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For-profit social enterprises offer several benefits, including positive social and environmental impact, economic sustainability through revenue generation, and the ability to attract customers, investors, and employees who value sustainability. However, they also face significant challenges:

1. Funding: Securing patient capital is crucial, as investors may need to wait longer for returns and accept lower profits, given the focus on stakeholder value.

2. Credibility: These enterprises may face distrust from both profit-focused stakeholders and those skeptical of their social or environmental claims. Transparency, ethical practices, and third-party certifications can help build trust.

3. Measuring Impact: Quantifying social or environmental impact is more complex than measuring financial performance but is essential for maintaining credibility.

4. Managing Supply Chains: Ensuring that all parts of the supply chain align with the enterprise's values is critical to avoid reputational damage.

5. Remaining True to Purpose: As the business grows, maintaining focus on its social or environmental mission becomes challenging, especially with diverse stakeholders and external changes.

Overall, while for-profit social enterprises have strong ethical and business potential, they must navigate these challenges carefully to succeed.

Main Features of Non-Profit Social Enterprises

Non-profit social enterprises aim to improve social or environmental outcomes and must prove their purpose to qualify for non-profit status. Key features include:

1. Funding: They rely on grants, donations, or revenue-generating activities (e.g., selling goods/services). Surpluses are legally required to be reinvested into the organization.

2. Governance: Typically run by a board of directors, which hires senior staff and ensures accountability to stakeholders like the community.

3. Purpose: Non-profits are classified by their primary purpose, such as education, healthcare, culture, religion, or advocacy for marginalized groups.

4. Limited Liability: Like corporations, non-profits are separate legal entities, protecting individuals from personal liability.

5. Tax Exemption: Surpluses are tax-free as they are reinvested, not distributed to owners or shareholders.

6. Volunteers: Non-profits often rely on volunteers, reducing operational costs.

7. Diverse Funding: They can access grants and donations unavailable to for-profits, broadening their funding sources.

Evaluation of Non-Profit Social Enterprises

Benefits:

1. Reinvestment of Surpluses: All profits are reinvested into the mission, ensuring funds are used for social/environmental impact.

2. Tax Advantages: Tax-exempt status reduces financial burdens.

3. Volunteer Support: Volunteers help lower costs and increase community engagement.

4. Access to Grants/Donations: Non-profits can tap into funding sources like grants and donations, which are often unavailable to for-profits.

Challenges:

1. Funding Instability: Reliance on grants and donations can lead to persistent funding challenges, as these sources are competitive and unpredictable.

2. Resource Allocation: Time and energy spent on fundraising can detract from the organization’s core mission.

3. Limited Salaries: Lower pay may hinder recruitment and retention of talent, though employee motivation is often high.

4. Administrative Burden: Setting up and maintaining non-profit status involves significant paperwork and compliance with legal requirements to prove social/environmental impact.

Example: Universities as Non-Profits

Universities often operate as non-profits, generating revenue through tuition, research grants, and donations. Surpluses are reinvested into the institution, sometimes accumulating as endowments, which generate interest to support long-term operations.

In summary, non-profit social enterprises offer unique advantages like tax benefits and access to diverse funding, but they face challenges such as funding instability and administrative complexity. Their success depends on balancing financial sustainability with their social or environmental mission.

Planning Begins with Purpose

Effective organizations start by defining their purpose—the "why" behind their existence. This purpose is typically articulated through vision and mission statements, which serve as guiding principles for the organization. A clear purpose not only helps achieve organizational goals but also fosters employee motivation by giving them a sense of personal meaning in their work.

Vision and Mission Statements

Vision Statement:

• Definition: A long-term goal or dream that outlines what the organization aspires to achieve in the future.

• Purpose: Inspires and motivates stakeholders by painting a picture of the desired future.

• Example: The Ellen MacArthur Foundation’s vision is to create a circular economy, where resources are reused and recycled to minimize waste.

Mission Statement:

• Definition: A concrete statement that describes what the organization does now to achieve its vision.

• Purpose: Provides a clear focus for daily operations and decision-making.

• Example: The Ellen MacArthur Foundation’s mission is "to accelerate the transition to a circular economy."

Importance of Vision and Mission Statements

1. Internal Alignment: They help employees stay focused on long-term goals while navigating daily tasks.

2. Crisis Management: Serve as a reference point during challenges or major decisions.

3. External Communication: Stakeholders, including customers and investors, use these statements to understand the organization’s priorities and purpose.

4. Credibility: If an organization fails to align its actions with its vision and mission, it risks losing trust and credibility.

Crafting Effective Statements

• Clarity and Precision: Statements must be carefully worded to reflect the organization’s true purpose.

• Commitment from Leadership: Senior management must take these statements seriously to ensure they are respected and followed.

• Employee Connection: Employees need to feel personally connected to the vision and mission to stay motivated.

Personal Purpose

Just as organizations need a purpose, individuals benefit from understanding their own "why." Resources like the Purpose Challenge (from the Greater Good Science Center) and Simon Sinek’s Finding Your WHY can help individuals explore their personal purpose.

Key Takeaways

• Vision: The dream or long-term goal (e.g., a sustainable circular economy).

• Mission: The actionable steps taken to achieve that vision (e.g., accelerating the transition to a circular economy).

• Impact: Clear, meaningful statements inspire employees, guide decision-making, and build credibility with stakeholders.

Value Creation in Business

When you walk into a bakery, you expect certain things: delicious bread, fresh coffee, friendly staff, comfortable seating, good music, or even WiFi. These needs, wants, and expectations represent the value the bakery creates for you as a consumer. Value is central to business activity, but it is subjective and varies depending on individual and shared beliefs, assumptions, and judgments. Different stakeholders perceive value differently, making it a dynamic and contested concept.

Relationship Between Value and Business Objectives

Value in a business context refers to any benefit experienced by stakeholders connected to the organization. Business objectives are closely tied to the creation and distribution of this value. For a business to succeed, it must create value for multiple stakeholders, each of whom contributes to and benefits from the business in different ways.

Table 1: Value Created by and Received by Stakeholders in a Bakery

Key Insights:

1. Common Interest: All stakeholders share a common interest in the business being financially viable. This means the business must at least cover its costs (or generate profits/surplus).

2. Diverse Value: Value takes many forms—financial, social, environmental, and experiential—and is created and received by multiple stakeholders.

3. Stakeholder Interdependence: The success of the business depends on the mutual exchange of value between stakeholders.

Business Objectives

Business objectives are stated outcomes that a business aims to achieve. They can be broad (e.g., mission and vision statements) or specific (e.g., team or individual goals). Specific objectives often follow the SMART criteria:

• S – Specific

• M – Measurable

• A – Attainable

• R – Relevant

• T – Time-focused

Objectives can relate to:

• Growth

• Profits

• Market share

• Customer satisfaction

• Ethics and sustainability

Connecting Purpose to Objectives

Understanding the purpose of the business (its "why") is essential for setting concrete objectives. The vision and mission statements provide the big-picture direction, while specific objectives align with this purpose to guide daily operations and decision-making.

Summary

• Value is subjective and varies by stakeholder, but it is central to business success.

• Stakeholders (owners, consumers, employees, suppliers) both create and receive value from the business.

• Business objectives are tied to value creation and should align with the organization’s purpose, often following SMART criteria.

• A clear purpose (vision and mission) is essential for setting meaningful objectives and ensuring long-term success.

Growth and Profits: Protecting Shareholder Value

Historically, the primary objective of businesses was to maximize profits for shareholders, a view popularized by economist Milton Friedman in 1970. He argued that the sole responsibility of businesses is to generate profits for their owners. However, this perspective is increasingly being challenged as businesses recognize the need to balance profit-making with the interests of other stakeholders and the environment.

The Traditional Focus on Growth and Profits

1. Shareholder Primacy:

   • Businesses prioritizing profit maximization focus on growth to increase revenue and reduce production costs, thereby boosting profits.

   • Growth and profit generation have created significant wealth for shareholders and owners.

2. Downsides of Excessive Profit Focus:

   • Excessive Value Extraction: Shareholders may capture a disproportionate share of value, often at the expense of other stakeholders (e.g., workers, the environment, or long-term business health).

   • Short-Termism: Many shareholders and managers prioritize short-term profits over long-term sustainability, leading to practices like:

     • Paying workers below a living wage.

     • Cutting costs through environmentally harmful processes.

     • Underinvesting in the business’s future.

3. Decline in Long-Term Perspective:

   • The average stock holding period has dropped from 8 years in the mid-20th century to just 5 months in 2020, reflecting a shift toward short-term gains over long-term stability.

The Changing Perspective

While profit remains essential for business sustainability, there is growing recognition that exclusive focus on shareholder value can harm other stakeholders and the environment. Businesses are increasingly adopting a stakeholder-oriented approach, balancing profit-making with social and environmental responsibilities. This shift is driven by:

• Consumer demand for ethical and sustainable practices.

• Regulatory pressures to address environmental and social issues.

• The realization that long-term business success depends on the well-being of all stakeholders.

Key Takeaways

1. Profit Maximization: Historically, businesses focused on maximizing shareholder value through growth and cost reduction.

2. Excessive Value Extraction: Prioritizing short-term profits can lead to unfair practices, harming workers, the environment, and long-term business health.

3. Short-Termism: The decline in stock holding periods reflects a lack of long-term perspective among shareholders.

4. Evolving Priorities: Businesses are increasingly balancing profit-making with social and environmental responsibilities to ensure sustainable success.

In summary, while growth and profits are important, businesses must consider the broader impact of their actions on all stakeholders and the environment to achieve long-term success.

Corporate Social Responsibility (CSR): Evolution and Impact

Businesses are increasingly broadening their objectives beyond growth and profit to include Corporate Social Responsibility (CSR). CSR has evolved significantly over time, shifting from external philanthropic actions to a more integrated, stakeholder-focused approach that emphasizes regenerative and distributive practices.

Evolution of CSR

1. Early CSR:

   • Initially, CSR referred to business self-regulation and contributions to societal goals through philanthropy, charity, or employee volunteerism.

   • These actions were often separate from core business activities.

2. Creating Shared Value (CSV):

   • Michael Porter’s CSV theory emphasized that businesses and communities are interdependent.

   • Solving social and environmental problems can improve a business’s bottom line, making CSR a tool for profit maximization.

3. Modern CSR:

   • CSR is no longer just about profit maximization but about distributing value to multiple stakeholders.

   • As Paul Polman (former CEO of Unilever) highlights in Net Positive, businesses should aim to optimize and distribute value for all stakeholders, not just shareholders.

   • This approach is captured in the question:
     How can our business support thriving people, in a thriving place, while respecting the wellbeing of people worldwide and the health of the whole planet?

CSR in Practice: A Matrix for Impact

Businesses must consider their social and ecological impacts at both local and global scales. The following matrix (Table 1) helps businesses evaluate their responsibilities:

Social Responsibilities

1. Local-Social Responsibilities:

   • Businesses should address basic human needs (e.g., food, employment, income) in their local communities.

   • Example: A bakery might provide secure jobs, fair wages, and contribute to local community networks.

2. Global-Social Responsibilities:

   • Businesses must ensure their supply chains are ethical and sustainable.

   • Example: A bakery should ensure suppliers pay living wages and provide safe working conditions.

Ecological Responsibilities

1. Local-Ecological Responsibilities:

   • Businesses can support local ecosystems through regenerative practices like urban gardening, renewable energy, and water recycling.

   • Example: A bakery might plant gardens to improve air quality and biodiversity.

2. Global-Ecological Responsibilities:

   • Businesses must reduce their impact on planetary boundaries (e.g., climate change, biodiversity loss).

   • Example: A bakery could reduce CO2 emissions, use regenerative agriculture, and adopt sustainable transportation methods.

Benefits of CSR

1. Positive Impact:

   • CSR helps businesses improve their social and environmental impact, aligning with ethical responsibilities.

2. Business Case for CSR:

   • Increased Revenue: Purpose-driven brands (e.g., Unilever’s sustainable brands) grow faster and have higher profit margins.

   • Customer Loyalty: Consumers prefer and remain loyal to businesses that align with their values.

   • Employee Motivation: Purpose-led businesses attract and retain talented employees.

   • Risk Reduction: CSR reduces future risks and prepares businesses for stricter regulations.

Limitations of CSR

1. Cultural Change:

   • Shifting to a CSR-focused culture requires significant effort and stakeholder buy-in.

   • Shareholders, managers, and employees may resist change.

2. Increased Costs:

   • Implementing ethical supply chains and sustainability training can raise short-term costs.

3. Reputational Risk:

   • Failing to meet CSR commitments can damage a business’s reputation, though the risk of inaction is often greater.

Activity: Applying CSR to Schools

1. Task:

   • Consider a change your school is planning (e.g., building renovations, new food offerings).

   • Use the CSR matrix to brainstorm how the change could improve social and ecological impacts at local and global scales.

2. Reflection:

   • How could this matrix improve school decision-making?

Key Takeaways

• CSR Evolution: From philanthropy to shared value and now to regenerative and distributive practices.

• Stakeholder Focus: Businesses must balance the needs of all stakeholders, not just shareholders.

• Local and Global Impact: CSR requires addressing both social and ecological responsibilities at local and global levels.

• Benefits: CSR enhances reputation, revenue, employee motivation, and risk management.

• Challenges: Implementing CSR requires cultural change, investment, and careful management of reputational risks.

By adopting CSR, businesses can become generative and distributive, creating value for people and the planet while ensuring long-term success.

Strategies and Tactics: Unilever’s Approach to Sustainability

Unilever, a multinational consumer products company, provides a compelling case study of how businesses develop strategies and tactics to achieve their objectives. In 2010, Unilever launched the Unilever Sustainable Living Plan (USLP), a 10-year strategy to improve sustainability. While the plan achieved some success, it also faced criticism, leading to the development of an updated strategy called the Unilever Compass.

What is a Strategy?

A strategy is a comprehensive plan designed to achieve specific long-term objectives. It involves significant decisions, senior management, and a focus on the "how" of achieving the business’s vision and mission. Key elements of strategic planning include:

1. Alignment with Vision and Mission: Ensuring the strategy reflects the business’s purpose.

2. Market and Product Research: Understanding the external environment and customer needs.

3. Local and Global Impact: Considering social and ecological responsibilities (see Table 1 in Section 1.3.4).

4. SWOT Analysis: Evaluating internal strengths/weaknesses and external opportunities/threats.

5. Funding and Milestones: Securing resources and setting benchmarks for progress.

Unilever’s Strategy: The Unilever Compass

The Unilever Compass outlines the company’s mission to make sustainable living commonplace. Key aspects of the strategy include:

1. Meeting Human Needs:

   • Addressing social sustainability by focusing on basic human needs (e.g., food, hygiene, health).

   • Aligning with the Doughnut Economics Model and the Social SDGs.

2. Environmental Sustainability:

   • Reducing environmental impact by respecting planetary boundaries (e.g., climate change, biodiversity loss).

   • Transitioning to circular production systems to minimize waste.

3. Stakeholder Engagement:

   • Prioritizing stakeholders (e.g., consumers, employees, suppliers) in decision-making.

4. Growth Objectives:

   • Balancing financial growth with social and environmental goals.

Activity: Analyzing the Unilever Compass

1. Mission Alignment:

   • Identify how Unilever’s strategy reflects its mission of making sustainable living commonplace.

2. Human Needs:

   • Explore how Unilever addresses social sustainability (e.g., food, hygiene, health).

3. Environmental Sustainability:

   • Examine Unilever’s efforts to respect planetary boundaries (e.g., reducing carbon emissions, promoting biodiversity).

4. Stakeholder Prioritization:

   • Analyze why Unilever lists stakeholders in a specific order and how this reflects its values.

5. Growth and Sustainability:

   • Evaluate the compatibility of Unilever’s growth objectives with its social and environmental goals.

6. Criticism and Credibility:

   • Research credible sources criticizing Unilever’s sustainability claims, using criteria like currency, relevance, authority, accuracy, and purpose.

Shift to Circular Strategies

Businesses are increasingly adopting circular strategies to replace linear (take–make–waste) production systems. Circular strategies focus on reducing waste and reusing resources, aligning with sustainability goals. Key drivers of this shift include:

What are Tactics?

Tactics are smaller, short-term actions taken to achieve strategic goals. Unlike strategies, tactics are:

• Less Ambitious: Focused on specific, reversible actions (e.g., pricing changes, promotions).

• Shorter-Term: Implemented over shorter timeframes.

• Less Risky: Errors are less likely to jeopardize the organization’s long-term success.

For example, a large corporation opening a new store might be a tactic, while for a small business, it could be a strategic decision.

Key Takeaways

1. Strategy vs. Tactics:

   • Strategy: Long-term, comprehensive plans to achieve major objectives.

   • Tactics: Short-term, smaller actions to support strategic goals.

2. Unilever’s Approach:

   • The Unilever Compass reflects a commitment to sustainability, balancing growth with social and environmental responsibilities.

3. Circular Strategies:

   • Businesses are shifting from linear to circular systems to reduce waste and respect planetary boundaries.

4. Tactical Flexibility:

   • Tactics allow businesses to adapt quickly without compromising long-term strategies.

By integrating strategic planning and tactical actions, businesses like Unilever can achieve sustainable growth while addressing the needs of people and the planet.

You may have walked through a forest and seen leaves scattered on the ground, perhaps along with plastic waste. Over the course of a few months, nature will decompose the leaves to form new fertile soil for the trees and plants. The plastic will take hundreds of years to break down. Figure 1. Nature wastes nothing; humans waste too much. Credit: ROBERT BROOK/SCIENCE PHOTO LIBRARY, Getty Images Circular business models aim to get businesses to work more like nature, by designing systems that feed back outputs as inputs, and designing out waste from the start. The short video below from the Ellen MacArthur Foundation, which you learned about in Section 1.3.5, explains the circular economy. Video 1. Explaining the circular economy. International Mindedness Circular models are not new. In fact, indigenous populations around the world are known for using circular strategies to live in harmony with nature and each other. In the United Nations article below, many examples of indigenous cultures using circular strategies are highlighted. For a truly circular economy, we need to listen to indigenous voices. One of the examples cited in the article is highlighted in the following video. (Note: the video in Spanish with English subtitles.) Video 2. How a group of farmers in Costa Rica are using a circular model. What can we learn bout improving global sustainability from these cultures? Principles of circular economy Before exploring circular business models, it helps to understand three underlying principles that guide thinking on circularity, according to the Ellen MacArthur Foundation. Concept Creativity and Sustainability Moving from a take–make–waste linear economic system to a more sustainable system that is based on circular principles depends upon designers and manufacturers thinking creatively. From the moment they have an idea about meeting a human need or solving a problem, designers and manufacturers need to consider how to embed circularity into choices of materials, manufacturing process, and the product’s end of life. This requires moving away from current materials and processes and reimagining or inventing new materials, manufacturing and recovery. New business models need to be used, requiring flexible thinking across traditional disciplines. Table 1. Principles of a circular economy. Principle Description 1. Eliminate waste and pollution Waste and pollution are design flaws. We can design products from the start to be circular. 2. Circulate products and materials With planning and good design, we can ensure that products can be reused, repaired or remanufactured. Food and packaging should be circulated, avoiding landfills. 3. Regenerate nature Nature wastes nothing. If we return nutrients to the Earth’s systems, we can enhance and rebuild natural resources.

Circular Business Models: Learning from Nature

Circular business models aim to mimic nature’s efficiency by designing systems where outputs become inputs, eliminating waste from the start. Unlike linear models (take–make–waste), circular systems prioritize sustainability and regeneration. This approach is inspired by indigenous practices and guided by principles developed by organizations like the Ellen MacArthur Foundation.

Key Principles of a Circular Economy

The circular economy is built on three core principles:

Learning from Indigenous Cultures

Indigenous communities have long practiced circular strategies, living in harmony with nature. Examples include:

• Costa Rican Farmers: Using circular models to sustainably manage resources (see Video 2).

• Global Indigenous Practices: Highlighted in the United Nations article, these practices emphasize respect for nature and resource efficiency.

Key Takeaway: Indigenous knowledge offers valuable lessons for improving global sustainability and transitioning to circular systems.

Creativity and Sustainability in Design

Transitioning to a circular economy requires creative thinking in design and manufacturing. Key considerations include:

1. Material Selection: Choosing sustainable, recyclable, or biodegradable materials.

2. Manufacturing Processes: Designing processes that minimize waste and energy use.

3. End-of-Life Planning: Ensuring products can be reused, repaired, or recycled.

4. New Business Models: Adopting models like product-as-a-service or sharing economies.

Video Resources

1. Explaining the Circular Economy (Ellen MacArthur Foundation):

   • A short video introducing the concept of circularity and its benefits.

2. Costa Rican Farmers’ Circular Model:

   • A video (in Spanish with English subtitles) showcasing how farmers use circular strategies to promote sustainability.

Key Takeaways

1. Circular Economy Principles:

   • Eliminate waste and pollution.

   • Circulate products and materials.

   • Regenerate natural systems.

2. Indigenous Wisdom:

   • Indigenous cultures provide proven examples of circular living and resource management.

3. Design for Circularity:

   • Creativity and innovation are essential for embedding circularity into products and processes.

4. Global Sustainability:

   • Circular models offer a pathway to reduce environmental impact and rebuild natural resources.

By adopting circular business models, businesses can align with nature’s principles, reduce waste, and contribute to a more sustainable future.

Introduction to stakeholders An organisation is often thought of as a single unit making decisions as one entity. In reality, organisations are made up of different groups, called stakeholders, that often compete for influence and control. A stakeholder is any individual or group that affects, or is affected by, an organisation. Stakeholders can be classified according to whether they are considered to be inside the organisation (internal stakeholders) or outside the organisation (external stakeholders). For example, the image below shows a variety of stakeholders, both internal and external, in a railway company. Figure 1. Internal and external stakeholders. Exam tip You should be aware that the distinction between internal and external stakeholders is not always very clear. For example, internal stakeholders such as employees are also part of the community and have a different view on business activities in their role as part of the community. As internal stakeholders, they might be interested in job security and work conditions, while as external stakeholders they might be concerned about the business damaging the natural environment. Internal stakeholders An internal stakeholder is an individual or group that affects, or is affected by, an organisation and is directly involved inside the organisation. Internal stakeholders include managers, employees and (usually) shareholders. Managers are the individuals who run the organisation. They are responsible both for setting aims and objectives, and for making sure these aims and objectives are met. In order to be successful, managers must create an environment in which employees can work together to meet these objectives. Managers may have personal ambitions too, such as the advancement of their own careers, compensation, benefits, legacy and job security. ​​Employees are the individuals who work for the company. Like managers, employees are motivated by personal interests in compensation, benefits, job security and working conditions. As many modern businesses have moved to empower employees, the distinction between managers and employees has become less clear. It is important to understand that in the real world people may have blurred stakeholder roles. Figure 2. Many employees, such as engineers, may have both managerial and operations responsibilities, blurring their stakeholder roles. Credit: TuiPhotoengineer, Getty Images Shareholders are the owners of the company. Shareholders invest in a business in order to receive a return on their investment. They are therefore primarily concerned with the company’s profitability. Profits will allow shareholders to receive a return on their investment in the form of dividends or an increase in the value of their ownership interest (capital gains). Shareholders are sometimes considered to be external stakeholders because, in the case of large publicly held companies, they are generally not involved in the day-to-day running of the business. However, shareholders appoint a board of directors, which chooses a CEO to run the company in the shareholders’ interest. This explains why most sources consider shareholders to be internal stakeholders. Figure 3. Shareholders in a corporation elect a board of directors to act in their interest. Credit: skynesher, Getty Images Internal stakeholders, such as managers and employees, can also be shareholders of the company. This is the case if some of their compensation is paid out in shares or if they choose to purchase company shares. In June 2020, during the COVID-19 pandemic, Zoom paid its employees stock bonuses, so its employees benefitted from the increase in stock price. Again, this shows that there can be significant blurring of stakeholder roles. Figure 4. Zoom gave stock to their employees in the pandemic. Credit: Paperghosts You should note that discussions related to shareholders tend to focus on publicly held companies. As mentioned in Section 1.3.1, investors in these companies often look for short-term profits, placing them in conflict with the longer-term interests of some other stakeholders. One way in which governments try to align the interests of shareholders and other stakeholders in companies is by imposing a higher capital gains tax rate on short-term (speculative) investment and lower tax rates on long-term investment. This encourages long-term investment, aligning the interests of shareholders and other stakeholders of the company, with both focused on the long-term performance of the business. In the case of sole traders, partnerships and privately held companies, there is no distinction between shareholders and managers. The individuals who own and run the organisation are the same, therefore their long-term interests are better aligned.

Introduction to Stakeholders

An organization is not a single entity but a collection of stakeholders—individuals or groups that affect or are affected by the organization. Stakeholders can be classified as internal (inside the organization) or external (outside the organization). However, the distinction between internal and external stakeholders is often blurred, as individuals can have multiple roles.

Internal Stakeholders

Internal stakeholders are directly involved in the organization and include:

1. Managers:

   • Responsible for setting and achieving organizational objectives.

   • Motivated by personal ambitions (e.g., career advancement, compensation, job security).

   • Create an environment for employees to work effectively.

2. Employees:

   • Work for the company and are motivated by compensation, benefits, job security, and working conditions.

   • In modern businesses, the line between managers and employees is often blurred, as employees may take on managerial responsibilities.

3. Shareholders:

   • Owners of the company who invest for a return on their investment (e.g., dividends, capital gains).

   • Primarily concerned with profitability.

   • In large publicly held companies, shareholders are not involved in day-to-day operations but appoint a board of directors to represent their interests.

   • Employees and managers can also be shareholders if they receive stock as part of their compensation (e.g., Zoom’s stock bonuses during the COVID-19 pandemic).

Blurring of Stakeholder Roles

• Employees as Shareholders: Employees who own shares have dual interests—job security and financial returns.

• Managers as Shareholders: Managers with stock options may prioritize short-term profits to boost stock prices.

• Community Members: Employees and managers are also part of the community and may have concerns about the organization’s environmental or social impact.

Shareholders and Long-Term Interests

• Publicly Held Companies: Shareholders often focus on short-term profits, which can conflict with the long-term interests of other stakeholders (e.g., employees, the environment).

• Government Intervention: To align shareholder interests with long-term goals, governments may impose higher capital gains taxes on short-term investments and lower taxes on long-term investments.

• Privately Held Companies: In sole proprietorships, partnerships, and private companies, owners and managers are the same, aligning their long-term interests.

Key Takeaways

1. Stakeholder Classification:

   • Internal Stakeholders: Managers, employees, and shareholders.

   • External Stakeholders: Community, customers, suppliers, government, etc.

2. Blurred Roles:

   • Employees and managers can also be shareholders, creating overlapping interests.

3. Shareholder Interests:

   • Shareholders prioritize profitability, but their focus on short-term gains can conflict with long-term sustainability.

4. Government Role:

   • Tax policies can encourage long-term investment, aligning shareholder interests with broader stakeholder goals.

By understanding the roles and interests of stakeholders, organizations can better balance competing priorities and work toward sustainable success.

An external stakeholder is an individual or group that affects, or is affected by, an organisation, but who is not directly involved inside the organisation. For the most part, external stakeholders have less influence over the organisation than internal stakeholders. However, this does not mean that they can be ignored. Figure 1. External stakeholders have less influence than internal stakeholders, but they cannot be ignored. Customers include both individuals and other businesses that purchase the products of the organisation. They demand good service and quality products that are also safe and are sold at a reasonable price. Customers can be a driving force for a company to change its practices in order to be more ethical and sustainable. In many research surveys, the majority of people that respond say that they would switch brands if a business violated their values. Activity Learner profile: Principled Approaches to learning: Research skills (media literacy) Consumers can affect business decisions, but only if they are informed about ethical and sustainable business practices. An increasing number of platforms help consumers put their power to use. One such platform is Ethical Consumer, a non-profit social enterprise that rates consumer goods. Open the Ethical Consumer website , find a chocolate brand that you are familiar with and find its ranking based on cocoa and palm oil sourcing. Find a chocolate brand similar to the one you have just accessed but that has a better rating. How easy or difficult would it be for you to change your buying habits to a business with a better rating? Why? Suppliers are the individuals and businesses that sell goods and services to another organisation. They want to be paid prices that are both fair and reasonable for these inputs. They also wish to maintain a stable business relationship with the companies they supply in order to ensure a reliable market for their goods. Suppliers are therefore concerned about the health and continued existence of the businesses to which they sell. International Mindedness In Subtopic 1.6 you will learn about multinational companies (MNCs). Since these businesses operate in more than one country, their stakeholders – such as customers, suppliers and employees – may be based in different countries. As a result, they may have different legal frameworks and also different expectations of what constitutes ethical and sustainable practices. Governments regulate organisations in order to protect the public interest. They also enforce laws and reprimand businesses when necessary. In addition, governments, particularly local governments, are dependent upon businesses to provide tax revenues and employment. In some cases governments are also customers of businesses, as is the case for the defence industry and the pharmaceutical industry. As you learned in Section 1.2.3, governments also sometimes hire for-profit social enterprises to provide essential public services, such as recycling. Governments may also intervene to align the interests of stakeholders. Figure 2. During the COVID-19 pandemic, governments introduced guidance and regulation to protect all stakeholders in an organisation. Credit: Mixetto, Getty Images Labour unions exist to protect the livelihoods and rights of employees; they are important stakeholders for many organisations. Unions usually represent employees in many different companies; that way they have more resources to defend employees’ interests than the employees in a single company acting alone. You will study unions in Subtopic 2.7. Banks and financial institutions lend organisations money so they can invest and carry out their operations. Banks want to be sure that these loans are paid back, with interest, on time. They will therefore monitor the organisation's financial health closely using final accounts (Subtopic 3.4). Banks will also pay attention to other indicators of the organisation’s health as reported in the community and in the media. In the event of difficulty, companies may be able to renegotiate the payment schedules they have with their lenders. You will study these issues in Subtopic 3.2, Sources of finance. Society as a whole, as well as the natural environment, is affected by business behaviour. When society’s interests are not adequately met by businesses or defended by government, local communities, pressure groups (also called interest groups) and/or environmental organisations may step in to hold businesses accountable to communities and the environment. Local communities are most directly impacted by business decisions to locate to a given area, or to shut down their operations there. These communities may benefit from jobs and tax revenues, but may also be disadvantaged by things like traffic and pollution. Figure 3. Environmental or other groups will often protest against business ​​​​​or government behaviour. Credit: E4C, Getty Images Activity Learner profile: Knowledgeable Approaches to learning: Thinking skills (critical thinking) Sort the following into internal and external stakeholders. Activity Learner profile: Thinkers Approaches to learning: Thinking skills (critical thinking, transfer) Think of a local business with which you are familiar. It could be an on-campus store or a local cafe. Copy and complete the table below showing the interests of external and internal stakeholders in the business and discuss with a partner or submit to your teacher. Local business name: Stakeholders What do they expect from the business? What structures and provisions exist to represent their interests? What can they do to get what they want? Internal stakeholders External stakeholders skip the activity

External Stakeholders

External stakeholders are individuals or groups that affect or are affected by an organization but are not directly involved in its operations. While they may have less influence than internal stakeholders, their interests cannot be ignored. Key external stakeholders include:

1. Customers

• Who They Are: Individuals or businesses that purchase the organization’s products or services.

• Expectations:

  • High-quality, safe, and reasonably priced products.

  • Ethical and sustainable practices.

• Influence: Customers can drive change by switching to brands that align with their values. For example, many consumers prefer brands with ethical sourcing practices (e.g., fair-trade cocoa or palm oil).

Activity:

• Visit the Ethical Consumer website to compare chocolate brands based on ethical sourcing.

• Reflect on how easy or difficult it would be to switch to a more ethical brand.

2. Suppliers

• Who They Are: Individuals or businesses that provide goods or services to the organization.

• Expectations:

  • Fair and reasonable payment for their inputs.

  • Stable, long-term business relationships.

• Influence: Suppliers depend on the organization’s financial health and sustainability for their own success.

3. Governments

• Who They Are: Local, national, or international regulatory bodies.

• Expectations:

  • Compliance with laws and regulations.

  • Contribution to public welfare through taxes and employment.

• Influence:

  • Governments enforce laws, protect public interests, and may intervene to align stakeholder interests (e.g., during the COVID-19 pandemic).

  • They may also act as customers (e.g., defense or pharmaceutical industries).

4. Labour Unions

• Who They Are: Organizations that represent employees across multiple companies.

• Expectations:

  • Protection of employees’ rights and livelihoods.

  • Fair wages, benefits, and working conditions.

• Influence: Unions advocate for employees’ interests and can negotiate with businesses on their behalf.

5. Banks and Financial Institutions

• Who They Are: Entities that provide loans and financial services to organizations.

• Expectations:

  • Timely repayment of loans with interest.

  • Monitoring of the organization’s financial health.

• Influence: Banks can renegotiate payment terms or withdraw support if the organization faces financial difficulties.

6. Society and the Environment

• Who They Are: Local communities, pressure groups, and environmental organizations.

• Expectations:

  • Businesses should operate responsibly, minimizing negative impacts (e.g., pollution, traffic).

  • Contribution to community well-being (e.g., jobs, tax revenues).

• Influence:

  • Communities and advocacy groups can hold businesses accountable through protests, campaigns, or legal action.

Activity: Analyzing Stakeholder Interests

1. Identify Stakeholders:

   • Sort stakeholders into internal (e.g., managers, employees, shareholders) and external (e.g., customers, suppliers, governments).

2. Local Business Example:

   • Choose a local business (e.g., a café or on-campus store).

   • Complete a table analyzing the interests of internal and external stakeholders:

Key Takeaways

1. External Stakeholders:

   • Include customers, suppliers, governments, unions, banks, and communities.

   • Have less direct influence but play a critical role in shaping business practices.

2. Customer Power:

   • Consumers can drive ethical and sustainable practices by supporting responsible brands.

3. Government Role:

   • Regulates businesses, protects public interests, and aligns stakeholder goals.

4. Community and Environmental Advocacy:

   • Pressure groups and communities hold businesses accountable for their social and environmental impact.

By understanding and addressing the needs of external stakeholders, businesses can build stronger relationships, enhance their reputation, and contribute to sustainable development.

Stakeholders are interdependent and yet there can be tension between their interests. Both this section and Section 1.4.4 will explore areas of stakeholder alignment and areas of stakeholder conflict. Stakeholder alignment Most stakeholders in a company will be better off if the company thrives; they have a 'stake' in the company's success. Stakeholder groups usually understand that the fulfilment of their interests is constrained by the interests of other stakeholders. For example, customers may benefit from low prices, but they can see that companies need to cover their costs or they will go out of business. Managers and employees appreciate generous pay packages, but they usually understand that profits are also necessary in order to ensure the future of the business. Shareholders may want to receive high dividends, but these cannot be paid year after year while satisfying customers and maintaining a happy and productive workforce. In general, stakeholder interests are often more aligned in the long term than in the short term. Economic sustainability: Most stakeholders will want to see a business survive and thrive, especially if it is meeting human needs. Stakeholders recognise that the business needs to cover its costs at a minimum. For-profit businesses will need to or want to earn profits, which may be distributed to shareholders or reinvested back into the business. Sociocultural sustainability: Most stakeholders associated with a business want it to have a positive impact on people, both locally and globally. This means distributing value to a wide range of stakeholders instead of extracting value for just one group. Businesses are part of societies and depend on social health. Environmental sustainability: Most stakeholders associated with a business want it to have a positive impact on the planet. Businesses are a part of the environment and depend on the health of the planet for their future. Even though stakeholders may all agree on these long-term objectives, they may disagree about the methods of reaching them. They may also disagree about the balance between these and other business objectives and the pace of actions to reach these objectives. Stakeholder conflict With so many diverse interests, stakeholders are bound to come into conflict. Although most stakeholders do not wish the company ill, they may prioritise their own interests over those of other stakeholders. It is usually the role of management to reconcile the competing interests of shareholders in the company’s interest. Not all stakeholders can be satisfied at all times. Management has to prioritise demands that are most legitimate and that must be met in the interest of the organisation. It would be impossible to list the many potential conflicts between stakeholders, but the following are a few of the more common examples: Managers and employees: Management may wish to maximise productivity, while employees may prefer to work under less stressful conditions. One potential solution to this is employee participation in management or ownership (see Section 1.2.3) and performance-related pay (see Subtopic 2.4 Motivation). Shareholders and managers: Managers may sometimes look after their own interests rather than those of the shareholders. They may engage in activities that improve their personal reputation or remuneration without improving profits. One potential solution to this is granting managers stock options to buy shares in order to try to align their interests with those of shareholders. This solution, however, has become controversial in recent years, and may pit managers with shareholders against other stakeholders with longer-term interests in the business. Figure 1. It is usually the job of management to reconcile the competing ​​​​​interests of stakeholders. Credit: Sorbetto, Getty Images Shareholders and the government: Governments expect businesses to pay their fair share of taxes, according to the law of the country in which they operate. Shareholders may pressure management to reduce the company’s tax burden through sophisticated accounting and legal schemes. Minimising taxes is not in the interest of the government of the country in which the company’s operations are located. Watch the video below to see how Amazon minimises its tax burden. Video 1. How Amazon keeps down its tax bills. Local community and shareholders: Shareholders often want to maximise returns on investment, while the concerns of the local community and/or environmental groups often focus on sustainability. For example, local communities would want to ensure that environmental resources are not depleted and the area where the business operates is inhabitable in the long term. Managers and unions: Managers may oppose unions’ intervention in the relationship between managers and employees at a particular firm. This is because unions can assist employees in obtaining better wages and benefits from management than employees might otherwise negotiate on their own. Customers and suppliers: Customers demand high quality and low prices, which may be in conflict with suppliers’ interest in being paid fairly. This conflict is played out between agricultural producers and consumers, with supermarkets in the middle coming under pressure from both stakeholders. Pressure groups and employees: Pressure groups may oppose certain projects that have the potential to harm the environment. These same projects may benefit the local community by providing employment.

Stakeholder Alignment and Conflict

Stakeholders are interdependent, meaning their interests are often interconnected. While they generally want the business to succeed, their priorities can differ, leading to both alignment and conflict. Understanding these dynamics is crucial for effective management.

Stakeholder Alignment

Most stakeholders share common long-term goals, even if their short-term interests differ. Key areas of alignment include:

1. Economic Sustainability:

   • Stakeholders want the business to survive and thrive.

   • For-profit businesses need to cover costs and generate profits, which can be reinvested or distributed to shareholders.

2. Sociocultural Sustainability:

   • Stakeholders want the business to have a positive social impact, distributing value to a wide range of stakeholders rather than extracting it for a single group.

   • Businesses depend on healthy societies for their success.

3. Environmental Sustainability:

   • Stakeholders want the business to have a positive environmental impact.

   • Businesses rely on a healthy planet for resources and long-term viability.

Challenges:

• Stakeholders may disagree on methods, pace, or balance of achieving these goals.

Stakeholder Conflict

Despite shared long-term goals, conflicts often arise due to competing short-term interests. Common examples include:

1. Managers vs. Employees:

   • Conflict: Managers may prioritize productivity, while employees seek better working conditions.

   • Solution: Employee participation in management or ownership, and performance-related pay.

2. Shareholders vs. Managers:

   • Conflict: Managers may prioritize personal gains (e.g., reputation, remuneration) over shareholder profits.

   • Solution: Stock options to align managerial and shareholder interests (though this can create conflicts with other stakeholders).

3. Shareholders vs. Government:

   • Conflict: Shareholders may push for tax minimization, while governments expect fair tax contributions.

   • Example: Amazon’s tax strategies (see Video 1).

4. Local Community vs. Shareholders:

   • Conflict: Shareholders seek high returns, while communities prioritize environmental sustainability and long-term livability.

5. Managers vs. Unions:

   • Conflict: Managers may resist union intervention, which can lead to higher wages and benefits for employees.

6. Customers vs. Suppliers:

   • Conflict: Customers demand low prices and high quality, while suppliers seek fair payment.

   • Example: Tensions between agricultural producers and supermarkets.

7. Pressure Groups vs. Employees:

   • Conflict: Pressure groups may oppose projects that harm the environment, even if they provide local employment.

Role of Management

Management plays a critical role in reconciling stakeholder interests. Key responsibilities include:

• Prioritizing legitimate demands that align with the organization’s long-term success.

• Balancing competing interests to ensure the business thrives while meeting stakeholder needs.

Key Takeaways

1. Stakeholder Alignment:

   • Most stakeholders share long-term goals related to economic, social, and environmental sustainability.

   • Differences often arise over methods, pace, or balance of achieving these goals.

2. Stakeholder Conflict:

   • Conflicts are common due to competing short-term interests (e.g., profits vs. wages, tax minimization vs. public welfare).

   • Management must prioritize and reconcile these conflicts to ensure the business’s success.

3. Management’s Role:

   • Managers must balance stakeholder interests, ensuring the organization meets its goals while addressing legitimate concerns.

By understanding and addressing both alignment and conflict, businesses can build stronger relationships with stakeholders and achieve sustainable success.

As you learned in Subtopic 1.3, growth is a common business objective. For some businesses growth creates new opportunities to increase market share and make more profit. However, expanding the business can also bring both risks and negative impacts in terms of environmental and social sustainability. This section analyses the reasons for growth as well as the positive and negative impacts resulting from the expansion of a business. Figure 1. Growth is a common business objective. Credit: boana, Getty Images What is growth? Growing a business means expanding the business. However, growth can be measured in different ways. Growth in sales revenue: increasing the money earned from selling the product; this is calculated by multiplying the prices of products by the number of products sold. Growth in profit: increasing the amount of money left over after costs of production have been subtracted from revenues. Growth in market share: increasing the percentage of a given market represented by a business’s sales. Growing impact: increasing the positive social and environmental consequences of the actions of the business. Growing a resilient business ecosystem: generating opportunities for other businesses to grow and to strengthen their relationships with a wide range of stakeholders, distributing more of the value of the business to them. There are a number of advantages and disadvantages of business growth. You will learn more about some of the global impacts of this growth in Subtopic 1.6, which explores multinational companies (MNCs). Advantages of growth for a business There are a number of advantages to growing as a business. For example: A business can achieve economies of scale to reduce costs. This will be explored further in Section 1.5.2. As businesses grow, new customers and markets are reached, increasing market share, sales revenue and profit. A large market share can be obtained by using creativity to develop unique and desirable products for consumers. Additionally, companies can expand into new markets where there is a particular need for the product or service that the company is offering. Being a large business allows the company to influence the prices of products and services. Businesses that are able to grow are in a better position to face competitors and external changes in the business environment. Larger businesses may be able to reduce risk and increase stability. Businesses that are growing often attract talented employees because they can offer good salaries, diverse experiences and opportunities for professional growth. Figure 2. Growing businesses often attract talented, ambitious employees. Credit: Nitat Termmee, Getty Images Disadvantages of growth for a business There are also some disadvantages of growth for a business. Some of these are caused by the increasing complexity and management problems that arise in larger organisations. For example: There may be problems with cash flow. In order to expand, a business may need a large amount of money, which can be difficult to obtain. Businesses may take out loans and then need to pay large interest payments for years to come. There may be problems with quality. Increased output, particularly if not well planned, can impact the quality of the product negatively. This can add to the costs of production and lower sales revenue. Related to the previous issue is the problem of loss of control of the business. As businesses grow, tasks and organisational structure become more complex. Finally, larger businesses may face higher labour turnover if human resources are not managed well. If a business grows and it does not recruit additional skilled workers, productivity and motivation of the current staff may fall and employees may decide to leave the business. Figure 3. Growing too fast can cause declines in quality and control. Credit: Westend61, Getty Images Theory of Knowledge When Google was first started, the company motto was 'Don't be evil'. This phrase was even included in the company's Code of Conduct. Many people joined the company in its early days because they saw it as a pure force for good in the world. However, as Google (now Alphabet) grew, the behaviour of the company changed, as did the public perception of it. The company faces legal battles associated with its size. Governments claim that the company has been stifling competition with its monopoly power and there are proposals to break it up. Others are upset with the company's lack of action around the spread of misinformation. Even inside its own walls, Google/Alphabet faces criticism of its handling of claims of inappropriate behaviour and its lack of diversity in the workplace. This case raises a number of interesting questions related to the Theory of Knowledge concepts of ethics and perception. Here are some links to further information. Does growth and increased power inevitably lead to unethical behaviour? Do our own perceptions of large, powerful organisations change as they grow? Why do we often root for the underdog? Advantages of growth nationally and globally When companies grow, they impact the economy of their country and the global economy in various ways. Higher levels of output produced by companies generate more tax revenue for local and/or national governments. This money can be spent in the construction of schools, hospitals and roads and for providing useful services for the whole community. Higher levels of output also reduce the rate of unemployment and increase incomes. This can occur locally, but also globally through the supply chains of larger businesses. This can also create incentives for workers to have better jobs and education. Related to the previous point, higher income levels can increase consumption and improve living standards at both the local and global level. Making connections The IBDP Economics course focuses its attention on economic growth, which comes about when individual businesses grow. Countries’ economies will grow and shrink over periods of time. This is known as the business cycle and was discussed in Section 1.1.6. Figure 4. The phases of the business cycle. Expansion, or economic growth, is one phase of the business cycle. This occurs when the businesses of a country produce more goods and services in one time period than in a previous one. It is usually measured by changes in the real gross domestic product (GDP). Disadvantages of growth nationally and globally Despite the benefits that growth can bring to the economy of a country or region, there are always some costs to be considered. One such problem is the increased pollution that can arise when businesses grow. From carbon emissions to wastewater, particulate matter and destruction of biodiversity, there are many negative environmental consequences, both locally and globally, of business growth. A related issue is the increased use of natural resources, which may be non-renewable. This can have wide-reaching negative global impacts. There can be negative impacts for people too. As businesses grow and achieve economies of scale, they may be able to replace workers with machinery, particularly where workers have low skill levels. Efficiencies like this will mean that the growth in employment will be slower. Finally, as mentioned above, as businesses grow and become more complex, they may lose some control of their operations. Businesses with complex supply chains may not be able to monitor worker conditions and pay throughout the supply chain, resulting in exploitation of human labour. ignore theory of knowledge

Business Growth: Advantages and Disadvantages

Growth is a common business objective, but it comes with both opportunities and challenges. This section explores what growth means, its advantages and disadvantages for businesses, and its broader impacts on national and global economies.

What is Growth?

Growth refers to the expansion of a business, which can be measured in various ways:

1. Growth in Sales Revenue: Increasing income from selling products or services.

2. Growth in Profit: Increasing the amount of money left after subtracting production costs from revenue.

3. Growth in Market Share: Increasing the percentage of a market controlled by the business.

4. Growing Impact: Expanding the positive social and environmental effects of the business.

5. Growing a Resilient Business Ecosystem: Strengthening relationships with stakeholders and distributing value more widely.

Advantages of Growth for a Business

1. Economies of Scale:

   • Larger businesses can reduce costs per unit by increasing production.

2. Increased Market Share and Profit:

   • Reaching new customers and markets boosts revenue and profitability.

3. Pricing Power:

   • Larger businesses can influence market prices.

4. Competitive Advantage:

   • Growth helps businesses withstand competition and adapt to external changes.

5. Attracting Talent:

   • Growing businesses can offer better salaries, diverse experiences, and career growth opportunities.

Disadvantages of Growth for a Business

1. Cash Flow Problems:

   • Expansion requires significant investment, which can strain finances.

2. Quality Issues:

   • Rapid growth can lead to declines in product or service quality.

3. Loss of Control:

   • Larger organizations face increased complexity and management challenges.

4. Higher Labour Turnover:

   • Poor human resource management during growth can lead to employee dissatisfaction and turnover.

Advantages of Growth Nationally and Globally

1. Increased Tax Revenue:

   • Higher output generates more taxes, funding public services like schools, hospitals, and infrastructure.

2. Reduced Unemployment:

   • Growth creates jobs locally and globally through supply chains.

3. Higher Incomes and Living Standards:

   • Increased employment and wages boost consumption and improve quality of life.

4. Economic Growth:

   • Business growth contributes to national GDP and economic expansion.

Disadvantages of Growth Nationally and Globally

1. Environmental Impact:

   • Growth often leads to increased pollution, resource depletion, and biodiversity loss.

2. Job Displacement:

   • Automation and economies of scale can replace low-skilled workers, slowing employment growth.

3. Exploitation in Supply Chains:

   • Complex supply chains may lead to poor monitoring of labor conditions, resulting in worker exploitation.

Key Takeaways

1. Growth Metrics:

   • Growth can be measured by sales revenue, profit, market share, social/environmental impact, or ecosystem resilience.

2. Advantages for Businesses:

   • Growth offers cost savings, increased market share, pricing power, and talent attraction.

3. Disadvantages for Businesses:

   • Growth can strain finances, reduce quality, increase complexity, and lead to employee turnover.

4. National and Global Benefits:

   • Growth boosts tax revenue, reduces unemployment, and improves living standards.

5. National and Global Costs:

   • Growth can harm the environment, displace jobs, and lead to labor exploitation.

By carefully managing growth, businesses can maximize benefits while minimizing negative impacts on stakeholders and the planet.

Businesses that are able to produce goods and services at a lower average cost than their competitors have an advantage in the marketplace because they can earn larger profits. They may also be able to lower prices for consumers while maintaining profits, which will enable them to increase their market share relative to competitors. One of the factors that can impact the costs of a business is the size of its operations. In general, businesses producing a higher output will be able to produce a given good or service at a lower average cost. Think about making biscuits. A modern food processing plant producing millions of biscuits per year can produce biscuits at a lower cost per biscuit than you can at home in your kitchen. Economists use the term economies of scale to refer to this situation. Credit: Anjelika Gretskaia, Getty Images Credit: sykono, Getty Images Figure 1. Businesses with a larger output can lower their average costs of production compared to smaller businesses. Economies of scale Economy of scale refers to a situation where the unit (average) cost of production decreases as the level of output increases. Economies of scale can be either internal or external. Internal economies of scale Internal economies of scale are cost reductions that can be achieved inside the company when it expands its output. They may occur in different ways: Purchasing economies of scale occur when a business buys inputs at a lower cost by purchasing larger amounts. For example, a food company buying thousands of eggs every week will be able to negotiate lower prices from suppliers compared to a small company buying a few dozen eggs at a time. This is also known as ‘buying in bulk.’ Credit: jayk7, Getty Images Credit: fotogaby, Getty Images Figure 2. Purchasing large quantities of paper will reduce unit costs compared to buying small quantities of paper. Marketing economies of scale occur when the cost of a marketing campaign is spread over a larger quantity of output, thus lowering the average cost of the campaign. It can be expensive to develop a marketing campaign. Also, larger corporations may be able to negotiate better rates for using a promotion platform if they buy more. Smaller firms may not be able to afford television advertising, for example, where costs are very high for a 30-second advertisement. Managerial economies of scale occur when the cost of hiring a manager is spread over a larger output. Lower costs of production also occur because businesses are able to hire specialists who are more efficient at completing their work. For example, it is unlikely that a sole trader responsible for the day-to-day operations of a business will have extensive expertise in each of the business functions. As the business grows, the sole trader may be replaced by a CEO who leads a team of specialists in human resources, finance, marketing and operations. Their combined expertise should, in theory, improve efficiency and decrease average unit costs. Technical economies of scale occur when a large company is able to invest in equipment that makes the business more efficient and results in a lower average cost of production. An industrial mixer, for example, will reduce costs compared to mixing ingredients using a smaller, less sophisticated tool. However, this large investment in equipment may not be profitable until production reaches a certain level. As output increases, the cost of equipment can be spread over a higher quantity of output. The use of equipment allows production to become more automated and efficient, lowering unit costs. Figure 3. A large mixer is expensive to buy, but can help a baker produce more bread at a lower unit cost. Credit: maki_shmaki, Getty Images Financial economies of scale occur when a large business takes out a larger loan for investment. Larger loans often have a lower interest rate. This means they cost less to repay, especially when the costs are spread over larger output. You will consider these issues further when you study sources of finance in Subtopic 3.2. External economies of scale External economies of scale are cost-savings that occur due to external factors in the region or industry that are not under the control of the business. These may be due to the following: Innovation: This is when an industry becomes significant for society. Innovation allows businesses to collaborate with universities or other research institutions in order to improve and create new products, and at the same time reduce their own research costs. Infrastructure: A good transportation network supports quick delivery of products and helps workers arrive at work on time, increasing productivity. Specialisation: This takes place when companies, suppliers, and workers start to focus on a particular industry due to its size. As the number of companies in an industry increases, it becomes more profitable for suppliers to focus on supplying customers within that industry. It also becomes easier for specialised workers to find a job in their field because of the availability of jobs in the industry. This in turn makes it easier for companies to hire specialised workers, which can reduce costs associated with recruiting and training. Exam tip When suggesting how a business may achieve economies of scale, always consider the type of organisation and the industry. Diseconomies of scale Companies, or some of their operations, sometimes get so big that they become less efficient, leading to an increase in unit costs as output increases. Such cases are called diseconomies of scale. There are a number of internal and external factors that cause diseconomies of scale. Internal diseconomies of scale An internal diseconomy of scale is an increase in average unit cost, usually explained by the difficulty of managing internally large operations. Some examples of internal situations which can produce an increase in costs are: Managerial issues: It can be difficult to efficiently run an enterprise once it gets too big. As we learned in subtopic 1.3, a strong vision and mission statement is required to keep the entire organisation working towards common objectives. Nonetheless, it is challenging for a single leader to set a direction and be followed by thousands of employees. There may even be rivalries between the different divisions of a large firm. A lack of coordination and cooperation can create inefficiencies and increase costs. Increase in size of the workforce: It can be challenging to control a large workforce. The growing size of the company may necessitate the creation of a complicated organisational structure, with many levels of hierarchy. A large number of managers between the CEO and employees can increase the expenses associated with salaries and wages. There could be overcrowding. Jobs in large firms may become so specialised that employees no longer see how their role fits into the company's operations as a whole. They may grow to feel alienated from decision-making. Communication: As organisations grow and become more complex, there may be several layers of management between the CEO and employees, making efficient communication more difficult. We will explore these issues in Subtopic 2.6. Communication challenges are amplified further when operations are spread globally. Case study Walmart was founded in 1962, as a discount retailer. Sam Walton, its founder, built his business based on the notion that low prices for customers would generate higher sales revenues. The company today operates more than 8 500 stores, with more than two million employees, and serves more than 200 million customers around the world. Walmart's main strategy is to offer the lowest retail prices among its competitors and avoid the use of promotion. This strategy is supported by rapid expansion and strategic geographical locations. Ninety percent of the US population lives within 24 km of a Walmart store. Sophisticated use of technology allows the company to keep a dynamic inventory, reducing the working capital necessary and preventing excess stock. Walmart’s large size gives it monopsony power in negotiations with some suppliers. This means it can put pressure on suppliers to lower the cost of the products that Walmart buys for its stores. While Walmart’s negotiating power with suppliers can mean lower prices for consumers, it puts enormous pressure on suppliers, who may have small profit margins. Because of Walmart’s large size in many markets, these suppliers may have no other choice but to sell to the company. In addition, the very low prices for Walmart’s products may cause other smaller retailers to go out of business. This in turn often leaves consumers with little choice but to buy from the large retailer. Thus, while Everyday Low Prices can be positive for consumers and economies, there are a number of ethical concerns associated with the strategy. Questions Define economy of scale. [2 marks] Explain two economies of scale which Walmart experiences as a large firm. [4 marks] Outline one ethical concern with Walmart’s Everyday Low Prices strategy. [2 marks] External diseconomies of scale External diseconomies of scale refer to the increased unit cost of production for a business due to the expansion of the industry in which the business operates. The expansion of the business and the industry as a whole can result in changes to the external environment (see STEEPLE factors in Section 1.1.6). These external changes can increase average costs for the individual business. There are a number of changes to the external environment resulting from industry expansion that can increase costs of production: Limited natural resources: When businesses grow their output, they need more inputs of natural resources. When this happens on an industry-wide scale, demand for raw materials may increase. Increased demand usually causes prices of raw materials to rise. This means that individual businesses may face higher costs of production. An example of this is when economies started to grow again in 2021 and 2022, after the COVID-19 pandemic began to subside. Businesses in certain industries, especially construction, faced higher costs of production for many inputs such as wood, copper and insulation. Demand for these resources had increased significantly. Limited infrastructure: When an industry expands, businesses will use infrastructure more often. They will send more lorries out on the roads for delivery; they will send more containers of products to ports; they will fill freight trains and ships with their products. This increased use of limited infrastructure can slow down deliveries and raise costs of production. Increased regulation: When an industry expands and has more power, governments will pay more attention to the businesses in that industry. Laws and regulations related to the industry may increase, which could increase costs of production. An example of this is in the technology industry, whose growth and power has raised concerns in society and government. Meta (formerly Facebook), Apple and Google all face increased regulation of their business activities in many countries, which will raise costs of production. Pollution: It is clear that the carbon dioxide emissions from business activity across all industries is causing climate change. Droughts, floods, storms and fires cost human lives and damage natural resources and infrastructure. The cost of production for firms will increase significantly in the future due to climate change. ignore the case study

Economies and Diseconomies of Scale

Businesses that produce goods and services at a lower average cost than their competitors gain a competitive advantage. This cost efficiency can result from economies of scale, which occur when the unit cost of production decreases as output increases. However, businesses can also face diseconomies of scale when they grow too large, leading to inefficiencies and higher costs.

Economies of Scale

Economies of scale are cost reductions achieved as a business expands its output. They can be internal (within the company) or external (due to industry or regional factors).

Internal Economies of Scale

1. Purchasing Economies:

   • Buying inputs in bulk reduces costs per unit.

   • Example: A large food company negotiating lower prices for eggs compared to a small bakery.

2. Marketing Economies:

   • Spreading marketing costs over a larger output reduces average costs.

   • Example: Large corporations negotiating better rates for TV advertisements.

3. Managerial Economies:

   • Hiring specialized managers improves efficiency and reduces costs.

   • Example: A CEO leading a team of specialists in HR, finance, and marketing.

4. Technical Economies:

   • Investing in advanced machinery lowers production costs as output increases.

   • Example: An industrial mixer reducing the cost per unit of baked goods.

5. Financial Economies:

   • Larger businesses secure loans at lower interest rates, reducing financing costs.

   • Example: A multinational corporation obtaining a large loan with favorable terms.

External Economies of Scale

1. Innovation:

   • Collaboration with universities or research institutions reduces R&D costs.

   • Example: Tech companies partnering with universities to develop new products.

2. Infrastructure:

   • Efficient transportation networks reduce delivery times and costs.

   • Example: A well-connected port facilitating faster exports.

3. Specialization:

   • Concentration of businesses in an industry attracts specialized suppliers and workers.

   • Example: A cluster of tech firms in Silicon Valley reducing recruitment and training costs.

Diseconomies of Scale

Diseconomies of scale occur when a business grows too large, leading to inefficiencies and higher unit costs. These can be internal or external.

Internal Diseconomies of Scale

1. Managerial Issues:

   • Large organizations become difficult to manage, leading to coordination problems.

   • Example: Rivalries between departments causing inefficiencies.

2. Workforce Challenges:

   • Managing a large workforce increases complexity and costs.

   • Example: Overcrowding and alienation among employees in a large firm.

3. Communication Problems:

   • Multiple layers of management slow down decision-making and communication.

   • Example: Delays in implementing strategies due to bureaucratic structures.

External Diseconomies of Scale

1. Limited Natural Resources:

   • Increased demand for raw materials raises input costs.

   • Example: Rising prices for wood and copper due to industry expansion.

2. Infrastructure Strain:

   • Overuse of transportation networks increases delivery times and costs.

   • Example: Congestion at ports slowing down shipments.

3. Increased Regulation:

   • Governments impose stricter laws on large industries, raising compliance costs.

   • Example: Tech companies facing higher costs due to data privacy regulations.

4. Pollution and Climate Change:

   • Environmental damage from industrial activity increases costs for businesses.

   • Example: Higher insurance premiums due to climate-related risks.

Key Takeaways

1. Economies of Scale:

   • Cost reductions achieved through increased output.

   • Include purchasing, marketing, managerial, technical, and financial economies.

   • External factors like innovation, infrastructure, and specialization also contribute.

2. Diseconomies of Scale:

   • Inefficiencies and higher costs due to excessive growth.

   • Include managerial issues, workforce challenges, and communication problems.

   • External factors like resource scarcity, infrastructure strain, and regulation also play a role.

3. Balancing Growth:

   • Businesses must carefully manage growth to maximize economies of scale while avoiding diseconomies.

By understanding these concepts, businesses can optimize their operations, reduce costs, and maintain competitiveness in the market.

If a business wishes to grow, it can do so through internal or external growth. This section analyses the characteristics of internal growth. Figure 1. Internal growth means expanding the business with its own resources. Credit: Maskot, Getty Images Companies who are interested in growing can choose to do so internally. Internal growth, also called organic growth, refers to expansion that is carried out by the organisation itself, without working with a partner. For example, a restaurant owner who hires new employees, adds new tables to the restaurant or even opens a second restaurant in another location is engaging in internal growth. Benefits of internal growth There are a number of benefits of internal, rather than external, growth for a business. Internal growth is less expensive than external growth: When businesses grow internally, it costs less and they often decide to use internal sources of finance, such as retained profit, for expansion. If they avoid using external sources of finance, such as bank loans, they can avoid interest rate payments or giving up equity in the business. You will learn more about the advantages and disadvantages of internal and external financing in Subtopic 3.2. Internal growth is less risky than external growth: When a business grows with its own resources, no other party is involved. This means that managers have more control over the resources used to grow and the way in which the business chooses to grow. Internal growth maintains more control of the business than external growth: With internal growth, as there is no need for external sources of finance, the owner of the company can keep control over the decisions of the company. Internal growth can respect the company’s values more than external growth: With internal growth, the culture of the company can be maintained since there is no risk of a third party changing it or imposing different values. Limitations of internal growth There are also a number of limitations with internal growth. Internal growth is slower than external growth: Growing only with the resources of the company may take a long time and, in the meantime, larger competitors might enter the market. Internal growth can cause cash flow problems: Growth can be expensive and if businesses do not see an increase in revenues right away, they may have cash flow problems. Internal growth can be limited: If a business operates in a small market, it may not be able to reach a size that results in acceptable profits. In addition, the growth of a business is limited by its own financial resources. Activity Learner profile: Thinkers Approaches to learning: Research skills (information literacy); Thinking skills (critical thinking) Using the information above, create a summary table for yourself of the benefits and limitations of internal growth. Use keywords rather than full explanations to synthesise the information. Strategies for growing internally In order to grow internally, companies can implement the following strategies: Increasing production and gaining market share: Businesses can increase the output of their current products if the market demands it. They can also increase their share of the existing market through pricing changes, improved promotion or improved distribution. Developing new products: Using market research, businesses can develop new products or improve their existing products to satisfy the target market and increase sales revenue. Finding new markets: Businesses can sell their existing products or services in a new location or to a new group of people. Establishing new markets is one of the most cost-effective internal growth strategies, since it does not involve new product research, development and production. These strategies are explored more fully in Section 1.5.7 (the Ansoff matrix).

Internal Growth: Characteristics, Benefits, and Limitations

Internal growth, also known as organic growth, refers to a business expanding using its own resources without partnering with or acquiring other organizations. This section explores the benefits, limitations, and strategies for internal growth.

Benefits of Internal Growth

1. Cost-Effective:

   • Internal growth is less expensive than external growth.

   • Businesses often use internal sources of finance (e.g., retained profits), avoiding interest payments or equity dilution.

2. Lower Risk:

   • Growing with internal resources reduces reliance on external parties, giving managers more control over the expansion process.

3. Maintains Control:

   • Owners retain full control over decision-making without external interference.

4. Preserves Company Culture:

   • Internal growth allows businesses to maintain their values and culture, as there is no risk of external influence.

Limitations of Internal Growth

1. Slower Growth:

   • Internal growth is slower than external growth, which can allow competitors to gain market share.

2. Cash Flow Challenges:

   • Expansion can strain finances, especially if revenues do not increase immediately.

3. Limited Scope:

   • Growth is constrained by the business’s financial resources and the size of its market.

Strategies for Internal Growth

1. Increasing Production and Market Share:

   • Boost output of existing products to meet demand.

   • Use pricing strategies, improved promotion, or better distribution to capture a larger share of the market.

2. Developing New Products:

   • Use market research to create or improve products that meet customer needs.

   • Example: A bakery introducing gluten-free options to attract health-conscious customers.

3. Finding New Markets:

   • Sell existing products in new locations or to new customer groups.

   • Example: A local café expanding to a neighboring city or targeting a younger demographic.

Summary Table: Internal Growth

Key Takeaways

1. Internal Growth:

   • Expands a business using its own resources.

   • Benefits include cost-effectiveness, lower risk, and control over decisions.

   • Limitations include slower growth, cash flow challenges, and resource constraints.

2. Strategies:

   • Increase production and market share.

   • Develop new or improved products.

   • Explore new markets for existing products.

By leveraging internal growth strategies, businesses can expand sustainably while maintaining control and preserving their core values.