Business and¬†society course 101
We develop management skills and¬†learn theories to¬†solve problems, that we will have in¬†future. This article contains the¬†main information, that was in¬†the¬†book.
Entrepreneurship is an¬†Essence of¬†business. It comprises 3 things: innovativeness, risk taking and¬†management skills. These qualities can be learnt, or¬†be the¬†talent.
The¬†innovative process is a¬†process of¬†‚Äúcreative destruction‚ÄĚ.
Henry Ford¬†‚Äď not¬†engineer, but¬†innovator.
He made a¬†car ‚ÄúTin Lizzy‚ÄĚ for¬†ordinary people for¬†$295*25 in¬†our currency. He established franchising system of¬†car shops, petrol stations and¬†promoted highway infrastructures.
The¬†average worker worked 8 hours a¬†day and¬†gained $5 for¬†that ($135 now). The¬†work was safe.
Till 1927 he sold 15m cars, but¬†GMC was more innovative and¬†Ford lost in¬†future.
Ray Kroc¬†‚Äď milkshake seller made a¬†franchise out of¬†a¬†small restaurant.
Dick and¬†Mac McDonald offered cheap and¬†tasty burgers.
Kroc just implemented a¬†conveyer system and¬†optimized the¬†kitchen area.
In¬†2000‚Äôs subway outperformed McDonald‚Äôs, because they made healthy food.
Dietrich Mateschitz¬†‚Äď brought Red Bull from Thailand to¬†Austria.
He had 49% of¬†company, while Thai partner had 51%.
Red Bull is a¬†sport sponsor and¬†has¬†‚ā¨6b in¬†revenues.
Has hundreds of¬†competitors.
Jobs¬†‚Äď Apple, Pixar, NeXT.
Best advertiser ever.
He was kicked out after successful projects, but¬†became an¬†intrapreneur¬†‚Äď entrepreneur in¬†a¬†company. He made Macintosh, but¬†was fired and¬†opened company NeXT, and¬†also sponsored Pixar¬†‚Äď P.S. he did not¬†invent Pixar, he just was the¬†main investor.
‚ÄúA¬†lot of¬†times, people don‚Äôt know what they want until you show it to¬†them‚ÄĚ
What is in¬†common?
- Idea or¬†vision. How to¬†do better?
- They weren‚Äôt engineers, they just implemented marketing, design...
- Work hard for¬†the¬†goal
- Content-related goals (e.¬†g. produce cheap and¬†good cars)
- Profit is on¬†the¬†second place
- Plenty customers who is ready to¬†pay
- Risk of¬†failure
- Create something and¬†make an¬†impact
- Independence or¬†autonomy
- Wealth and¬†fame
Theory of¬†entrepreneurship explains:
- How company grows from startup to¬†enterprise
- How business helps the¬†national economy
- Why businesses fail
- How to¬†create a¬†suitable environment for¬†business (VC, Angels etc)
- Why after a¬†growth, companies loose their positions
Joseph Schumpeter¬†‚Äď Austrian pioneer of¬†the¬†theory of¬†entrepreneurship
Joseph defines dynamic entrepreneur or¬†pioneer as¬†the¬†engine that is driving a¬†progress. Pioneer develops new processes or¬†products. by¬†doing that, he takes an¬†advantage over competitors or¬†creates a¬†new market (blue ocean). But¬†other companies try to¬†imitate or¬†copy the¬†idea of¬†a¬†pioneer. This is called Dynamic competitive process.
When another pioneer will bring a¬†new idea, the¬†old pioneer‚Äôs idea will be destroyed. It is a¬†Process of¬†creative destruction. The¬†last type is a¬†Recombinant Innovation¬†‚Äď when a¬†new idea is a¬†combination of¬†existing ideas.
Entrepreneurial behavior is often ‚Äúirrational‚ÄĚ, rather intuitive. Pioneer‚Äôs idea is innovative, because it breaks old patterns. To¬†increase chances to¬†be successful, we need a¬†business plan.
Business plan shows us an¬†overall concept of¬†a¬†business idea for¬†investors, shows chances and¬†risks, helps to¬†think about further development of¬†business, identifies threats and¬†protects you from overconfidence and¬†wonders.
Disruptive innovation displaces an¬†existing technology.
Business model innovation does not¬†change a¬†product, but¬†a¬†logic of¬†a¬†business plan.
For¬†example: Netfilx displaced video stores, Uber changed a¬†business model of¬†taxi companies.
How much money do you earn or¬†loose?¬†‚Äď How to¬†measure financial business performance? What is a¬†value of¬†a¬†company? How to¬†ensure liquidity and¬†solvency? How to¬†decide on¬†investments?
Taxi OPC example
Lena has¬†‚ā¨50k and¬†wants to¬†open a¬†taxi company. She will buy a¬†car for¬†‚ā¨40k and¬†offer newspapers and¬†coffee to¬†customers for¬†free. To¬†be successful, she need data. Lena asks her friend about taxi business. They forecast¬†‚ā¨3000 in¬†receipts from customers¬†‚Äď revenues. Plus, she will spend¬†‚ā¨500 per¬†month for¬†expected ongoing expenditures such as¬†gas, insurance and¬†coffee.
Her operating (net) cash flow is¬†‚ā¨3000 --¬†‚ā¨500 =¬†‚ā¨2500. Inflow -- outflow = flow.
Lena will buy a¬†car, coffee machine and¬†washing machine. These are capital expenditures or¬†CAPEX. CAPEX is a¬†cash flow from investment activities. The¬†difference is that Lena can sell these things, but¬†used gas or¬†eaten chocolate¬†‚Äď not.
She will sell car (and¬†all other CAPEX) for¬†‚ā¨15k and¬†buy a¬†new one for¬†‚ā¨45k in¬†5 years.
let‚Äôs count cash inflow and¬†outflow
CAPEX (-40000) + Revenues (3000*12) + expenditures (-500*12) = Overall cash flow (-10000) in¬†the¬†year 1.
Revenues (3000*12) + expenditures (-500*12) = Overall cash flow (30000) in¬†the¬†year 2,3,4.
Sell and¬†buy car (15000-45000) + Revenues (3000*12) + expenditures (-500*12) = Overall cash flow (0) in¬†the¬†year 5.
Looks like she lost money in¬†the¬†1st year. but¬†she did not. These are cash flows, not¬†profits. She will definitely loose money if her operating cash flow was negative. Her cash flow is¬†‚ā¨2500. If her cash flow will be higher, she will afford to¬†hire a¬†driver or¬†buy the¬†second taxi. Don‚Äôt forget about capital expenditures. Cash flow is often negative in¬†the¬†1st year, so Lena has to¬†make a¬†Financing decision, where to¬†get money. If she had not¬†‚ā¨50k, she had to¬†borrow money to¬†buy a¬†car. The¬†cash flow from loans or¬†your savings is called Cash flow from financing activities. We don‚Äôt count them in¬†overall cash flow.
Measure profit: Income Statement (P&L)
The¬†problem of¬†CAPEX in¬†cash flow is that we write CAPEX only in¬†the¬†year, when we bought a¬†car, but¬†we used car equally for¬†5 years.
Let‚Äôs count capital expenditure as¬†resale value of¬†car divided for¬†the¬†time you used a¬†car.
‚ā¨40000 --¬†‚ā¨15000 =¬†‚ā¨25000. This is a¬†resale value of¬†a¬†car. Then we payed¬†‚ā¨5000 per¬†year for¬†a¬†car. This is a¬†Straight line Depreciation.
If we are not¬†sure about selling this car, we can count¬†‚ā¨40000/5years = 8000. This is a¬†normal Depreciation, the¬†5th element of¬†EBITDA.
Expenses are the¬†monetary value of¬†resource consumption during a¬†time period (coffee, newspapers)
Revenues are the¬†monetary value of¬†goods/services that were sold during a¬†time period
Difference between Expenses and¬†Expenditures.
Profit in¬†cost of¬†sales method = revenues -- expenses.
Profit in¬†cost of¬†production method = monetary value of¬†goods/services produced during a¬†time period -- expenses. Here we count all the¬†produced and¬†semi-produced goods, that have been sold and¬†have not¬†been sold yet.
Revenues (36000) -- Ongoing expenses (6000) -- Depreciation (5000) = Profit (25000)
This profit is the¬†same for¬†all the¬†years, because the¬†costs are equally allocated.
But¬†can the¬†cost be really equally allocated? What if i the¬†2nd year there were in¬†2 times more rides than in¬†the¬†first? Does not¬†matter, the¬†cost of¬†a¬†car stays the¬†same
Measure profit: Balance Sheet
Corporate net worth (equity) in¬†the¬†beginning of¬†1st year is Taxi (40000) + Bank deposit (10000)¬†‚Äď Liabilities (0) =¬†‚ā¨50000.
Corporate net worth in¬†the¬†end of¬†1st year is Taxi cost (40000)¬†‚Äď Depreciation (5000) + bank deposit(10000 + revenues(36000)¬†‚Äď ongoing expenditures(6000) ) = 35000 + 40000 =¬†‚ā¨75000
Profit = money in¬†the¬†beginning of¬†1st year (75000)¬†‚Äď money in¬†the¬†end of¬†1st year (50000) =¬†‚ā¨25000
difference between income statement and¬†balance sheet
Income statement helps you to¬†optimize your profits. It shows your transactions, that create resources (products, services) and¬† transactions, that consume resources (wages, buying materials, selling goods)
balance sheet shows you, which part of¬†the¬†company is yours and¬†which part does the¬†bank or¬†investor have. Creditors use balance sheet to¬†count risks of¬†your failure.
Both of¬†them are important for¬†shareholders and¬†stakeholders (workers, banks, tax authorities)
There are some legal rules, that say how the¬†structure and¬†valuations have to¬†be made.
It helps e.¬†g. investors to¬†compare different firms. Accounting systems and¬†procedures, that help (external) stakeholders are called Financial Accounting.
Accounting systems (Income statement or¬†balance sheet) provide the¬†basis for¬†company-internal analyses such as¬†forecasting profits and¬†making profound business decisions. Accounting systems and¬†procedures, that help managers are called Management Accounting.
The¬†planning and¬†steering of¬†a¬†company by¬†means of¬†(accounting) data and¬†analytics is also referred to¬†as¬†Management Control or¬†Management/Managerial Accounting.
The¬†three main pillars of¬†accounting
ROI = Profit / invested capital (with government bonds and¬†other securities).
Capital in¬†denominator should always correspond to¬†the¬†definition of¬†profit in¬†numerator.
**Return On¬†Capital Employed* I*
ROCE = EBIT (Earnings Before Interest and¬†Taxes) / Capital employed
Capital does not¬†contain securities. Profit contains interest
Return On¬†Capital Employed II
Roce = Operating Profit (before or¬†after taxes) / Operating Assets
Operating assets are on¬†the¬†left side of¬†the¬†balance sheet
ROE = Profit/Equity
Equity is on¬†the¬†right side of¬†the¬†balance sheet
ROI is the¬†most popular, because it can be easily translated into a¬†value driver system
- You can use the¬†income statement to¬†see the¬†drivers of¬†profit.
- You can use the¬†balance sheet to¬†see the¬†types of¬†capital that comprise overall
capital (types of¬†assets as¬†well as¬†types of¬†claims).
Profit Margin = Profit / Revenues
Liquidity Ratio = Current Assets / Short-term Liabilities
Gearing (leverage ratio) = Dept (liabilities) / Equity
Corporate Finance and¬†investment Decisions
Investment decisions are decisions about business transactions with an¬†initial cash outflow, in¬†the¬†expectation of¬†future cash inflows that exceed the¬†cash outflow in¬†value.
Lena invests in¬†a¬†taxi (cash outflow) to¬†generate revenues in¬†the¬†future (cash inflow). Investment Theory explores the¬†investment decisions and¬†develops criteria for¬†reasonable decision making.
Financing decisions help us to¬†find money for¬†the¬†investments. Financing starts with a¬†cash inflow followed by¬†cash outflows (interest and¬†repayment). Financing Theories deal with the¬†analyses of¬†financing opportunities and¬†financing structures. Lena‚Äôs investments are solely financed with equity. But¬†most entrepreneurial activities cannot be pursued without any use of¬†debt financing.
Financing decisions help corporations got raise equity by¬†issuing shares on¬†the¬†capital market. They can also raise debt capital by¬†issuing bonds (it‚Äôs cheaper than lending money in¬†a¬†bank).
Capital Market Theory is based on¬†Microeconomic Theory, and¬†tries to¬†explain market mechanisms and¬†price determination on¬†capital markets.
The¬†value of¬†a¬†company is given by¬†its equity = Assets -- Liabilities.
Eugen Schmalenbach noted that the¬†(economic) value of¬†an¬†asset for¬†the¬†owner does not¬†follow from the¬†price the¬†owner paid when purchasing the¬†asset, but¬†from the¬†future value (utility) the¬†asset generates for¬†the¬†asset owner. A¬†buyer purchases an¬†object, if the¬†price is lower than the¬†value of¬†future usage from the¬†buyer‚Äôs subjective perspective. Since the¬†price can be observed objectively, but¬†the¬†future value (utility) depends on¬†the¬†buyer and¬†is hard to¬†determine, the¬†purchase price of¬†an¬†asset is often used as¬†an¬†approximation for¬†its value. E.g., the¬†balance sheet uses purchase prices (minus depreciation) as¬†an¬†approximation of¬†asset value.
The¬†purchase price of¬†an¬†asset is an¬†adequate approximation of¬†its value, if the¬†asset is traded on¬†a¬†well-functioning market (many suppliers and¬†consumers, high information transparency, low transaction cost).
Very few assets (and¬†hardly any companies) are traded (as¬†a¬†whole) on¬†well functioning markets. Therefore, there is no¬†‚Äúobjective‚ÄĚ value of¬†most goods (and¬†companies). It all depends on¬†the¬†subjective judgments of¬†potential buyers on¬†their use of¬†these assets (or¬†companies).
When we counted the¬†value of¬†the¬†company by¬†measuring cash flows, we did not¬†count the¬†Inflation.
-40,000 + 30,000 / (1 + r) + 30,000 / (1 + r^2) + 30,000/ (1 + r^3) + 30,000 / (1 + r^4) + 45,000 / (1 + r^5)
= 101,637 for¬†r=0.05
We also did not¬†count a¬†salary. If Lena will have the¬†salary of¬†‚ā¨24k per¬†year, then
+6,000 / (1 + r) + 6,000 / (1 + r^2) + 6,000/ (1 + r^3) + 6,000 / (1 + r^4) +21,000 / (1 + r^5)
= -2,270 for¬†r=0.05
The¬†Net Present Value (NPV) is negative¬†‚Äď so, this is bad investment. Let‚Äôs find the¬†average rate of¬†return. This is r in¬†the¬†previous equation:
+6,000 / (1 + r) + 6,000 / (1 + r^2) + 6,000/ (1 + r^3) + 6,000 / (1 + r^4) +21,000 / (1 + r^5)
the¬†average rate of¬†return r = ~ 3.3%. That means, if there is no¬†inflation, then this business will generate 3.3% of¬†profit a¬†year. Lena will return investments in¬†33 years.
What about investments
Investors are not¬†so much interested in¬†historical purchase prices of¬†assets (balance sheet), but¬†they are more interested in¬†the¬†future cash flows (or¬†earnings) generated by¬†a¬†company‚Äôs activities. While historical purchase prices, however are verifiable, future cash flows are not.
Stock prices are depending on¬†the¬†expectations and¬†future cash flows (earnings) generated by¬†a¬†firm.
Possible purposes for¬†evaluating company value are:
- determination of¬†income taxes
- information of¬†investors, providers of¬†debt (banks) or¬†other stakeholders¬†‚Äď measuring and¬†managing the¬†financial performance of¬†the¬†company
strategy is about competitive advantage and¬†about finding appropriate ways to¬†reach predefined goals.
In¬†a¬†strategic analysis, the¬†resource-based view and¬†the¬†market-based view complement each other.
Ford model T example
There was not¬†such an¬†affordable car on¬†market.
Standardized manufacturing process. lower manufacturing costs than competitors (‚Äúcost leadership‚ÄĚ)
Reason for¬†success¬†‚Äď high value creation for¬†the¬†customer due to¬†low price
Why was a¬†leader just for¬†10 years? imitators copied the¬†manufacturing process and¬†they met the¬†customer preferences. You don‚Äôt have an¬†advantage forever, you should regain it.
Red Bull example
first provider of¬†an¬†energy drink. There are a¬†lot of¬†imitators, who make the¬†same products, unique selling proposition was vanished.
Competitive advantage is a¬†popular and¬†well-perceived brand.
Red Bull is more expensive than competitors, but¬†customers are ready to¬†pay for¬†superior, special product.
Cost leadership, quality leadership and¬†market barriers
Competitive advantage is based on¬†the¬†fact that companies manage to¬†establish potential market barriers against potential competitors
Barriers can be based on:
- low manufacturing cost¬†‚Äď cost leadership
- High product quality, brand¬†‚Äď quality leadership
- Niche product¬†‚Äď combination of¬†both
Strengths and¬†Weaknesses are the¬†Resource-Based View.
Opportunities and¬†Threats are the¬†Market-Based View.
Find your unique and¬†powerful abilities. Think how to¬†improve weak abilities.
What does the¬†market want. How to¬†develop my strengths.
Relative market share = The¬†company‚Äôs own market share / market share of¬†the¬†company‚Äôs strongest competitor
Market growth = increase in¬†market volume compared to¬†the¬†previous year / market volume in¬†the¬†previous year.
Customer perspective focuses on¬†needs and¬†wants, benefits and¬†value created for¬†a¬†customer. Customer oriented view is a¬†core of¬†modern marketing.
‚ÄúThe¬†basic function of¬†marketing is to¬†attract and¬†retain customers at¬†a¬†profit‚ÄĚ.
Customer attraction and¬†retention has to¬†be profitable.
Red Bull example
Customer need¬†‚Äď ‚Äúlifestyle drink‚ÄĚ for¬†sport and¬†adventures.
Advertising and¬†marketing¬†‚Äď associates Redbull with success, sport, fun.
This created an¬†added value for¬†customer. And¬†established a¬†valuable brand.
Ads and¬†marketing are the¬†unique customer advantages of¬†Redbull.
Ford Model T
Customer need¬†‚Äď ‚Äúcheap basic car‚ÄĚ.
By¬†Franchising Ford created a¬†customer-oriented distribution network.
Price and¬†distribution are the¬†unique customer advantage of¬†Ford.
- Physiological needs (food, sleep, shelter)
- Safety Needs (financial security)
- Social Belonging (family, love)
- Esteem (recognition, prestige)
Basic needs are mostly satisfied nowadays.
Marketing stimulates needs from higher layers
Marketing is dishonored as¬†‚Äúdubious‚ÄĚ or¬†‚Äúshallow‚ÄĚ.
In¬†the¬†long run, marketing cannot be successful by¬†deceiving customers, but¬†only by¬†creating a¬†sustainable customer benefit
- Product: which products and¬†services should be offered to¬†a¬†particular group of¬†customers? New products, designs and¬†variations. Brand names, guarantees, packaging, product serving.
- Price: At¬†which price should a¬†product be offered? Price policy, discrimination, willingness to¬†pay of¬†a¬†particular group of¬†customers. Discounts and¬†negotiations.
- Promotion: How can potential new customers be informed about a¬†particular new product and¬†be convinced about its benefit? Ads, promotions, online marketing, social media. Gifts, discount cards for¬†loyal customers.
- Place: How should the¬†product or¬†service be provided to¬†a¬†customer? sale channels (indirect/direct), transport, storage. Number and¬†location of¬†shops
A¬†company can differentiate its products from its competitors and¬†gain a¬†competitive advantage by¬†using the¬†‚Äú4Ps‚ÄĚ
The¬†realized revenue is the¬†central source of¬†‚Äúgenerating money‚ÄĚ. The¬†pricing is crucial with regard to¬†the¬†financial success; a¬†higher price can be justified by¬†more advertising, better service or¬†a¬†customer-oriented distribution.
The¬†precise knowledge about customer wants and¬†needs is essential for¬†the¬†optimal choice of¬†the¬†marketing mix.
Creating sustainable customer benefit is the¬†top priority
Processes and¬†activities within the¬†company should be aligned to¬†wants and¬†needs of¬†the¬†customers
Production and¬†process perspective
The¬†Production perspective deals with the¬†transformation of¬†production
inputs into products and¬†services.
The¬†Process perspective has a¬†goal to¬†optimize the¬†supply chain with regard to¬†customer benefit and¬†the¬†cost of¬†creating goods and¬†services
Ford Model T example
Revolutionary Production process made Ford model T the¬†most affordable car.
The¬†total manufacturing process was divided into small specialized tasks, which were then optimized. For¬†each task it was analyzed which sequence of¬†motions was most suitable to¬†perform the¬†predefined task in¬†a¬†minimum amount of¬†time. This form of¬†optimization using scientific analysis of¬†motion sequences is referred to¬†as¬†‚ÄúScientific Management‚ÄĚ or¬†‚ÄúTaylorism‚ÄĚ (Frederick Taylor).
Ford combined Taylorism with assembly line production.
McDonald‚Äôs made a¬†burger for¬†30 seconds instead of¬†30 minutes. To¬†do that, they made the¬†Business process reengineering. they decomposed a¬†hamburger production in¬†a¬†sequence of¬† activities Taylorism/‚Äúassembly line production
They focused on¬†2 types of¬†burgers (cheeseburger and¬†hamburger) and¬†few softdrinks to¬†reduce complexity of¬†production process and¬†to¬†make fast preparation possible.
In¬†a¬†knowledge based society human resources are key for¬†economic success
The¬†consideration of¬†the¬†production process as¬†an¬†interaction of¬†people is at¬†the¬†core of¬†the¬†employee perspective.
Hawthorne studies¬†‚Äď lights experiments in¬†factory
Engineers conducted a¬†series of¬†scientific management (Taylorism) studies to¬†optimize job performance. There were 2 groups. In¬†the¬†control group received a¬†constant level of¬†light density, while in¬†a¬†‚Äėtreatment group‚Äô the¬†light density was changing. Interesting, but¬†the¬†productivity was increasing in¬†both groups, when they increased the¬†level in¬†both and¬†increased in¬†treatment, when decreased the¬†intensity of¬†illumination.
Harvard professor told that emotional factor were responsible for¬†this effect. He added, that informal structures and¬†social factors (group dynamics, informal hierarchies, group coherence, etc.) influenced the¬†job performance.
These studies had a¬†strong impact on¬†the¬†theory of¬†labor relations and¬†the¬†relevance of¬†incentives and¬†motivation for¬†workers within an¬†organization, development of¬†behavioral (and¬†humanistic) management theories as¬†a¬† ‚Äėcountermovement‚Äô of¬†Taylorism (scientific methods)
- Traditional view of¬†Taylorism and¬†Fordism is that production process is divided into individual tasks to¬†economize the¬†benefits of¬†specialization and¬†to¬†optimize the¬†fulfillment of¬†subtasks.
- Hierarchical organization structure clearly defines responsibilities and¬†authorities
- Motivation and¬†performance is based on¬†centralized authority (threat of¬†layoff), bureaucracy (rules and¬†procedures) and¬†explicit incentives (precised motivation)
Humanistic Management Theory
Business management does not¬†only have an¬†objective/rational component (optimization of¬†processes), but¬†also has ‚Äėpersonal, human, psychological, social‚Äô component. Managers can also influence employees by¬†being charismatic, being a¬†role model or¬†just a¬†good leader with vision of¬†the¬†full picture.
In¬†industrial company machines are the¬†main strategic resources. In¬†today‚Äôs ‚Äėknowledge-based‚Äô society ‚Äėhuman capital‚Äô is the¬†most relevant strategic resource and¬†source of¬†competitive advantage.
Thus, questions on¬†leadership and¬†management of¬†human capital have gained core relevance for¬†the¬†economic success of¬†companies
Corporate Governance as¬†the¬†set of¬†rules and¬†mechanisms that shape value generation and¬†distribution of¬†value (appropriation) among stakeholders.
The¬†independence between the¬†size of¬†the¬†pie and¬†its distribution
three cases to¬†show the¬†importance of¬†business ethics
- Was that harassment in¬†the¬†workplace?
- The¬†Ford Pinto case
- Ethics vs. Career
Check yourself in¬†a¬†quizz
in¬†this PDF you can find answers for¬†the¬†mock exam
If you like that article, please write some comments or¬†share this post in¬†Facebook or¬†anywhere else. Then I will made the¬†same thing for¬†Contemporary Challenges in¬†Business and¬†Economics and¬†other courses.