Business Characteristics, Environment, Decisions and Risk

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BUSINESS CHARACTERISTICS

Business characteristics can be identified in accordance to the businesses’ willingness and capability of continuously delivering goods & services for which they are rewarded in the form of profits. These characteristics include the following:

  1. Producer/Distributor – The owner of a business can decide on the business’ occupation based on factors reflecting demand and potential growth from investments in a particular product/service. Accordingly, a business can be a producer (for example, FMCG companies like HUL) or provider of services (For example, IT consulting business like Infosys or Accenture). A business can also be involved in trading or distribution of goods/services (For example, retail shops/malls selling FMCG products or in-house sales consultants within IT industry selling their services). Other occupations can include seller/supplier, broker, consultant, etc
  2. Industry representation – Based on the product / service the business is involved in defines the industry representation for the business. For example, Hindustan Lever (HUL) represents the FMCG industry. Similarly, network provider – Vodafone, mobile manufacturers – Nokia, represents the telecommunication industry. These businesses accordingly contribute to the growth and development of their respective industries
  3. Resource Allocation – Businesses influence direct and indirect resource allocation that can effectively lead to exchange of goods and services catering to relevant human demands. Direct resource allocation refers to natural resources, human resources and capital required within the representative industry whereas indirect resource allocation refers to resources allocated in other industries providing resources like electricity, water, oil & petroleum products, transportation, infrastructure, banking, etc
  4. Creativity & Dynamism – Creativity means a tendency to generate or recognise ideas, alternatives for problem solving, communications and/or entertainment whereas dynamism refers to a business’ ability to vigorously deliver goods/services in accordance to changing human needs.
  5. Continuity & Risks – Businesses provide or at least aim at providing good/services in a continuous or regular basis. The continuity however depends upon internal factors especially management of costs, prices and profits earned by business. There are also external factors or risks / uncertainties that in turn influence the continuity if businesses. Risks or uncertainties are events whose outcomes lead to possible losses. Risks or uncertainties to any business can include changes in technologies, changes in tastes and preferences, changes in policies and regulation, presence of substitutes, increased market competition, etc. For example, network providers like Vodafone, Airtel, etc compete on the basis of declining prices for specific applications like mobile Internet or SMS. What are substitutes? Example of an industry affected by substitutes? Businesses have to account for such risks in order to continuously provide goods & services.
  6. Social Responsibility & Welfare – Businesses need to have well-organized systems with trained and qualified professionals who can responsibly deliver goods and services efficiently and on timely basis. This responsibility also ensures that the business can sustain in the ling-run and demand customer loyalty and long-term business profits (What is customer loyalty?) The profits earned can be either reinvested in the business or can be contributed in community development projects such as education, health, etc. leading to overall satisfaction, well-being and welfare.

BUSINESS ENVIRONMENT

Business Environment can be defined as “a set of conditions, circumstances and influences that surround and affect the functioning of the organization. This environment is made up of different individuals (like customers, local citizens, etc); organizations (like suppliers, labour unions) and government bodies (like regulatory agencies, legislators, etc)”[1] – Dunham Pierce.

The definition implies that the functioning of a business is influenced by internal and external factors. Based on these factors businesses need to continuously and quickly adapt to the changing environment in order to survive and grow in the long-run. Internal factors generally include factors affecting human resources (labor), raw materials, machinery, finance and management available for business. These internal factors are further influenced by external factors, which refer to the external aspects of the surroundings of a business enterprise affecting the functioning of the business.External factors could be micro-level or macro-level, wherein micro-level refers to factors immediately affecting the business and macro-level refers to factors influencing growth and survival of the business. Micro-level and macro-level external factors may individually and/or collectively affect businesses depending upon the nature of the industry the business represents.

Micro-level external factors include:

a)      Suppliers who supply raw materials to a business. Reliability and accessibility of suppliers for continuous supply of raw materials is critical aspect for functioning of a business

b)      Customers that are different for different businesses (wholesale, retail, industrial, government or foreign) whose tastes and preferences keep changing

c)      Market intermediaries like warehouses, transport agencies, advertising agencies, media firms, banks, insurance companies, financial institutions, financial markets, etc. that act as a link between the business and end-customer also influence the functioning of the business.

d)     Public or media that include people living in the area where the business is set up and people who show interest in the workings of the business and include newspapers, magazines, television, etc.

Macro-level factors include social, economic, political, legal, technological and demographic factors that are detailed below.

  1. Economic factors – Economic factors include income levels, distribution of income, demand and supply trends and trade cycles that affects the willingness and ability to purchase goods / services and market share of businesses. The prevailing economic system i.e. mixed economy (government and private sector co-exist) also influences in preparing the business policies.
  2. Social factors – Social factors refer to customs, habits, belief, expectations, family system, religion, languages, urbanisation, etc. that keep changing and businesses need to keep up or adapt to these changes. For example, local restaurants in Mumbai offer Jain food for people following Jainism (a religion) or real estate developers offering 3 or 4 BHK (Bedroom-Hall-Kitchen) homes for joint families in suburban areas of metro cities, etc
  3. Political factors – A stable and dynamic political environment is advantageous for business growth. Political ideologies of the government shape up rules and regulations in a country that influences the formation of business systems. For example, Mobile Number Portability (MNP) is a regulation initiated by India’s Department of Telecommunications, Ministry of Communications & Information Technology that enables customers to change their mobile network providers (For example, Vodafone, Airtel) without change in mobile numbers. The introduction of this regulation has or may have led network providers to use aggressive competitive strategies for retaining their existing customers.
  4. Legal factors – The government in India has framed legislations, which regulate and control the business. The main legislations regulating the business are as follows:
    1. Industrial Dispute Act, 1947
    2. Factories Act, 1948
    3. Industrial Development and Regulation Act, 1951
    4. Companies Act, 1956
    5. Consumer Protection Act, 1986
    6. The Environment (Protection) Act, 1986
    7. Foreign Exchange Management Act, 1999
    8. Depositories Act, 1996
    9. Securities and Exchange Board of India Guidelines, 2000 (SEBI guidelines)
    10. Competition Act 2002

The compliances play a critical requirement for a business to legitimately and efficiently provide goods and services.

  1. Technological factors – Technology is a systematic application of scientific or other organized knowledge to practical tasks that brings about changes in products / services, lifestyles and living conditions. For example, mobile (cordless) phones that enable mobility and communication or Internet that connects the world irrespective of different time zones, etc
  2. Demographic factors – Demographic factors are related to the size, density, distribution and growth of population. Businesses can target specific goods and services depending upon a particular population segment. For example, increase in life expectancy rate influences insurance companies for promoting life insurance policy or middle-class families are targeted for affordable cars (Tata Nano) or instant food mixes targeted to working women, etc.
  3. Natural factors – Natural factors includes geographical and ecological factors such as weather and climatic conditions, landforms, seas, rainfall, etc. These factors also play an important role in the functioning of a business. For example, iron and steel companies like Tata Steel are located at Jamshedpur where raw materials like coal and iron are available in abundance. Also, hot weather or humid influences the demand for Air-conditioners (AC) or humidifiers and cold weather influences the demand for warm or woollen clothing, etc.

BUSINESS DECISIONS

Based on the environmental surroundings, businesses need to make relevant decisions that enable the smooth functioning of operations and continuous delivery of goods and services. The decisions of the business can be classified into three types – (A) Management; (B) Marketing and; (C) Finance and each of these are discussed below[2]

(A) Management: A typical large corporation (For example, Bharti Airtel, Tata Steel, Nestle India, Afcons, Infosys, JK Cement, Tata Motors, ICICI Bank[3] and Hiranandani Real Estate)[4] comprises of various departments within their organizational structure. Some broad departments in these companies could be marketing department (all 9 companies considered for an assignment), R&D department (most companies except Hiranandani and ICICI), purchasing department (most companies except ICICI),  services (For example, ICICI) / engineering (For example, Afcons) / production department (For example, JK Cement), information processing department (all of 9) , customer care department (all of 9), etc. In every department, the 9 companies employ employees in large numbers who conduct all operational activities. These employees are organized under different teams that will be supervised by managers. Every manager is responsible for day-to-day operational activities, conducts training and resolves problems of team members within the department. The managers belong to the “First-line Managers” set who in turn report to their leader or senior manager / director who plans and sets goals (related to revenue generation within the department) for all managers that should be achieved at a specific time period (mostly end of every quarter of a year). The leaders represent the “Middle Management” heading departments like marketing, production, customer care, etc. and mainly focus of problem-solving aspects of their respective departments. The leaders report to the “Top-Management”, which are responsible for long-term decisions, delegations and empowerment. The “Top-Management” are generally characterised with knowledge, experience and long-term goals of every organization flows from the top to the employees[5].

(B)  Marketing: Most large companies have a marketing division responsible for promoting the product / service of the company. This division is also responsible for creating awareness and providing knowledge regarding the benefits of utilizing their company’s products / services. Though all companies conduct marketing activities, companies in FMCG and telecommunications carry out cut-throat marketing activities that are an essential part of their businesses. The marketing division of a company considers 4 aspects to satisfy customers’ requirements of products / services[6]: a. Product; b. Price; c. Place and; d. Promotion as explained below

  1. Product – The marketing division needs to match the product / service in accordance to the requirements of the company’s customers and may require radically changing the product or changing its features or its packaging or describing it in a different manner. For example, packaging of Maggie packets includes bright yellow and red colors with a blue “2-minute Noodles” printed on the packets[7] OR ICIC bank’s slogan, “khayaal aapka[8]
  2. Price – Pricing strategies include providing mobile network to mobile phone users at affordable prices or providing luxury products like imported wrist watches (Rado, Rolex, etc) at high prices. Pricing strategies considered are dependent upon the costs of producing or providing services and the target customers identified for selling.
  3. Place –             Place or location is where products / services are distributed to the end-customers. For example, tyre manufacturers (or their stockists) are located near automobile manufacturers OR potato chips or chocolates are available at any PCO, paan shops, or kirana shops.
  4. Promotion – Promotion involves communicating the characteristics of the business’ product / service to end- customers and includes the use of media such as television, newspapers, advertisements or emails via Internet, text messages on mobile phones, etc

(C)  Finance – Finance is the means by which firms obtain and use funds for functioning of business operations including salaries for all individuals involved in the management and marketing decisions of a business and the costs involved for development and distribution of products / services. The financial decisions are all made by the management of the business that is directed to production and distribution

In summary, business decisions focus on allocating resources through management, directing the product / services to the right customers and creating demand through marketing and obtaining funds from creditors or investors for running the business through finance with the main objective of generating profits. The decisions on management, marketing and finance lead to total expenditures on production, marketing and interest payments respectively. The marketing decisions are also directed towards generating demand for the business’ products / services that create revenues. The difference between revenues and total expenditures create earnings or profits for the business (ceteris paribus).

Support Functions for Business Decisions

Businesses strongly rely on support functions such as “Accounting” and “Information Systems” that enhance businesses decisions.

Accounting – Accounting as a support function is required by the business based on which most decisions related to recruiting/layoffs of employees, development or improvement of products / services, changes of funds for operations or marketing strategies or creating demand for products / services. Accordingly, main objectives of accounting are:

  1. Monitoring the operations of the business
  2. Reporting the financial conditions of the business
  3. Assessing previous performance of previous production, marketing and finance decisions
  4. Eliminating inefficient uses of business resources to generate higher earnings or profits

Information Systems – Information systems are associated with 3 factors – technology, information and people. Based on these factors, information systems apply technological advanced equipments for maintaining information related to production and distribution of goods / services as well as the buying behaviour of consumers to accordingly cater to any demands or grievances. For example, customer care services provided by telecommunication and banking companies or data on supplies from auto-component (wipers, tyres, seats, etc) manufacturers held by automobile manufacturers like Tata Motors, Maruti Udyog, etc. Following are the broad functions of information systems highlighted:

  1. Processing transactions – sales entry, payroll (salaries), employee records (incomes, provident funds, paid-leaves, absenteeism, etc), deliveries of goods, etc
    1. Producing fixed, regularly scheduled reports to management
    2. Compiling large amount of information for middle-management for problem solving
    3. Accessing quick summary reports on different departments like accounting, human resources and operations.

BUSINESS RISKS

Given the environment and surroundings of a business and the internal business decisions undertaken, the business is subject to various controllable or uncontrollable risks. Risk can be defined, “as the possible variation in an outcome from what is expected to happen” – From Risk Awareness and Corporate Governance by Brian Coyle. Accordingly, the elements of risks are:

  1. Variability (or frictions) due to uncertainty of future events. For example, physical injury to a batsman while playing one-day cricket.
  2. Related to expectations. For example, gambler would take a chance by placing bets in huge amounts with the expectations of winning the bet.
  3. Differences in what actually happens to what is expected. For example, a summer holiday planned in Goa would be cancelled in the last minute due to an unexpected cyclone.

Study on risks is critical because risks can affect a business in the form of varying profits or losses[9]. These risks also affect investors, who have invested in a business, in terms of varying returns from their investments. Risks can be broadly classified into “Pure” and “Speculative” risks. Pure risks are risks, which cannot be avoided or are uncontrollable and losses are inevitable. For example, an employee experiences an accident at work place, or business property suffers from a fire, flooding or burglary. These risks are unavoidable though the possibilities of such events occurring may encourage a business for taking insurance claims on damage to business property or accidents on employees. Alternatively, speculative risks are risks naturally occurring from businesses and are caused by actions of stakeholders internally or externally influencing the functioning of the business. These risks also lead to losses that can be avoidable depending upon the willingness or ability of the stakeholders to take suitable actions to minimize losses. Pure and speculative risks can be further classified under following categories:

  1. Business risks – Business risks are risks arising from the nature, operations and condition of business. These risks can be further characterised as follows:
    • Product risk – This risk arises from buying behaviour of consumers, which implies whether consumers would be willing to purchase the products / services. This risk is also associated with regards to the performance or quality of products / services and existing competition that influences the buying behaviour. Price wars between network providers in telecommunication lead to changes in consumers’ usage of services or applications.
    • Macroeconomic risk – This risk refers to the effect on a business due to unexpected changing economic conditions. For example, demand for necessary goods is higher during a economic slowdown or a recession than for durable or luxury items.
    • Technological risks – This risk is associated with any change in technology leads to changes in the production or delivery of services. For example, the emergence of Internet banking and ATM services by private and foreign banks in India have forced most public-sector (government) banks like State Bank of India (SBI) to introduce the same to retain their existing customers.
    • Strategy risks – There are risks associated with choosing or changing a particular strategy by a business. For example, marketing strategy used to promote a snack through television or by directly meeting people in malls or market places for tasting the snack
    • Enterprise risks – This risk refers to the success or failure of a business operation and whether it should have been undertaken in the first place. For example, changing a handloom- run (labour-intensive) textile business into a powerloom –run (capital intensive) business.
    • Property / Casualty risks – A business is exposed to risks related to loss of property or accidents (or death) of employees at the work place. These risks are associated with health and safety risks.

Among the abovementioned categories of business risks, all are speculative risks except property / casualty risks, which is a pure risk.

  1. Financial risks – Risks that are financial in nature and arises from factors internal / external to a business are financial risks, which are further categorised as follows:
    • Credit – Risk associated with default in credit payment to creditors. Some companies lose value in market due to a low credit-rating that reflects the company’s ability to make loan repayments
    • Foreign Exchange – Risks associated with fluctuations in exchange rates. Companies involved in import and export of raw materials and/or finished goods are the ones who are exposed to foreign exchange risk
    • Interest Rate – These are risks associated with changes in interest rates especially when interest rates increase, businesses need to pay high interest on loans.
    • Market – Adverse changes in market prices (securities market like stock market, money markets, etc) can have adverse effects on foreign exchange rate and interest rates
    • Liquidity – Also known as cash flow risk, refers to a possibility of unexpected shortage of cash which could result to inability to pay debt or loan obligations
    • Operational – This risk is linked to financial losses arising from human or technological errors. For example, faulty machines manufacturing out-of-shape containers or human erroneously dispatching finished products to a different location instead of the designated or labelled location.
    • Gearing – Gearing risks refers to risks of high borrowing in relation to the amount of shareholders’ capital in the business. A high level of debt could increase the earnings per share of leading to price volatility. Also, high-borrowing could indicate the businesses’ inability to make loan repayments
    • Commodity price – Companies dealing in commodities (such as gold, rice, wheat, oil, etc.) face the risk of fluctuating commodities’ prices. For example, rise in oil prices increase the cost of distributing food across the country leading to rise in inflation
    • Capital adequacy – Capital adequacy is mostly associated with banks who are required to have sufficient capital to support the volume of its business

All financial risks are speculative risks.

  1. Event risks – Event risks are uncontrollable risks for a business. These risks can be categorized as follows:
    • Physical – These are risks associated with climate and geology. For example, floods, earthquakes, ill-health, etc
    • Social – These risks are related to changes in tastes and preferences of consumers or demographic changes (for example, increase in child mortality may influence the need for medical facilities or medicines)
    • Political – These risks are related to changes in government leading to changes in political decisions.
    • Legal – Legal risks are related to changes in legislation or regulations or failing to fulfil duties or obligations by law ( For example, not filing property taxes or income taxes)
    • Operational – These are risks generated by an organization while carrying out its activities. For example, wastes and effluents emitted in the surrounding causing health and safety risks for people living in the surrounding areas.

All event risks are pure risks, except operational risks that are speculative risks

  1. Systemic risks – Systemic risk refers to errors or failures of one participant in the economic system that causes a chain reaction or ripple effect on all other industries, sectors and businesses leading to financial difficulties. For example, if a large infrastructure-related bank cannot repay its debt obligations, then it could lead to less liquidity available for construction companies. This in turn would lead to financial difficulties to construction companies who need to repay suppliers of cement, steel and other raw materials, which is turn affects loan repayment problems for cement and steel producing companies thus systemically affecting the construction sector and end-consumers (citizens) who have invested (through their savings) in real estate properties. Systemic risks are mostly associated with financial errors or failures in banking sector.


[1] Business Environment by T R Jain, Mukesh Trehan and Ranju Trehan

[2] Introduction to Business by Jeff Madura

[3] ICICI Bank has several departments related to their products and services (personal banking, wealth management, NRI deposits, Insurance, loans, etc) depending upon the nature of financial instruments held by their customers. They offer Internet and Retail banking (branches and ATMs) and are largely a service-based company

[4] Presentations conducted by First Year students in BAF, KC college

[5] Organizational Behaviour: Managing People and Organizations, by Ricky W. Griffin and Gregory Moorhead

[6] Marketing by David Mercer

[7] FYBAF Class Presentation Compiled by Group C

[8] www.icicibank.com

[9] Risk awareness and corporate governance, by Brian Coyle