan, 368
Railroads, 256 Richburg, Keith B., 358
Rampell, Catherine, 364 Rickets, Todd, 28
Ranking system, 207 Ricks, David, 356
Rao, Leena, 358 Risk, 225
Rao, Narendra, 366 Risk assessment, 340
Rapuano, Rina, 362 Rite Aid, 349
Ratio analysis Ritz-Carlton, 146, 225
asset utilization ratios and, 307 Robertson, Jordan, 353
debt utilization ratios and, 308 Robinson-Patman Act (1936), 54
explanation of, 306 Robotic Industries Association, 168
industry analysis and, 309–310 Robots, 168
liquidity ratios and, 307–308 Rockefeller, John D., 17
per share data and, 308–309 Rodriguez, Juan, 127
profitability ratios and, 306–307 Rogers, Jim, 355
Ratner, David, 64 Rolex, 164
Raw materials, 245 Rolls Royce, 229
Ray, Augie, 368 Romano, Andrew, 368
Ray, John J., 358 Rosener, Judy B., 217, 365
RCN Corporation, 93 Rosetta Stone, 256
Real property, 52 Roth, David Lee, 183
Receivables turnover, 307 Routing, 172–174
Recession, 12–14, 188, 261, 338 Roxane Laboratories, Inc., 24
Recreational Equipment (REI), 194, 196 Royal Dutch Petroleum Co., 99
Recruitment Royal Dutch/Shell Group, 79
diversity, 127 Royal Dutch Shell PLC, 161
explanation of, 201–202 Rubin, Courtney, 353
legal issues in, 205–206 Rubin, Rita, 354
of managers, 132–133 Rush, Andra, 106
Recycling, 40–42 Rush Trucking, 106
Redbox, 233 Russia, 69
Red Cross, 4 Ryan, Denis, 366
Reddy, Sudeep, 371 Ryan, Vincent, 371
Red Lobster, 226
Reebok, 77
Reed, Stanley, 357, 360
S
Reference checks, 204–205 Sacred Power, 105
Reference groups, 236 Safety, 37
Regulations. See Legislation/regulations Safeway, 42, 148
Regulatory administrative agencies, 48–49 Sager, Ira, 371
394 index
Said, Summer, 356 Self-actualization needs, 187
Sains, Ariane, 357 Self-directed work team (SDWT), 152, 153
Saks Fifth Avenue, 319 Selling, 225, 260
Salary. See also Compensation The Senior’s Choice, Inc., 113
explanation of, 212, 213 Separations, 209–210
of unionized vs. nonunionized employees, 214 Sephora, 256
Sales agreements, 49–50 Serial bonds, 342
Salesforce.com, 35, 43 Service Corps of Retired Executives (SCORE), 113
Sales orientation, 227 Service economy, 16
Salespersons, 260 Service industry
Sales promotion, 261 careers in, 19
Sampling, 177–178 operations management in, 161–164
Sam’s Clubs, 251, 253 small businesses in, 106–107
Samsung, 6, 51, 61, 73, 128, 230 Service Merchandise, 253
Sam’s Wholesale Club, 248 Services
Sanchanta, Mariko, 352 distribution of, 254–255
Sanyo, 73 explanation of, 231
Sara Lee, 99, 248 quality of, 249
Sarbanes-Oxley Act (2002), 24, 54, 56–57, 94, 311 Sesame Workshop, 93
Sarillo, Nick, 130 7-Eleven, 246
SAS, 196 Seventh Generation, 4
Satyam, 77 Shanahan, Kevin, 370
Saunders, 89 Shankar, Venky, 365
Savings accounts, 318 Shareholders. See Stockholders
Savings and loan associations (S&Ls), 324, 325 Shellenbarger, Sue, 364
Savings Association Insurance Fund, 325 Shell Oil, 75, 336
SBI Holdings, 97 Shell Transport & Trading Co., 99
Scabs, 216 Sherman Antitrust Act (1890), 53, 54
Scarborough, Norman M., 360 Sheth, Jagdish, 360
Schaal, Dennis, 353 Sheth, Niraj, 358
Scheduling, 172–174 Shoplifting, 253
Schmall, Emily, 368 Shopping products, 245
Schmidt, Eric, 131 Shriver, Adam, 354
Schmidt, Michael, 353 Shuffle Master, 243
Schmit, Julie, 370 Siemens, 79
Schmitt, John, 365 Silbert, Mimi, 110
Schultz, Howard, 6, 356 Silly Bandz, 246
Schultz, Ulrike, 279 Simmons, Russell, 236
Schumpeter, Joseph, 359 Singer, 113
Schweppes, 69 Sinopec Group, 79
SC Johnson, 219 Sirius, 98
S corporations, 84, 91, 97 Six Degrees.com, 273–274, 281
Scott, David Meerman, 368 Six Flags, 52
Scott, Lee, 121 Skechers USA, 344
Scott, Robert E., 64 Skilling, Jeffrey, 18
Scott Paper, 40 Skinner, B.F., 192
Scribd, 337 Sky Canaves, 356
Sears, 248, 253, 282, 319, 326 Skype, 85, 286
Sears World Trade, 76 SkyRock, 274
Secondary data, 234 Skywest, 78–79
Secondary markets, 327, 345 Skyworks Solutions, 72
Second Life, 279–280 Slater, Samuel, 16
Secured loans, 337–338 SLM, 325
Securities and Exchange Commission (SEC), 33, 48, 94, 96, 290, Sloan, Carrie, 365
310, 346 Small Business Administration (SBA), 19, 104–105, 111–113
Securities markets Small Business Development Centers (SBDCs), 113
explanation of, 345–346 Small businesses. See also Business; Entrepreneurship
over-the-counter market, 346 advantages of, 107–108
performance measurement for, 346–349 big businesses functioning as, 117
stock markets, 346 career options in, 116
Security needs, 186 disadvantages of, 108–110
Segway, 97 explanation of, 104
Selection future outlook for, 114–116
employee, 202–205 in manufacturing, 107
legal issues in, 205–206 methods to start, 110–114
Selective distribution, 256 overview of, 103
index 395
Small businesses—Cont. Southwest Windpower Inc., 116
retail and wholesale, 106 Spago, 17
role in economy, 104–106 Spalding, 77
in service fields, 106–107 Specialization, 143
social networking and, 278 Special Olympics, 4
substance abusing employees in, 204 Specialty products, 245
in technology fields, 107 Spicer, Jonathon, 358
Small Business Institutes (SBIs), 113–114 Spors, Kelly K., 365
Smarter Students for a Smarter Planet, 140 Sridhar, K.R., 294
Smith, Adam, 9, 11, 143, 361 Srinivasan, Rags, 367
Smith, Douglas K., 362 Stack, Ed, 343
Smith, Fred, 242 Stack, Richard, 343
Smith, Frederick, 17 Staffing, 123–124
Smith, Geri, 357 Stakeholders, 4
Smith, Molly, 360 Standardization, 165
Smith, Phil, 358 Standard Oil, 17
Smith Barney, 326, 327 Standard & Poor’s Composite Index, 347
SmithKline Beecham Plc., 99 Stanford University, 89
Smoking Loon, 224 Starbucks, 6, 35, 62, 79–80, 104, 214, 234, 244, 251, 278, 298,
SmugMug, 276 300–301, 303–310, 344
Snap Fitness Inc., 122 Starwood Hotels & Resorts Worldwide, 219
Social classes, 236–237 State Farm Insurance, 326
Social entrepreneurs, 110 State Grid, 79
Social Innovation Fund (SIF), 110 Statement of cash flows, 304–306
Socialism, 9 Statistical process control, 176
Social Media Examiner, 287 Statutory law, 46
Social needs, 186 Stecklow, Steve, 370
Social networks Steel, Emily, 368
business uses for, 274, 277 Stein, Joel, 365
explanation of, 273 Steiner, Ivan, 152
Facebook, 277–278 Stella & Chewy’s, 176
function of, 268–269 Stella & Dot, 84
historical background of, 273–274 Stempel, Jonathan, 361
LinkedIn, 278 Stepanek, Marcia, 371
marketing research using, 234–235 Sterling Drug, 98
Myspace, 277 Stewart, Doug, 364
negative aspects of, 272 Stock
recruitment and, 202 common, 94–95, 343, 344
Twitter, 278–279 explanation of, 91
Social responsibility. See also Business ethics; Ethical issues preferred, 94, 343
arguments for and against, 35 Stockholders
careers in, 43 explanation of, 91, 94–95
in community relations, 42–43 social responsibility toward, 35, 37
in consumer relations, 37–38 Stock markets, 346
dimensions of, 34 Stock quotes, 343, 344
in employee relations, 37 Stone, Brad, 368–370
explanation of, 34 Stoppelman, Jeremy, 236
nature of, 34–35 Storing, 225
pyramid of, 34 Strategic alliances, 78–79
in relations with owners and stockholders, 35, 37 Strategic plans, 122
in sustainability issues, 38–42 Stratus Building Solutions, 113
Social roles, 236 Strauss, Gary, 359
Social Security, 327, 328 Strikebreakers, 216
Social technographics, 281 Strikes, 216
Sodexo, 173, 218, 219 Structure, 141–142. See also Organizational structure
Sodiaal, 126 Stuart, Alix, 206
Solar Attic, Inc., 116 Stuart, Gretchen K., 354
Sole proprietorships Student Loan Network, 277
advantages of, 85–86 Studer Group, 107, 175
disadvantages of, 86–87 StudiVZ, 274
explanation of, 84–85 Substance abuse, 204
Solid waste, 40 Subway, 4, 77, 112, 113, 117, 159, 163
Somalia, 69 Sub-Zero, 251
Sony Corporation, 6, 29, 62, 73, 90, 190, 248, 256 Sullivan, Elisabeth, 356
Southern Methodist University, 279 Summers, Nick, 369
Southwest Airlines, 117, 122, 132, 163, 175, 249, 344 SunChips, 39
396 index
Sun Microsystems, 115 virtual, 151
Sunny Delight, 169 Teather, David, 352
Super Bowl, 259 Technical expertise, 130, 131
Supplies, 245 Technology. See also Digital media; Internet
Supply, 10–11 career options and, 19
Supply chain management international business and, 70, 80
business products and, 255 mobile marketing and, 280
career options in, 178 operations systems and, 167–168
consumer products and, 254–255 in service businesses, 162
explanation of, 169, 254 small businesses and, 107, 115–116
inventory and, 170–172 virtual teams and, 151
outsourcing and, 172 Telecommuting, 37, 194
purchasing and, 169–170 Telephone Consumer Protection Act (1991), 54
routing and scheduling and, 173–174 Tencent, 268
Supply curve, 11 Tender offers, 98
Suri, Rajneesh, 367 Tenet Healthcare, 349
Susanto, Yan, 108 Tenneco, 349
Sustainability. See also Environmental issues; Green Tennessee Valley Authority, 9
businesses Tepperman, Jonathan, 356
alternative energy and, 40 Terhune, Chad, 367
business responses to, 40–42, 161 Terracycle, 105
career options and, 19, 43 Tesco, 248
community relations and, 42–43 Tesla Motors, 128
explanation of, 38 Testing. See Employee testing
manufacturing and, 168–169 Test marketing, 243, 244
pollution and, 39–40 Texaco, 79, 248
Sutherland, Jason, 232 Texas A&M University, 325
Sutter, John D., 352 Thailand, 69
Suzuki, 73 Theladders.com, 202
Swartz, Jon, 370 Theory X, 189–190
SwizzzProzzz AG, 68 Theory Y, 189–190
Sylt, Christian, 358 Theory Z, 190–191
Syria, 69 Theory Z—How American Business Can Meet the Japanese Challenge
System4, 113 (Ouchi), 190
Szaky, Tom, 105 Thomas, Edward G., 355
Thompson, 123
T Thorne, Debbie, 352
threadless.com, 282
Taco Bell, 55, 108, 252 360-degree feedback, 208
Tactical plans, 122 3M, 117, 139, 347
Tag Heuer, 26 Thrust Fund, 326
Tangible goods, 162–163 TIAA-CREF, 136
Taobao, 273 Tide, 224
Target Corporation, 35, 42, 203, 219, 253, 278, 319 Tiffany, 136
Target market Timberland, 344
explanation of, 229 Time, 259
selection of, 229–231 Time, Inc., 136
Tariffs, 67–68 Time deposits, 318
TARP (Troubled Asset Relief Program) program, 329 Times interest earned ratio, 308
Task forces, 152 Time Warner, 99, 219, 258
Tata Motors, 79 Tims, Dana, 359
Tax issues Tinseth, Randy, 368
for corporations, 96 Title VII (Civil Rights Act) (1964), 205
job growth opportunities and, 166–167 T-Mobile USA, 24
for partnerships, 90 Tomas, G., 360
for sole proprietorships, 86, 87 Tommy Hilfiger, 64
Taylor, Frederick W., 184–185 TOMS Shoes, 140
Taylor, Robert, 152 Top managers, 125–127
Teach, Edward, 211 Torres, Craig, 352
Teams Torts, 50
explanation of, 151–152 Toshiba, 70, 73
groups vs., 151, 152 Total asset turnover, 307
product-development, 152, 153 Total-market approach, 229
project, 152, 153 Total quality management (TQM), 176
quality-assurance, 152, 153 Totten, Zoe Finch, 182
self-directed work, 152, 153 Toyoda, Akio, 131, 152, 362
index 397
Toyota Motor, 73, 79, 131, 152, 159, 190, 219, 248, 279 Uniform Commercial Code (UCC), 49–50
Toys ‘R`’ Us, 252 Uniform Partnership Act, 87
Tracy, John, 363 Unilever, 6, 79, 228, 275–276
Trade Union Pacific, 120
balance of, 64–65 Unisys, 349
between countries, 63–64 United Airlines, 175, 249
exporting and importing and, 75–76 United Auto Workers, 37
methods for getting involved in, 75–79 United Parcel Service (UPS), 35, 159, 292
reasons for, 62–63 U.S. Army, 147
Trade agreements/organizations/alliances U.S. Bureau of Labor Statistics, 137, 194
Asia-Pacific Economic Cooperation, 73–75 U.S. Bureau of the Census, 76, 85, 105, 218, 234, 333
European Union, 73 U.S. Chamber of Commerce, 50
function of, 70 U.S. Foreign Corrupt Practices Act, 29
General Agreement on Tariffs and Trade, 70–71 U.S. Postal Service, 93, 147, 163, 230
International Monetary Fund, 75 U.S. Public Debt, 13, 14
North American Free Trade Agreement, 71–73 United States Sentencing Commission, 56
World Bank, 75 United States Steel Corporation, 17
Trade barriers United Technologies, 347
economic, 65–66 University of California at Davis, 280
ethical, legal and political, 66–69 University of Texas, 280
social and cultural, 69–70 Univision, 230
technological, 70 Unsecured bonds, 342
Trade credit, 112, 337 Unsecured loans, 338, 339
Trade deficit, 64, 65 Unsworth, Kerrie, 361
Trademark Counterfeiting Act (1980), 54 Upward communication, 154
Trademark Law Revision Act (1988), 54 Urban Outfitters, 147
Trademarks, 52, 247. See also Intellectual property US Airways, 175, 249
Trader Joe’s, 35, 171 USA Today, 25, 175, 349
Trade surplus, 65 Useem, Jerry, 339, 362
Trading companies, 76
Training
career options in, 195
V
ethics, 33 Valentino-DeVries, Jennifer, 370
explanation of, 206–207 Valorem tariff, 67–68
Transaction balances, 334 Value
Transfer, employee, 209 created by marketing, 225–226
Transparency International, 29 explanation of, 225
Transportation, 225, 256–257, 263 of money, 316
TransUnion, 338 Van Grove, Jennifer, 368
Travelers Companies, 347 Vanguard Cleaning Systems, 113
Travelers Insurance Company, 194 Van Halen, 183
Travelzoo, 188 Vann, Mick, 352
Treacy, Michael, 365 Vascallero, Jessica E., 355
Treasury bills (T-bills), 335 Venezuela, 69
Treasury Department, U.S., 15, 317, 327, 329, 335, Venture capitalists, 111
336, 348–349 Verizon Communications, 92, 219, 258, 347
Trial court, 47 Vermont Business Environmental Partnership, 210
TriMet, 184 Vesilind, Emili, 365
Trucks, 256 Viacom, Inc., 286
Truong, Alice, 369 Viaweb, 337
TRUSTe, 284 victorandspoils.com, 282
TRW Automotive Holdings, 349 Video, 275
Tuenti, 274 Video sharing, 275–276
Tupperware, 84 Vietnam, 67, 74–75
Turnover, employee, 208–210 Viewpoints Network, 282
Twitter, 16, 80, 115, 159, 164, 232, 234, 261, 269, Villanova University, 330
271–273, 275, 277–279, 281–282, 285, 287 Virgin Blue, 78–79
Two-factor theory of motivation, 187–188 Virtual teams, 151
Tyco, 17, 18 Virtual testing, 234
Tyrangiel, Josh, 369 Virtual worlds, 279–280
Visa, 25, 319, 324
U Vista Bank Texas, 97
Vkontakte, 274
Undercapitalization, 110 VMG Global, 30
Underwood, Ryan, 362 Voluntary agreements, 50
Unemployment, 13, 349 Volvo, 236, 263
398 index
Vranica, Suzanne, 369 Wild Oats, 98
Vroom, Victor, 191 Wilkins, Matthew, 356
Willemsen, Marc C., 354
W Williamson, Elizabeth, 357
Wilson, Jeanne M., 362
W. Atlee Burpee and Co., 108 Wilson, Zachary, 369
Wachovia, 324, 329, 330 Window-dressing, 291
Wages, 210, 211, 213. See also Compensation; Salary Winfrey, Oprah, 105
Walker, Marcus, 357 Wingfield, Nick, 352
Wall Street Journal, 25, 97, 135, 210, 343 Winn-Dixie, 253
Walmart, 17, 34, 37, 43, 79, 92, 108, 110, 116, 120–122, 131, 133, Wipro Technologies, 173
168–169, 191, 211, 242, 248, 253, 271–273, 275, 336, 347 Witkin, Jim, 360
Walsh, Bryan, 354, 363, 366 Wm. Wrigley Jr. Company, 91–92
Walsh, Mary Williams, 370 Wolverine Worldwide, 344
Walt Disney Company, 19, 40, 85, 219, 258, 278, 347 Womack, Brian, 361
Walton, Sam, 17, 43, 110 Women
Wang, Jennifer, 352 employment discrimination against, 205–206
Warehousing, 257 as small-business owners, 104
Warner-Lambert, 248 social responsibility issues and, 37
Warranties, 49–50 Woods, Tiger, 26
Warren, Elizabeth, 329, 371 Woody, Todd, 370
Washington Mutual, 324 Workforce
Washington State University, School of Food Science, 153 assessing performance of, 207–208
Watananbe, J., 87 compensation of, 185, 205–206, 211–214
Waterfield, Bruno, 357 motivation of, 184–185, 192–196
Water pollution, 39 training and development of, 206–208
Watts, Jonathan, 358 turnover of, 208–210
The Wealth of Nations (Smith), 9, 143 Workforce diversity
Webb, Marion S., 355 affirmative action and, 220
Webb-Pomerence Export Trade Act (1918), 67 benefits of, 219–220
Webshots, 276 characteristics of, 217
WeddingChannel.com, 84 importance of, 126–127, 216–217
Wegmans Food Markets, 196 minorities and, 205, 217–219
Wehrum, Kasey, 361 population data and, 217–219
Weisul, Kimberly, 371 top companies for, 219
Welch, Liz, 352 women and, 205–206
Weldon, William, 131 Working capital management, 334
Wellins, Richard S., 362 Workplace
WellPoint, 219 abusive and intimidating behavior in, 27–28
Wells Fargo, 219, 294, 324, 330 conflict of interest issues in, 28–29, 32
Wendlandt, Astrid, 356 discrimination in, 205–206
Wendy’s, 77, 252 misuse of company resources in, 27, 30
Wentz, Laurel, 365 safety in, 37
Western Digital, 349 World Bank, 74, 75
Western Electric Company, 185–186 WorldCom, 291
Westinghouse, 95, 207 World Fuel Services, 349
Westin Hotels and Resorts, 146 World Trade Organization (WTO), 70–71, 165
Whalen, Jeanne, 356 Worthen, Ben, 357
Wheeler-Lea Act (1938), 54 Wright, Orville, 227
Whelan, David, 353 Wrigley, 134, 227
Whelan, Elizabeth M., 352 Wrigley, William, Jr., 134
Whiskas, 92 Wriston, Walter B., 357
Whistleblowing, 33 Wyndham Hotels and Resorts, 160
White, Bobby, 353, 368 Wysocki, Bernard, Jr., 362
White, Gregory L., 369
White, Michael, 358
Whitney, Eli, 16
X
Whole Foods, 35, 40, 98, 122, 148 Xerox Corporation, 12, 35, 42, 117, 192, 219, 247
Wholesalers XM Satellite Radio, 98
explanation of, 253–254 XTO Energy, 127, 349
functions of, 254
small businesses as, 106
Wiersema, Fred, 365
Y
Wikipedia, 153, 275 Yahoo, 53, 55, 267, 275, 276, 283, 348
Wikis, 275 Yammer, 274
Wilchins, Dan, 361 Yancey, Kitty Bean, 356
index 399
Yash, Miriko, 352
Yates, John, 369 Z
Y Combinator, 337 Zappos.com, 196, 271, 274
Yelp, 236, 249–250 Zebco, 122
Yen, Hope, 365 Zedillo, Ernesto, 95
YMCA, 203 Zegna, 64
Yogen Fruz, 77 Zeithaml, Valarie A., 362
Yogurtland Franchising, Inc., 113 Zellner, Wendy, 353
Yoplait, 76, 126 Zendrian, Alexandra, 354
York, Emily Bryson, 369 Zidle, Marcia, 364
Young, Lucie, 359 Zimmerer, Thomas W., 360
Young American Bank, 7 Zimmerman, Ann, 366, 367
YouTube, 80, 132, 246, 247, 270, 272, 275, 276, 286 Zongshen Power Machinery, 334
Yowza!!, 280 Zoo Games, 246
Yu, Roger, 369 ZoomShops, 256
Yum Brands, 127 Zoom Systems, 255–256
Yun, Michelle, 356, 357 Zuckerberg, Mark, 107, 126
Yunus, Muhammad, 110
400 index

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Library of Congress Control Number: 2011940365

CHAPTER 1 THE DYNAMICS OF BUSINESS

CHAPTER 2 BUSINESS ETHICS AND SOCIAL

part three MANAGING FOR

QUALITY AND COMPETITIVENESS 118

CHAPTER 6 THE NATURE OF MANAGEMENT 119

CHAPTER 13 DIGITAL MARKETING AND SOCIAL

CHAPTER 15 MONEY AND THE FINANCIAL

W ness in this chapter by

business in this text. LO6 Trace the evolution of the American

CHAPTER 1 | The Dynamics of Business and Economics 3

The Goal of Business

4 PART 1 | Business in a Changing World

CHAPTER 1 | The Dynamics of Business and Economics 5

6 PART 1 | Business in a Changing World

Why Study Business?

CHAPTER 1 | The Dynamics of Business and Economics 7

8 PART 1 | Business in a Changing World

CHAPTER 1 | The Dynamics of Business and Economics 9

[ “Demand is the number of goods and services that consumers are

10 PART 1 | Business in a Changing World

CHAPTER 1 | The Dynamics of Business and Economics 11

P atagonia founder and owner Yvon

12 PART 1 | Business in a Changing World

CHAPTER 1 | The Dynamics of Business and Economics 13

14 PART 1 | Business in a Changing World

CHAPTER 1 | The Dynamics of Business and Economics 15

16 PART 1 | Business in a Changing World

CHAPTER 1 | The Dynamics of Business and Economics 17

FIGURE 1.5 One of the primary lessons of the scan-

duct and also help decrease the rate of

ee misconduct.26 Although these results

suggest that ethics is improving, the

fact that employees continue to report

18 PART 1 | Business in a Changing World

CAN YOU LEARN one of the economic systems as the

BUSINESS IN A reach agreement on one economic

CHAPTER 1 | The Dynamics of Business and Economics 19

20 PART 1 | Business in a Changing World

A nonproﬁts, has to manage the

CHAPTER 2 | Business Ethics and Social Responsibility 23

24 PART 1 | Business in a Changing World

1960s 1970s 1980s 1990s 2000s

The Role of Ethics in Business

Well-publicized incidents of unethical and illegal activity—

CHAPTER 2 | Business Ethics and Social Responsibility 25