CHAPTER ONE –ENTREPRENEURSHIP AND FREE ENTERPRISE

1.1 Definitions of Entrepreneurship:

Entrepreneurship refers to the ability of some people to bring the necessary inputs
together and produce something valuable. Note that resources will not be gathered and
get combined by themselves, (when such things happen we call the process a natural
process – not production) somebody else should take the task of deciding, planning,
mobilizing the resources and make the actual production in to reality. These people are
called entrepreneurs.
The term "entrepreneur" is derived from the 17th century French word "entreprendre",
which referred to individuals who undertook the risk of establishing new-enterprise.
Different definition of entrepreneurship by different scholars:
Basicallyentrepreneurship
Basicallyentrepreneurship essentially consists in doing things that are not generally done
in the ordinary course of business routine"
 J. Schumpeter: - Entrepreneurs allocate resources "to opportunities rather than to
problems."
 Peter Drucker:- Entrepreneurship is the dynamic process of creating wealth. This
wealth is created by individuals who assume the major risks in terms of equity,
time, and/or career commitment of providing value for some product or service.
The product or service itself may or may not be new or unique but value must
somehow be infused by the entrepreneur by securing and allocating the necessary
skills and recourses.
 Robert Rostald:- An entrepreneur is "energetic, single-minded" person having a
mission and clear vision, he or she intends to create out of this vision a product or
service in a field many have determined is important to improve the lives of
millions."
 David Silver:- Entrepreneurs are those who incubate new ideas, start enterprises
based on those ideas, and provide added value to society based on their
independent initiative.
 David Holt:- Entrepreneurs are those who create and/or expand business through
innovative combination of resources.

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Distinguishing factors are that entrepreneurs have vision for growth,
growth, commitment for
for
constructive change,
change, persistence to gather necessary resources,
resources, and energy to
achieve unusual results.
Entrepreneurship is the process of wealth creation rather than wealth accumulation.
accumulation. It
is a crucial dimension of wealth creation and every new venture innovation.
innovation.

1.2. History, theory and practices of Entrepreneurship

The first man who gave the concept of entrepreneurship central role in economics was
Richard Cantilion a French economist (in 1755). He described an entrepreneur as a
person who pays certain price, thereby making decisions about obtaining and using
resources. For example, the entrepreneur invests to produce goods and services and/or
transport them to the market and make a profit or loss. A critical point in his argument
was that the entrepreneurs consciously make decisions about resource allocation.
Entrepreneurs would always seek the best opportunities for using resources for their
highest commercial yields.

Adam Smith (1776) also stressed that an entrepreneur is an individual who undertook the
formation of an organization for commercial purpose. He also said that an entrepreneur
is a person with unusual foresight who could recognize potential demand for goods and
services and so transform demand into supply.
In 1803 Jean Batist say (French economist) described an entrepreneur as a one who
possesses certain arts and skills of creating new economic enterprises; one who possesses
exceptional insight into society’s needs and one who is able to fulfill them.
In 1871 Carl Menger an Austrian economist underlined the fact that Change does not
arise from circumstances but from an individual’s awareness and understanding of those
circumstances. Therefore, the entrepreneurs are change agents who transform resources
into useful goods and services. That is, throughentrepreneurs, resourcesthat have no
direct use in terms of fulfilling human needs are transformed into highly valued products
that directly fulfilled human needs. E.g. Grain to Bread.

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Joseph Shumpeter in 1934 described entrepreneurs as innovators who shatter the status
quo through new combination of resources and new methods of commerce e.g. Thomas
Edison.

Haggen in 1958 an entrepreneur is an economic man who tries to maximize his profits by
innovations.

David McClelland in 1961 entrepreneur is an energetic moderate risk taker.

Peter Drucker in1964 entrepreneur maximizes opportunities through systematic

innovations.

Albert Shapero in 1975 entrepreneur takes initiative, organizes some socioeconomic

mechanisms, and accepts risk of failure.

Gifford Pinchot in 1983 intrapreneur is an entrepreneur within an already established

organization.

Robert Hisrich in 1985 entrepreneur is the process of creating something different with
value by devoting the necessary time and effort, assuming the accompanying financial,
psychological, and social risks and receiving the result- rewards of monetary and
personal satisfaction.

Vasant Desai in 1990 the entrepreneur brings in overall change though innovation for the
maximum social good. Human values remain sacred and inspire him to serve society. He
has firm belief in social betterment and he carries out this responsibility with conviction.
In the process, he accelerates personal, economic as well as human development. The
entrepreneur is a visionary and an integrated man with outstanding leadership qualities.
With a desire to excel, the entrepreneur gives top priority to Research and Development.
He always works for the well being of the society. More importantly, entrepreneurial
activities encompass all fields/sectors and foster a spirit of enterprise for the welfare of
mankind.

Practically a hand ax was invented, made the wheel a reality, and discovered new ways
by ancient people to grow crops long time ago. Much later, sails mounted on boats made
seafaring trade possible. Still later, Robert Fulton's steam engine revolutionized sea and

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land transportation. These were watershed events in human history, but it was 19 th-
century entrepreneurs who dramatically thrust the world into industrialism.

Eli Whitney, Samuel Colt, and Samuel Morse were the three early pioneers. Whitney
Invents Cotton Gin

American Eli Whitney invents the cotton gin, a device that rapidly and effectively
removes seeds from cotton fiber. This task had previously been done by hand, making
fiber processing slow and expensive. The invention will help spur expansion of the cotton
industry in the southern United States. Whitney's cotton gin made an extraordinary
increase in productivity for exported cotton.

Colt, Samuel (1814-1862), American inventor, who developed the first practical single-
barreled pistol with a revolving cylinder. Known as a revolver, this weapon became the
most popular pistol in the United States and revolutionized military tactics in the mid-
19th century. Colt's weaponry helped increase the firepower needed to expand westward.

The story of radio begins in the development of an earlier medium, the telegraph, which
was the first instantaneous system of information movement. Patented simultaneously in
1837 in the United States by inventor Samuel F. B. Morse and in Britain by scientists Sir
Charles Wheatstone and Sir William Fothergill Cooke, the electromagnetic telegraph
realized the age-old human desire for a means of communication free from the obstacles
of long-distance transportation. The first public telegraphs line, completed in 1844.
Morse's telegraph revolutionized communications technology. An era of "tycoons"
emerged that vaulted America into the 20th century and during this era the foundations of
modern industry were laid.

Later, Henry Ford pioneered mass assembly of automobiles. Ford Motor Company, one
of the world’s largest manufacturers of automobiles and the world’s largest producer of
trucks. Under the leadership of its founder, Henry Ford, the company implemented the
assembly-line method of mass production and made cars affordable to middle-class

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consumers. Ford is the second largest company in the United States based on overall
sales, trailing only General Motors Corporation.

Other famous founding names such as Swift (meat packing), Vanderbilt (railroads), and
Rockefeller created oil empires and fortunes that are legendary.

In 1870, John D. Rockefeller founds the Standard Oil Company of New Jersey, and by
1900, he controls most of the oil refined in the United States. John D. Rockefeller,
controlled nearly 2 percent of the entire United States gross national product before he
was 40 years old, but even more interesting, he was a billionaire and his oil empire was
largely in place before he was 30.

Other perhaps the current period of entrepreneurship began with innovators such as Cyrus
McCormick and Alexander Graham Bell.

McCormick introduced the mechanical horse-drawn reaper in 1831 that revolutionized

agriculture. The reaper allowed the average farmer to harvest his crops five times faster
than before. The reaper replaced the hand scythe, which had been the best harvest tool
available for generations.

Alexander Graham Bell is best known for inventing the telephone. Bell was a passionate
educator and innovator throughout his life. He developed the telephone, and then went on
to experiment with ideas ranging from the recording cylinder to hydrofoil boats. Bell's
invention of the telephone may have been in great part an accident. Bell had been
working for years on a way to improve communications for the deaf and hearing
impaired; he really wanted to create a hearing aid, but his mechanical voicebox gave to
society the telephone. Unlike McCormick and Bell, Henry Ford was not an inventor, but
he was an astute entrepreneur. When he founded Ford Motor Company, olds and several
other auto companies had been in production for nearly 20 years. Ford, however, created
a manufacturing process based on a system of specialization that no one else could
match.

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Thomas A. Edison was the most famous individual, whom we credit with the light bulb.
In fact, the light bulb had been around for years, but no one had been able to make one
that lasted long, nor one that used alternating current. He experimented with more than a
thousand models before he was successful, but even then, the light bulb was only a
gadget. Edison was successful only after he made the light bulb commercially viable by
establishing an electric-generating industry.

McAdam was the first to formulate the principle of successful road construction and to
reduce the subject to a science. His road construction technique required that the road be
laid above the general level of the adjacent ground, and be formed from small broken
stones, with suitable drainage on each side of the road. No separate binding material was
used and traffic passing over the road was the chief consolidating agent. McAdam also
reorganized the road system from top to bottom.

These historical underpinnings have one common thread: entrepreneurs were responsible
for innovations that significantly improved human productivity. This pattern is repeated
time and again. The bicycle mobilized the human race. McAdam (blacktop) gave us the
material for commercial highways. Ford gave us the highly productive assembly line.
Edison gave us light and a tremendous new use for electric power. And Bell gave us the
means to communicate instantaneously.

International Business Machines Corporation (IBM), one of the world’s largest

manufacturers of computers and a leading provider of computer-related products and
services worldwide. IBM makes computer hardware, software, microprocessors,
communications systems, servers, and workstations. Its products are used in business,
government, science, defense, education, medicine, and space exploration. IBM was
established through the early efforts of its founder Thomas Watson, Sr., who converted
the clumsy mechanical typewriter into an electrically operated office machine. He
marketed the electric typewriter aggressively, and then spearheaded the early
development of punch card accounting systems. Under the dynamic leadership of
Thomas J. Watson, Jr., the founder's son, IBM flourished as a corporate giant in

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computers. Steven Jobs and Stephen Wozniak made personal computing possible with
the Apple Mitchell D. kapor, who founded Lotus in 1981, was responsible for the best-
selling PC software program ever devised the Lotus 1-2-3 spreadsheet. In each instance,
Productivity was improved by extraordinary measures. From a mechanical typewriter to
the electronic model, and then to the personal computer with sophisticated word
processing, office capabilities have quintupled. Electronic spreadsheets made pencil and-
ledger accounting practices obsolete, and the calculation power of spreadsheets used with
high-speed PCs made slide rules museum pieces.

Many corporations that we take for granted as industry giants began very modestly as
entrepreneurial ventures. Intel Corporation in microelectronics, Data General Corporation
and Digital in business and scientific computing. Ashton-Tate in software, Sun
Microsystems in electronic workstations, and Wang Laboratories in office systems come
to mind as "high-tech" examples in the computer industry.
"High tech" is not limited to information technology, and other firms with products that
seldom become household words have dynamic entrepreneurial foundations.
Biopolymers (chemicals secreted naturally from microbes) are being developed for
industrial use by a small but rapidly growing firm, Petroferm. These biopolymers allow
water and oil to combine, and this ability can in turn help expedite oil extraction. The use
of biopolymers could double oil field production. The biopolymer process also creates an
inexpensive new substitute for fuel oil that alone could free up nearly 2 million barrels of
crude oil per day. Genetic engineering is a field only recently making its debut and led by
a few entrepreneurial firms that have begun to provide commercially viable medicines
and industrial chemicals. These firms have mysterious names such as Genentech and
Amgen, and most product names have little meaning by themselves, such as TPA and
EPO, but the ramifications of these innovations are awesome. For example, the U.S. Food
and Drug Administration Recently approved several new genetically engineered products
that include therapeutic proteins, human insulin, and human growth hormones. One of
these products, interferon, has promising use in cancer treatment. The product known as
TPA is now in use in Europe for medical rehabilitation of patients with heart disease, and
EPO is being tested for its use in replacing red blood cells for kidney dialysis patients.

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There are literally hundreds of examples that have had (or promise to have) extraordinary
implications for society. Our methods of communication have changed, our traditional
office systems have changed, our medical treatments of serous illnesses have changed,
and many of our production and manufacturing processes have changed. That is only a
beginning, and it hardly explains the nature of entrepreneurship. "High tech" is a
buzzword, and productivity is relative. The commercial application of electricity by
Edison, the production of steel by Carnegie, the mass assembly of automobiles by Ford,
and the systematic packaging of meat products by Swift were all "high tech" in their time;
in each instance, productivity improved enormously.

In each example, whether taken from early tycoons or contemporary wizards, there were
inspired individuals who went out on very thin limbs to create new ventures that solved
problems or created new opportunities. In the evolution of modern industrial nations, the
nature of entrepreneurship is best explained by the profound observation that
entrepreneurs "created opportunities." It is completely immaterial whether a venture is
high tech or not, or whether it offers a product or a service.

For instance, Fuddruckers (ranked 85th in 1987 and 62nd in 1989 by Inc.) is a chain of
unusual and highly successful hamburger restaurants, but not a likely candidate to rival
IBM or General Motors. On the other hand, Apple Computers and Lotus Development
Corporation began as small companies listed on Inc. 100, but both are now major players.
The composite Inc. list for 1989 shows that 30 percent of the firms were in computers
and microelectronics, yet 16 percent of the Firms were in health care, and there were
several top-rated enterprises in communications, entertainment, food services, genetic
engineering, cosmetics, merchandising, and parcel express services.

An interesting example of how entrepreneurs embrace new opportunities is Doskocil, a

firm with gross annual sales in excess of quarter billion dollars. The company's founder,
Larry Doskocil, started out in a rented chicken hatchery making sausage in Hutchinson,
kansas. He recognized the growth in the pizza industry during the early 1980s, and began

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processing wholesale sausage and pepperoni packaged specifically for pizza restaurants.
His business has grown to the point of being the Pizza-topping king of the United States.

Entrepreneurs who solved a problem or saw an opportunity, took the risk of a new
venture, and succeed because they gave society something of value. Successful
entrepreneurs are also usually close to the problem or opportunity in terms of skill,
knowledge, access, or resources. Most entrepreneurs do not dream up radical new ideas
or merely brainstorm their way into business. Edison had been working with electricity
and various forms of illumination for years. Bell had been working on audio transmission
long before he conceived of the telephone. Doskocil had spent years scratching out living
processing sausages in traditional ways before recognizing the market opportunity in
pizza toppings. The founders of nearly all genetic engineering firms were research
scientists with substantial qualifications. As other examples are presented, it will become
apparent that most founders had some knowledge of their markets, some product
experience, or a unique skill that guided them toward opportunities. In many instances
they have had opportunity thrust on them, but only rarely have new ventures occurred
through luck.

Microsoft Corporation, leading American computer Software Company, develops and

sells a wide variety of software products to businesses and consumers and has subsidiary
offices in more than 60 countries. The company’s Windows operating systems for
personal computers are the most widely used operating systems in the world.

Microsoft’sother well-known products include Word, a word processor; Excel, a

spreadsheet program; Access, a database program; and PowerPoint, a program for
making business presentations. These programs are sold separately and as part of Office,
an integrated software suite. The company also makes software applications for a wide
variety of server products for businesses. Microsoft’s Internet Explorer allows users to
browse the World Wide Web. Among the company’s other products are reference
applications; games; financial software; programming languages for software developers;
input devices, such as pointing devices and keyboards; software for personal digital

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assistants and cellular telephones; handwriting-recognition software; software for
creating Web pages; and computer-related books.

Microsoft operates the Microsoft Network (MSN), a collection of news, travel, financial,
entertainment, and information Web sites. Microsoft and the National Broadcasting
Company (NBC) jointly operate MSNBC, a 24-hour news, talk, and information cable-
television channel and companion Web site.

Bill Gates is the chairman, chief software architect, and cofounder (with Paul Allen) of
Microsoft Corporation, the world’s leading computer software company. The company’s
success made Gates one of the world’s richest people.
1.3. Role of entrepreneurship for economic development

Entrepreneurs are the innovators; they identify business opportunities, plan to address
market needs, gather resources, and manage the process of building business.
Entrepreneurs create jobs, transfer technology to the market and create value, adding
immeasurably to our well being. Entrepreneurs make unique contributions to a country's
economy. Using innovations to grow their business, they provide concrete benefits to the
national economy. In general they play role in reducing unemployment, stabilizing
inflation, normalize balance of payment and business cycle and so on.
Developing economies need greater number of people possessing entrepreneurial
qualities and capable of taking decisions under conditions of uncertainties to transform
their underdeveloped economies into developed one. For this, well-developed
institutional support is important.
1.4. Entrepreneurship, creativity and innovation
Innovation is the process of entrepreneurship. Innovation implies action, not just a new
idea. When people have passed through the illumination and verification stages of
creativity, they may have become inventors; but they are not yet innovators. For an idea
to have value, it must be proven useful or be marketable. Innovation is the transition of
creative idea into a useful application. It requires four things to be fulfilled.

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  Analytical planning: - analytically working out the details of product design or
service, to develop marketing (i.e., marketing strategy), obtain finance and plan
operation.
 Organizing recourses: - obtaining materials, technology, human resource and
capital.
 Implementation: - here the plan is changed to reality where accomplishment in
establishing organization, product design, manufacturing and services are
achieved.
 Commercial application: - it is the stage where creative idea transforms into
application. This commercial application provides value to customers (utility),
reward for employees (salary), revenue for investors (profit) and satisfaction for
founders.
One quality of entrepreneur is innovation. Schumpter has emphasized in his writings that
innovation as a step forward to shatter the status quo through new combination of
resources and new methods of commerce.
Now, it is necessary to see the distinction (difference) between creativity, invention and
innovation.
 Creativity is the ability to bring something new into existence. Here, there is no
action to make the idea a reality. It is the seed that inspires entrepreneurship and
it is the prerequisite to invention.
 Invention is the creation of something new, which results in new knowledge
 Innovation is the process of doing new things. It is the transformation of creative
ideas into useful applications, which results in new products, services or
processes. E.g. Thomas Edison's light bulb was only a curiosity until he
developed an electric system supplying power to consumers.
Entrepreneurs need to pursue, and ideas usually evolve through a creative process. In the
creative process, most social scientists agree on five stages. These stages are idea
germination, preparation, incubation, illumination and verification.
Idea Germination:
Germination: It is a seeding process. For most entrepreneurs ideas begin with
interest in a subject or curiosity about finding a solution to a particular problem.

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Preparation: Once a seed of curiosity has taken form as a focused idea, creative people
embark on a conscious search for answers. If it is a problem they are trying to solve, then
they begin an intellectual journey, seeking information about the problem and how others
have tried to solve it (e.g. Bell's determinations to help those with impaired hearing). If it
is an idea of new product or service, the business equivalent is market research (i.e., for
design, market.)
Incubation: It is the assimilation of information by the subconscious mind. In this stage,
the subconscious intellect assumes control of creative process. Conscious focus 
behaves rationally to attempt to find systematic resolutions. Subconscious process 
minds are not hampered by the limitations of human logic; and therefore open to unusual
information and knowledge that we cannot assimilate in a conscious state.
Illumination (enlightenment): It occurs when the idea resurfaces as a realistic creation.
This stage is critical for entrepreneurs because ideas, by themselves, have little meaning.
Verification: An idea once illuminated in the mind of an individual still has little
meaning until verified as a realistic and useful. Entrepreneurial effort is essential to
translate an illuminated idea into a verified, realistic and useful application. It is the
development stage of refining knowledge into application.
1.5. Characteristics of entrepreneurs
The characteristics of an entrepreneur that contribute to success are the result of his/her
achievement motivation. A successful entrepreneur must be a person with technical
competence, initiative, good judgment, intelligence, leadership qualities, self-confidence,
energy, attitude, creativeness, fairness, honesty, tactfulness and emotional stability.
Mental ability:
ability: It consists of intelligence and creative thinking. An entrepreneur must be
reasonably intelligent, and should have creative thinking and must be able to engage in
the analysis of various problems and situations in order to deal with them. The
entrepreneur should anticipate changes and must be able to study the various situations
under which decisions have to be made.

Clear objectives:
objectives: An entrepreneur should have a clear objective as to the exact nature of
the business, the nature of the goods to be produced and subsidiary activities to be
undertaken. A successful entrepreneur may have the objective to establish the product, to
make profit or render social service.

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Business secrecy:
secrecy: An entrepreneur must be able to guard business serious. Leakage of
business secrets to trade competitions is a serious matter, which should be carefully
guarded against by an entrepreneur. An entrepreneur should be able to make a proper
selection of his assistants.
Human relation ability:
ability: The most important personality factors contributing to the
success of an entrepreneur are emotional stability, personal relations, consideration and
tactfulness. An entrepreneur must maintain good relation with his/her customers if he/she
is to establish relations that will encourage them to continue to patronize his/her business.
He/she must also maintain good relations with his employees if he is to motivate them to
perform their jobs at a high level of efficiency. An entrepreneur who maintains good
human relation with customers, employees, suppliers, creditors and the community is
much more likely to succeed in his/her business than the individual who does not practice
good human relations.
Communication ability:
ability: Communication ability is the ability to communicate
effectively. Good communication also means that both the sender and the receiver
understand each other and are being understood. An entrepreneur who can effectively
communicate with customers, employees, suppliers and creditors will be more likely to
succeed than the entrepreneur who does not.
Technical knowledge:
knowledge: An entrepreneur must have a reasonable level of technical
knowledge. Technical knowledge is the one ability that most people are able to acquire if
they try hard enough.
An entrepreneur who has a high level of administrative ability, mental ability, human
relations ability, communication ability, and technical knowledge stands a much better
chance of success than his counterpart who possesses low levels of these basic qualities.
Brilliant men/women with first class degrees from university shy away from becoming
entrepreneurs because the one thing they cannot be taught is coping with human
emotions.
Robert D. His reaserch has identified a few more capabilities or personal characteristics
that an entrepreneur should possess. According to him, the entrepreneur must have an
adequate commitment, motivation, and skills to start and build a business. The

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entrepreneur must determine if the management team has the necessary complementary
skills necessary to succeed. Some key characteristics of successful entrepreneur are:
Motivator:
Motivator: An entrepreneur must build a team, keep it motivated, and provide an
environment for individual growth and career development.
Self-confidence:
Self-confidence: Entrepreneurs must have belief in themselves and the ability to achieve
their goals.
Long-term involvement:
involvement: An entrepreneur must be committed to the project with a time
horizon of five to seven years. No ninety-day wonders are allowed.
High energy level:
level: Success of an entrepreneur demands the ability to work long hours
for sustained periods of time.

Persistent problem-solver:
problem-solver: An entrepreneur must have an intense desire to complete a
task or solve a problem. Creativity is an essential ingredient.
Initiative:
Initiative: An entrepreneur must have initiative, accepting personal responsibility for
actions, and above all make well use of resources.
Goal setter:
setter: An entrepreneur must be able to set challenging but realistic goals.
Moderate risk-taker:
risk-taker: An entrepreneur must be a moderate risk-taker and learn from any
failures.

These personal traits go a long way in making an entrepreneur a successful man/woman.

But, however, no entrepreneur possesses total strengths. In such cases, he acquires and/or
associates and thus strengthens his enterprise.
The above-mentioned characteristics of entrepreneurs can be classified into three clusters
and major their components:

Opportunity seeker entrepreneur asks him/herself the following questions:

 What am I going to solve through my business?
 What do people lack/need?
 What am I capable of doing?

To improve your capacity of generating new ideas:

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 copy somebody else's successful idea,
 combine two or more ideas to form a new one,
 solve problems to people,
 find what the competitors are doing,
 develop hobby, build on your skills,
 turn wastes into useful things,
 brainstorm the idea,
 talk and listen to people,
 make lists and play around with,
 look for gaps in the market, and
 find new ways to do things

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 CHAPTER– TWO
Small Business-Vital Component of the Economy
2.1 Definition and importance
Small Medium Enterprises (SMEs) have been defined in a variety of ways using various
factors. Although many countries around the globe seem to be using common factors in
their definitions, the degree of emphasis and measures used differ quite considerably.
These factors include number of employees, volume of sales, and the capital value of the
business.
In recent times, there has been some degree of convergence in SMEs definitions
particularly in Europe. The European Commission defines SMEs using a combination of
employee numbers, annual turnover or balance sheet total and ownership (Hillary, 2000).
However, the above convergence does not in any way suggest a common agreement of
the specific numbers in terms of these variables. To this end, different governments and
writers in SMEs differ considerably. This difference is influenced largely by Population
and stage of a country’s economic development.
A definition of SME in the developed world would differ from how SMEs is defined in
the third world. Given the number of businesses in the United States of America (USA)
and Europe, SMEs (if defined according to the number of employees and turnover) would
be a definition adopted for large enterprise in Africa. For example, Fay (2000), Clarck
(2000), the European Commission and the Organization for Economic Cooperation and
Development (whose membership includes European and Asian countries like Japan)
define SMEs as having below 250 employees. On the other hand, Ethiopia defines SMEs
as having employees not exceeding 10 (CSA).
The second factor commonly used in defining SMEs is annual turnover. Again, the
acceptable figures differ from country to country, depending among other factors on
population and stage of economic development. For example, the accepted definition of
small enterprises in Vietnam is VND10 billion (USD700, 000). In the USA, the accepted
definition of a small business is “an entity with average annual gross revenues for the
preceding three years not to exceed $15 million, and very small business as an entity with
average annual gross revenues for the preceding three years not to exceed $3

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million”(Weaver, 1999). In Ethiopia, small enterprises defined in their paid up capital
which is more than Birr 20,000 ($2,500) but not more than Birr 500,000 ($62,500).
Recognizing that there are no standard definitions of SMEs and that their definitions vary
from country to country depending largely on the size of the economy, the levels of
development, culture and population size of a country involved the definition of small
enterprises varies from one country to another. In most of the countries of the world, the
criterion for defining a small enterprise is related to the size of employment. For instance,
in USA, small business is one which has employment of less than 500 people. In U.K, it
is less than 20 skilled workers, in Germany less than 300 workers, in Sweden less than 50
and Italy less than 500.
The definitions of small scale industries prevalent in some countries are; china: In china,
the definition of small industry is less quantified and varies with the product. These
industries are designed to mobilize local raw materials, local skills, local finance and
local markets.
In Egypt, Israel and Turkey: the United Nations Report (1958) on the development of
the manufacturing industry in Egypt, Israel and Turkey refers to all manufacturing
establishments employing less than 10 persons as small scale industries. Germany,
Sweden, Norway, and Denmark: Units employing up to 300 workers are considered to be
small scale units.
In Sudan: Small industries are defined as those industries which have a capital
investment of less than $ 142,000 or which employs less than 30 full time workers. Most
industries in this category are workshops, small oil mills. Perfumeries ice factories
tanneries etc.
In Japan: The government applies the term to those industries which employ less than
$133,000 and in the commercial and professional services sector, with a capital of less
than $ 26,000 employing less than 50 persons. The small enterprise includes retail shops,
shopping districts, beauty saloons hair dressing establishments and laundry shops.
In Vietnam: A small industry is defined as one employing less than 300 persons and
having not more than $250,000 in capital investment.

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In Ethiopia: Small enterprises are defined with an investment capital of $ 2350 to $ 5880
(Birr 20,000 – Birr 50,000). Micro enterprises are those with an investment paid up
capital not exceeding $ 2350 (Birr 20,000).
Statistical Authority (CSA) which defines enterprises according to the number of
employees and paid up capital.
Ministry of Trade and Industry adopted official definition of Micro and a Small
enterprise in Ethiopia is as follow: Micro enterprises are business enterprises found in all
sectors of the Ethiopian economy with a paid-up capital (fixed assets) of not more than
Birr 20,000, but excluding high-tech consultancy firms and other high-tech
establishments. Small Enterprises are business enterprises with a paid-up capital of more
than Birr 20,000 ($2,500) but not more than Birr 500,000 ($62,500) but excluding high-
tech consultancy firms and other high-tech establishments
The Central Statistical Authority (CSA), for the purposes of its survey on "Urban
Informal Sector Activity Operators and Small-scale Manufacturing Industries", attached
various definitions to enterprises in different sectors, viz: the informal sector, cottage or
handicrafts, small-scale manufacturing industries and medium- and large-scale
manufacturing industries. The CSA based its definitions on the size of employment and
extent of automation for small-, medium- and large-scale enterprises and used a
combination of criteria for defining informal sector operators.
CSA definition of enterprises:
 "Large and medium scale manufacturing enterprises have been classified as
establishments with more than ten employees using automated machinery.
 Small and medium enterprises are establishments that engage less than 10
persons using power driven machinery.
 Cottage/handicrafts are household type enterprises located in households or
workshops normally using own or family labour and mostly manual rather than
automated/mechanical machinery."
Why are small businesses important to the economy?
Most small scale industries have a low capital intensity and high potential for
employment generation. They possess location flexibility which services as an effective
instrument for achieving a wide dispersal of industries. Small scale units serve as a means

18
semi-urban and rural areas. The small scale sector has a high potential for employment,
dispersal of industries, promoting entrepreneurship and earning foreign exchange to the
country. The following points demonstrate the importance of small scale industries:
1. Small is beautiful:
“Small is beautiful”, said E.F. Schumacher. He maintains that man’s current pursuit of
profit and progress, which promotes giant organizations and increased working
conditions. Schumacher emphasizes on small working units, communal ownership and
regional work places utilizing local labor and resources.
2. Innovative and productive:
It is the small units which are highly innovative though they do not maintain their own
research and development.
3. Individual tastes, fashions, and personalized services:
Small firms seem to have and edge in industries that call for personalized service,
attention in detail and the flexibility to adapt quickly to changes in the business or
technological environment.
4. Symbols of national identity:
Small enterprise are almost always locally owned and controlled, and they can strengthen
family and other social systems and cultural traditions that are perceived as valuable in
their own right as well as symbols of national identity.
5. Happier in work:
People who work in small enterprises are happier in their work than those who work in
large ones in spite of lower wages and poor standards of safety, comfort and welfare
faculties.
6. Winners of the game:
Small enterprises and new entrepreneurs were at the forefront of every business boom of
the last decaled, whether it was computers, television sets, consumer electronics,
Garments, diamond exports or advertising.
7. Dispersal over wide areas:
It is only small scale units which have a tendency to disperse over wider areas. Small
scale industries allay a key role in the industrialization of a developing country. This is
because they provide immediate large scale employment and has a comparatively higher

19
labor-capital ratio: they need lower investments: offer a method of ensuring a more
equitable distribution of national income and facilitate and effective mobilization of
resources of capital and skill which might otherwise remain unutilized: and they stimulate
the growth of industrial entrepreneurship and promote a more diffused pattern of
ownership and location.
Advantages of small scale enterprise
Small enterprises have distinct advantages both economic and social. Some of these are:
1. Some small scale industries do not require a high level of technology.
2. Small scale industries as generally labor intensive and do not require a large
amount of capital. The energy of unemployed or underemployed people may be
use for productive purposes in and economy in which capital is scarce.
3. Small scale industries projects can be undertaken in a short period and hence can
increase production both in the short run and log run.
4. Most developing countries are rich in certain agricultural, forest and mineral
resources; small scale enterprises can be based on the processing of locally
produced raw materials.
5. It is possible both to save and to earn foreign exchange by producing and
exporting goods processed from local resources.
6. Small scale industrial enterprises are the training ground for local entrepreneurs
on decision making. Form small scale industrial enterprises. Knowledge and skill
can be transferred to other enterprises: small enterprise many grow in to medium
sized enterprises.
7. By creating opportunities for the small business, small industrial enterprises can
bring about a more equitable distribution of income which is socially necessary
and desirable.
8. Small scale enterprises in developing countries help to create economic stability
in society by diffusing prosperity and checking the expansion of monopolies.
9. The development of small scale enterprise will relate jobs in the rural areas of the
developing countries where unemployment and underemployment are high.

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 10. Small scale enterprises will make possible a transfer of manufacturing activities
from the metropolitan and rural areas. This will also help in bringing about a
geographical diffusion of skill and technology in a country.
11. Apart from the linkages between agricultural of rural development and small scale
industrial enterprises. There is an essential linkage between large scale enterprises
opportunities of facilitates for the growth of the small scale enterprises.
12. Small scale enterprises have their own place in country’s economy. Imperfect
competietion protects the small firm’s markets and enables them to exist where
they are not efficient in terms of cost.
13. The development of small scale enterprises can be apart of integrated rural
development programs. Due attention needs to be given to the industrial and non-
agricultural components or activities in the context of rural development
programs.
2.2. Economic, social and political aspects of small business enterprise
Small businesses (enterprises) have to play a vital role in Ethiopian economy. They need
a strong support on socio-economic and political grounds.
Socialistic idea
Our goal is to establish a socialistic pattern of socialistic pattern of society. The main
objectives are equitable distribution of wealth and decentralization of economic power.
The benefits of industrial growth should be shared by as many people as possible and
should improve the general standard of living. Proliferation of small enterprises will go a
long way in achieving these objectives.
Less capital and more labor
We have vast manpower but inadequate capital which has resulted in increasing
unemployment planners have realized the necessity of encouraging small industries
because they require less capital but generate a much higher degree of employment than
the large scale sector. The small industries will stand in good position because they are
less capital intense and d more employment oriented.
Removing regional imbalances
There is continuous shifting of people from rural to urban which causes overcrowding in
cities the slum conditions due to lack of social and medical amenities which require

21
heavy investments. This problem can be solved by inducing people to set up small
industries in rural areas. The prolific setting up of agro-based industries will go a long
way in creating a balance in the economy. Young entrepreneurs who can easily set up
their own units with package assistance from the government.
Ancillary function
Many small-scale industrial units supply parts and accessories to bigger industries. This
ancillary function involves specialization in specific areas and results in greater
profitability. The government has relaxed the ceiling of investment in plant and
machinery for ancillary unit.
Export promotion
Small-scale industries are opening up fresh avenues in the export market. Realizing the
importance of small-scale sector in the economy, the Ethiopian government has adopted
several measures to speed up the growth for small industries.
Supply of critical raw materials
The government has also liberalized the import policy to ensure regular supply of raw
materials to small industrial units, and devised a more efficient and consistent system of
distribution of critical raw materials.
2.3 .Risk and Failure of Small Business
Weitzel and Jonsson (1989) discuss business failure as being the last stage of
organizational life cycle. They found that the numerous characteristics shared by failed
firms are directly related to personal decision-based characteristics of the owner (e.g.,
lack of insight, inflexibility, emphasis on technical skills etc), managerial deficiencies
(e.g., lack of managerial skills, appropriate management training, and previous
managerial experience) and financial shortages (e.g., no accounting background, cash
flow analysis, financial records). In contrast, Star and Massel (1981) related business
failure rates to types of businesses. They found that failure rates were higher for firms
that:
(1) Were smaller in size,
(2) were located in rural areas,
(3) Sold low priced merchandise, and
(4) Operated as sole proprietorship.

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The most common causes for small business failure are changes in debt availability,
interest rates, local demand for goods and services, regional employment trends,
production prices required by larger companies, and government regulations. Slight
changes in tax laws, for example, can quickly turn a profitable small business into
unprofitable enterprise.
From a financial standpoint, most small businesses rely on commercial loans tied to
premium interest rates. Small changes in economic conditions result in huge changes in
profits. Smaller businesses that are relatively debt free still operate in a more intense,
price-sensitive environment. Most cannot afford to trim prices, nor can they substantially
reduce costs. On the other hand, many smaller firms are isolated from “macro” economic
variables. Inflation, for example, rarely affects two communities in exactly the same way.
Just how many businesses fail because of uncontrollable external factors and how many
fail owing to personal factors is debatable. However, statistics attribute about 52 percent
of all business failures to “management issues,” and as much as 90 percent of small
business failures to incompetent managers. Specifically, this is because of inability of
small business managers to control purchasing costs (inventory), to control capacity
(production or operating costs), to generate customers (lack of marketing expertise), or to
manage financial assets (feeble cash control being the primary issue).
Too often, entrepreneurs launch their enterprises without having sufficient experience to
succeed. Inexperience can be translated to mean a lack of technical skills or management
acumen. Each of these shortcomings can lead to disaster, but they also can be overcome
by an individual willing to make the commitment of time and energy to learn about
business.
Experienced managers often make the mistake of assuming that since they are reasonably
successful in a salaried position, they can transfer that knowledge to an independent
business. Personnel specialists may feel confident when they strike out on their own to
open an executive placement agency, only to find that the “agency” requires marketing
expertise, not just knowledge in corporate personnel. Engineers launch their own firms to
pursue the manufacture of innovative products only to find that they know practically
nothing about production. Each of these individuals may be “experienced,” but the kind
of expertise they bring to their enterprises has limited value.

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Many small businesspersons-particularly inventors and innovative entrepreneurs with
new products-become egocentrically engrossed in their ventures. They become consumed
with their own brilliance, convinced beyond reason (often without market research) that
their bright idea will change the world-it’s got to sell; Their arrogance will not allow
them to take advice from others. They will shun all innuendo of failure. Such arrogance is
often needed to succeed, and there are many fine examples of those who have defied the
odds, yet for each success story, there is a legion of failures.
Humble entrepreneurs steeped n experience can still go under simply through
mismanagement of resources; they simply make bad decisions in critical situations.
Given the competitive nature of most small businesses and the volatility of profits,
business results are quite sensitive to small errors. Several categories of management
mistakes are critical for small businesses to avoid.
An unfortunate aspect of many business failures is that too often individual owner’s
priorities get in the way of sound business practices. In the least obtrusive way,
entrepreneurs may not be fully committed to the long hours required to make a venture
successful. The new venture is a mistress requiring long hours and constant attention. The
early stages of starting a business require intensity of effort, sacrifices, and the ability to
endure at high energy levels without becoming overextended to the point of exhaustion.
As the business stabilizes, the challenge is to hire good employees who can manage in the
owner’s absence.
Research shows that less than half of small business owners had formal plans prior to
going into business. Many engaged in formal planning soon after starting their
businesses, but one-third could not recall ever having a formal business plan. Little
research exists to determine the extent of planning in failing businesses. This lack is
understandable because few of those who failed are around to be interviewed. However,
research supports a strong case for well-developed plans with clear objectives prior to
starting any venture. It is nearly impossible to acquire capital, obtain loans, or solidify
vendor contracts without documented sales forecasts, financial statements, market
analyses, and a clear statement of the business purpose.
3. What are the most common causes for small business failure?

2.4. Small business problems in Ethiopia

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Traditionally, small business problems are divided according to business functions. This
classification assumes that different business functions have different problems. It is the
failure of owner/managers to effectively carry out the various business functions that
consequently lead to business failure.
Small-scale industries have not been able to contribute substantially as needed to the
economic development particularly because of financial, production and marketing
problems. These problems are still major handicaps to development. Lack of adequate
finance and credit has always been a major problem of Ethiopian small business. Small
scale units do not have easy access to the capital market because they mostly organized
on proprietary partnership basis and are of very small size. They do not have access to
industrial sources of finance partly because of their size and partly because of the fact
that their surpluses which can be utilized to repay loans are negligible. Because of their
size and partly because of their limited profit, they search funds for investment purposes.
Consequently, they approach money-lenders who charge high rate of interest. Hence
small enterprises continue to be financially weak.
Small scale enterprises find it difficult to get raw materials of good quality and at cheaper
rates in the field of production. Very often they do not get raw material in time. As a
result, these enterprises fail to produce goods in request quantities and of good quality at
a low cost. Furthermore, the techniques of production, which these enterprises have
adopted, are usually outdated. Because of their poor financial position they are not able to
buy new equipment, consequently their productivity suffers. Many small business
enterprises are suffering with the problem of marketing their products. It is only by
overcoming all these constraints that small entrepreneurs can hope to make their
enterprises successful.
2.5 Setting Small Business
Setting up for a small new enterprise is a very challenging and rewarding task. Several
problems are involved in this task. Right from the conception of a business idea up to the
start of production, numerous decisions have to be taken. In order to succeed in this task,
an entrepreneur must correctly perceive the nature and intensity of the problems to be
faced and prepare and implement appropriate plans.
2.5.1 What is Basic Business Idea?

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In practical situation it is seen that an entrepreneur finds it rather convenient to think of
product, keeping in view the immediate future rather than the long term goals. Business
atmosphere being what it is with all its intendants, uncertainties, it is more likely to face a
serious problem either when he wants to expect or when the first product meets with a
failure.
It is logical, therefore to think of a goal for the unit in the long run rather than to look for
the immediate tomorrow. This long term thinking is called Basic Business Idea.
2.5.2 What project an Entrepreneur should have?
In the precise sense, a project presupposes commitment to task to be performed with well
designed objectives, schedules and budget.It can be defined as a scientifically evolved
work plan devised to achieve specific objective within specified period of time.Taken in
this perspective, while project can differ in size, nature, objectives and complexity, they
must all partake of three basic attributes of being a course of action, of having specific
objectives and of involving a definite time perspective.
Project classification: Project has been classified in various ways by different
authorities. Little and Mirrelees divide projects in to two broad categories. These are
quantifiable projects and non quantifiable projects. Sector wise also project can be
classified in to different categories. Project can also be classified on the basis of techno-
economic characteristics.Some financial institutions classify projects on the basis of the
nature of the project and its life cycle.
2.5.3 Definition of industry and small scale industry
An industry is an institution where raw material is purchased from suppliers, converted in
to finished product using machinery and labor and sold to buyers.Conversation of raw
material means changing the size, shape, chemical properties, and assembling different
[parts, etc.For example, in shoe making unit, different type of leather are purchased, cut
in to different shapes and sizes and then stitched as shoes, etc.This is a simple conversion
of size and shape of raw material. In the case of cement plant the raw material used are
limestone, gypsum, etc.These materials are chemically processed, i.e. they are properly
mixed, heated and powdered to get cement as the final product.
Industries again are not the same. Some are big like steel plant and some are small like a
unit manufacturing of wooden furniture. Some industries make cycle tube and tires while

26
some other make radios and transistors. Thus, industries differ widely and can be
classified in different ways.
Small scale industry: Small business would include individuals and firms managing a
business enterprise e4stablished mainly for the purpose of providing any services other
than professional.
Small scale industries have been defined as industrial units engaged in
manufacturing/preservation activities or repairing/ servicing operations including such
operations as quarrying.
2.5.4 Steps in setting a small scale unit
1. The first key to success in any manufacturing activity is to select the right product. In
the beginning, information of possible lines of activity must be obtained, by taking to
knowledgeable people, from industrial publications, or from various organizations. The
information available from these sources may be supplemented by ones’ ideas and some
alternative feasible lines of activity identified. These lines of activity must necessarily be
those, which are the consistent with ones own personal qualities and capacity. They must
essentially be of interest to the entrepreneur.
These must be examined with a view to assess:
a) The marketing aspect-Published data, talks with people in the field etc., to obtain a
general idea of the marketing conditions.
b) Technical aspects-Detailed assessment of the goods and services needed for the project, the
type of technology to be adopted for the project.
c) Financial aspects-General idea of the overall investment and scale of operations, sources and
mode of financing it, etc. The product must be suitable for an entrepreneur is to be identified from
the above.
2. Having selected a product, a detailed project report needs to be prepared. This will cover the
following aspects:
a) A detailed estimate of demand is to be made. The total demand, existing suppliers and the
capacity of existing units, the demand gap remaining to be met , the customers, the distribution
channel required, have all to be studied. The required information may be obtained from
published data, literature available in some organizations, through information gathered
personally from persons already in the field, users, dealers, etc, or by means of detailed market
survey conducted by government organizations, or by private organizations and consultants.

27
b) Technical specifications of the process should be carefully studied. The know- how may be
available with the person himself or may be obtained from literature, or from others including
government laboratories like the national laboratories.
c) The equipment required their sources are to be specified.
d) Requirements of space, land, shed etc. and other utilities like power and water are to be
assessed.
e) Man power requirements of direct and indirect personnel are to be determined and their
availability ensured.
3. The detailed project report having been prepared and availability of the enterprise established,
the action phase begins.
4. Once all the required authorization and sanctions have been obtained, simultaneous action is to
be taken for the following:
 Ordering machinery from suppliers
 Obtaining utilities like power and water connections after construction of sheds, if
necessary
 Recruitment of staff
 Arranging supplies of materials
 Arranging for distribution of the product
5. Once these are complete, the plant is ready for commissioning
6. The unit is then ready for commercial production.

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CHAPTER THREE

THE BUSINESS PLAN

I.1 Why is planning is so important?

“Business don’t plan to fail, they just fail to plan”

Before we go into the nitty-gritty part of business plan, it is important that every
individual understand the importance of planning for the success of any venture. As the
matter of fact, in Ethiopia most of us are not used to the planning process. Planning
which is the process of setting objectives and devising actions to achieve those
objectives, answers such as what business I have? What is my sales strategy? Where I can
found the needed personnel? How much profit can I expect?
Planning is the process never ends for a business. It is extremely important in the early
stage of any new venture when the entrepreneur will need to prepare a preliminary
business plan. The plan will be finalized as the entrepreneur has a better sense of the
market, the product or service to be marketed, the management team, and the financial
needs of the venture. For any given organization, it is possible to find financial plan,
marketing plan, and human resource plan, production plan, and sale plan, etc.

I.2 What is Business Plan?

A business plan is the written document that details the proposed venture. It must
describe current status, expected needs, and projected results of the new business.
Every aspect of the venture needs to be covered: the project, marketing, research and
development, manufacturing, management, critical risks, financing, and milestones or
a timetable. A description of all of these facets of the proposed venture is necessary to
demonstrate a clear picture of what that venture is, where it is projected to go, and how
the entrepreneur proposes it will get there. The business plan is the entrepreneur’s
roadmap for a successful enterprise. Whatever the name, it should lay out your idea,
describe where you are, point out where you want to go, and how you propose to go
there. The business plan may present a proposal for launching an entirely new
business. More commonly, perhaps; present a plan for a major explanation of a firm
that has already started operation.

I.3 Benefits of a Business Plan

Specifically for the entrepreneur:

• The time, effort, research, and discipline needed to put together a formal business
plan force the entrepreneur to view the venture critically and objectively.
• The competitive, economic, and financial analysis included in the business plan
subject the entrepreneur to close scrutiny of his or her assumptions about the
venture’s success.

29
 • Since all aspects of the business venture must be addressed in the plan, the
entrepreneur develops and examines operating strategies and expected results for
outside evaluators.
• The business plan quantifies objectives, providing measurable benchmarks for
comparing forecasts with actual results.
• The completed business plan provides the entrepreneur with a communication
tool for outside financial sources as well as an operational tool for guiding the
venture towards success.
• Details of the market potential and plans for securing a share of that market.
• The venture’s ability to service debt or provide an adequate return on equity.
• Identifies critical risks and crucial events with a discussion of contingency plans.
• A clear, concise document that contains the necessary information for a thorough
business and financial evaluation.

I.4 The purpose of business plan

The most important steps in establishing any new business is the constructions of a
business plan. Business plan:
1. It can help the owner/manager crystallization and focus his/her idea.
2. Although planning is a mental process, it must go beyond the realm thought.
Thinking about a proposed business become more rigorous as rough ideas must be
crystallized and qualified on paper.
3. It can help the owner/manager set objectives and give him a yardstick against
which to monitor performance.
4. It can also as a vehicle to attack any external finance needed by the business.
5. It can convince investors that the owner has identified high growth opportunities.
6. It entails taking a long _term view of the business and its environment.
7. It emphasizes the strengths and recognizes the weaknesses of the proposed
venture.
8. The plan can uncover weakness or alter the entrepreneur to sources of possible
danger.

I.5 Users of business plan

A business plan has two primary functions:
 To provide clearly articulated statement of goals and strategies for internal use
and,
 To serve a selling document to be shared to the outsiders.
Those who might have an interest in a business plan for a new venture consists of
outsiders who are critical to the firm’s success: customers, suppliers, and investors. The
other group is the internal users of the business plan: the new firm’s management. Let us
consider the internal users first.

30
 I. Internal user of the business plan
Any activity without adequate preparation tends to be disorganized. This is particularly
true of such a complex process as initiating a new business. Although planning is a
mental process, it must go beyond the realm of speculation. Internal users are, firms
management and employees of the venture.
II. External users of the business plan
By enhancing a firm’s credibility, the business plan can serve as an effective selling tool
to use with prospective customers and suppliers, as well as investors. Suppliers for
example, extend credit, which is often an important part of a new firm’s financial plan. A
well prepared business plan may be helpful in gaining a supplier trust and securing
favorable credit terms. Both investors and lenders use the business plan to better
understand the new venture, the type of product/service it offers, the nature of the market,
and the qualification of the entrepreneur and the management team.

I.6 When the business plans are produced?

1. At the start up of a new business :
After the concept stage of initial ideas and feasibility study, a new business start
up many go through a more detailed planning stage of which the main output is
the business plan.
2. Business purchase:
Buying an existing business does not neglect the need for an initial business plan.
A detailed plan, which tests the sensitivity of changes to key business variables,
greatly increases the prospective purchasers understanding of the level of risk
they will be accepting, and likelihood of rewards being available.
3. Ongoing:
Ongoing review of progress, against the objectives of either a start up or small
business purchase, is important in a dynamic environment. An initial business
plan is not a document to be put in a drawer and forgotten.
4. Major decisions:
Even if planning is not carried out on a regular basis, it is usually investigated at a
time of major change. For example, the need for major new investment in
equipments, or funds to open a new outlet, It may be linked to failure, such as a
recovery plan for an ailing (or in bad condition) business.

I.7 Who produced the business plan?

Three types of people will be interested in a business plan:
1. Managers: are involved in small business planning as both producers and
recipients of the plan. Business plans are written to aid small business
managers.
2. Owners: the manager of a small enterprise may also be the owners and take a
keen (eager) interest in the planning process, wearing their shareholders hat.

31
 3. Lenders: the major banks/lenders all encourage the production of business
plans to justify overdrafts and loans, offering literature and advice on putting
together business plans.

I.8 Why the business plans are produced?

1. Assessing the feasibility and viable of the business plan/project: it is in every
ones interests to make mistakes on paper, hypothetically testing for feasibility,
before trying the real thing.
2. Setting objectives and budgets: having a clear financial vision will believable
budgets is a basic requirement of everyone involved in a plan.
3. Calculating how much money is needed: a detailed cash flow with
assumptions is vital ingredient to precisely quantify earlier the likely funds
required.

I.9 The format of a business plan

The business plan needs to answer three –straight forward questions:
1. Where are we now?
An analysis of the current situations of the market place, the competitions, the
business concept and the people involved. It will include any historical
background relevant to the position to date.
2. Where do we intend going?
Qualitative expression of the objectives, quantifiable targets will clarify and
measure progress towards the intended goals.
3. How much we get there?
Implementing of accepted aims is what all the parties to a plan are interested in as
a final result.Plans for marketing and managing the business, with detailed
financial analysis are the advisable preliminaries before putting it all in to practice.

Writing the business plan

The business plan could take much time to prepare, depending on the experience and
knowledge of the entrepreneur as well as the purpose it is intended to serve. It should be a
comprehensive enough to give any potential investor a complete understanding of the
new venture. The outline for a business plan is illustrated in figure 5.2.

Introductory page
This is the title or cover page that provides a brief summary of the business plan’s
contents. The introductory page contains the following:
 The name and address of the company
 The name of entrepreneur(s) and telephone number
 A paragraph describing the company nature of the venture
 The amount of financing needed. The entrepreneur may offer a package that
is
stock, debt and so on.

32
  A statement of the confidentiality of the report. This is for security purpose
and it is important for the entrepreneur.
This title page sets out the basic concept that the entrepreneur is attempting to develop.
Investors consider it important because they can determine the amount of investment
needed without having to read to the whole through the entire plan.

Executive summary

This section of the business plan is prepared after the total plan is written. About three to
four pages in length, the executive summary should stimulate the interest of the potential
investor. The investor uses the summary to determine if the business plan is worthy
reading in total. Thus, it would highlight concisely and convincingly the key points in the
business plan, that, is the nature of the venture, financing needed, market potential, and
support as to why it will succeed.

Industrial analysis
It is important to put the new venture in a proper context. In particular the potential
investors, while assessing the venture on a number of criteria, it needs to do an industry
analysis in order to know which industry an entrepreneur will be competing on it. The
entrepreneur should also provide insight on new product development in this industry.
Competitive analysis is also an important part of this section. Each major competitor
should be identified, with appropriate strengths and weakness described particularly as to
how they might affect the new venture’s success in the market.
Who is the customer? The market should be segmented and the target market of the
entrepreneur identified. Most new ventures are likely to compete effectively in only one
or few of the market segments.
Description of the venture
The description of the venture should be detailed in this section of the business plan. This
will enable the investor to ascertain the size and scope of the business. Key elements are
the product(s) or services(s), the location and size of the business, the personnel and
office equipment that will be needed, the background of the entrepreneur(s) and the
history of the venture. Location of any business may be vital to its success particularly if
the business is retail or involves a service. Thus, the emphasis on the location in the
business plan is a function of the type of business. In assessing the building or spaces the
business will occupy, the entrepreneur needs to evaluate such factors as parking, delivery
rates, access to customers, suppliers and distributer, and accommodating own regulation
or zoning laws.
This simple assessment of the location, market and so on saved the entrepreneur from a
potential disaster.

Production plan
If a new venture is a manufacturing operation, a production plan is necessary. This plan
should describe the complete manufacturing process. If some or all of the manufacturing
process is subcontracted, the plan should describe the subcontractors(s), including
location, reasons for selection, costs, and any contracts that have been completed. If the
manufacturing is to be carried out the whole or in part by the entrepreneur(s), s\he will

33
need to describe the physical plant nay out; the machinery and equipment needed to
perform the manufacturing operation raw materials and suppliers’ names, address, and
terms, cost of manufacturing and any further capital requirement.
If the venture is not a manufacturing operation but a retail store or service, this section
would be titled ‘’merchandising plan’’ and purchase of merchandise, inventory control
system, and storage needs should be described.
Marketing plan
The marketing plan is an important part of the business plan since it describes how the
product(s) or service(s) will be priced, promoted and distributed. Specific forecasts for
products are indicated in order to project profitability of the venture. The budget and
appropriate controls needed for marketing strategy decision should be discussed.
Potential investors regard the market plan as critical to the success of the new
venture .thus the entrepreneur should make any effort to prepare as a comprehensive and
detailed plan as possible so that investors can be clear as to the goals and strategies of the
venture. Marketing planning will be an annual requirement (with careful monitoring and
changes made on weekly or monthly basis) for the entrepreneur and should be regarded
as the road map for short term decision making.
Organizational plan
The organizational plan describes the venture’s form of ownership –that is,
proprietorship, partnership, or corporation. For instance, if the venture is the partnership,
the term of the partnership should be included. If the venture is a corporation, it is
important to detail the share of the stock authorized, share options, names and address
and resumes of the directors and officers of the corporation.

Assessment of risk
Every new venture will be faced with some potential hazards, given the particular
industry and competitive environment. It is important that the entrepreneur makes an
assessment of risk and prepares an effective strategy to deal to them.
Major risk for a new venture could result from a competitor’s reaction; weakness in the
marketing or production, and new advances in technology that might render the new
product obsolete. It also important for the entrepreneur to provide alternative strategies
should any of the above risk factors occur.

Financial risk
The financial plan, like the marketing, production, organization plans, is an important
part of business plan. It determines the potential investment commitment needed for the
new venture and indicates whether the business plan is feasible.
Generally, three financial areas discussed in this section of the business plan. First, the
entrepreneur should summarize the forecasted sales and the appropriate expense at least
the first five years. It includes the forecasted sales, cost of good sales, and the general and
administrative expenses.
Second, cash flow figure must be presented for at least the first three years, with the first
year’s projection provided with monthly. The last financial item needed in this section
of the business plan is the projected balance sheet. This shows the financial condition of
the business at specific time. It summarizes the asset of a business, its liabilities, the

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investment of the entrepreneur and any partners, and retained earnings or cumulative
losses.
Appendix
The appendix of the business plan generally contains any back up material that is not
necessary in the text of the document. Reference of to any of the document in the
appendix should be made in the plan itself.

Using and implementing the business plan

The business plan is designed to guide the entrepreneur through the first three year of
operation. It is important that the implementation of the strategy contain control points to
ascertain progress and to initiate contingency plans, if necessary.
Many business fail because of the entrepreneur inability to plan effectively. Intelligent
planning is not difficult or impossible exercise for the inexperienced entrepreneur. With
the proper commitment and support from any outside resource, the entrepreneur can
prepare an effective business plan.

I.10 Why some business plan fails

Generally a poor prepared business plan can be blamed on one or more of the following
factors:
 Goals set by the entrepreneur are unreasonable
 Goals are not measurable
 The entrepreneur has not made a total commitment to the business.
 The entrepreneur does not have experience in the planned business.

Components of business plan (outline of a business plan)

I. Introductory page
A. Name and address of the business
B. Name(s) and address(s) of principals
C. Nature of business
D. Statement of financing needed
E. Statement of confidentiality of report
II. Executive summary
III. Industry analysis
A. Future outlook and trends
B. Analysis of competitors
C. Market segmentation
D. Industry forecast
IV. Description of venture
A. Product(s)
B. Service(S)
C. Size of business
D. Office equipments and personnel

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 E. Background of entrepreneur
V. Production plan
A. Manufacturing process (amounts sub contracted)
B. Physical plant
C. Machinery and equipments
D. Names of supplier of raw material
VI. Marketing plan
A. Pricing
B. Distribution
C. Promotion
D. Production forecast
E. Controls
VII. Organizational plan
A. Form of owner ship
B. Identification of partners and principal share holders
C. Authority of partners
D. Management team background
E. Roles and responsibility of members of organization
VIII. Assessment of risks
A. Evaluation of weakness of business
B. New technologies
C. Contingencies plan
IX. Financial plan
A. Pro forma income statement
B. Cash flow projections
C. Pro forma balance sheet
D. Break even analysis
E. Source and application of funds
X. Appendix
A. letters
B. market research data
C. leases and contracts
D. price lists from suppliers

Summary
This chapter has established the scope and value of business plan and outlined the steps
in its preparation. The business plan may be read by employees, investors, customers,
supplier, and consultants. The scope of the plan deepened on who reads it, the size of
venture, and the specific industry for which the venture is intended.
The business plan is essential in launching a new venture. The results of many hours of
preparation will represent a comprehensive, well written, and well organized document
that will serve as a guide and an instrument to the entrepreneur raise the necessary
capital.
Before beginning to write the business plan, the entrepreneur will need information on
the market, manufacturing operations, and financial estimations. This information should

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 be evaluated based on the goals and objectives of the new venture. These goals and
objectives also provided a frame work for setting up controls for the business plan.

Assignment
Assume that you want to start a business to produce something or provide service;
prepare a business plan for your business in the near future, be noted that you
should follow the outline of preparing the plan and not more than 12 pages type
written business plan.(Maximum score is 30%).

CHAPTTER FOUR

PRODUCT AND SERVICE CONCEPT

4.1. New product

New products are the lifeblood of an organization. Once a company has carefully
segmented the market, chosen its target market or customers, identified their needs and
determined its market positioning, it is better able to develop new products. Marketers play

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a key role in the new-product process, by identifying and evaluating new product idea and
working with R&D and others in every stage of development.
New product development shapes the company’s future. Improved or replacement products
must be created to maintain or build sizes. Customers want new products, and competitors
will do their best to supply them.
New Product Defined
New product is a good, service, and idea that is perceived by some potential customers as a
new.

Figure 4.1
By new products we mean original products, product improvement, product modifications,
and new brands that the firm develops through its own R$D departments.
According to Booz, Allen, and Hamilton there are six categories of new products.

Figure 4.2፡ Categories of New Products

1. New –to-the world product-: is a new product that creates totally new market or new
to the world or products that are technological innovative that creates a completely
new market that previously did not exist.

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2. New product line (new category entries) – this is new products that allow a company
to enter an established market for the first time. These products are new to the
company, but as a category, the product is not new to the consumer. E.g. The entry of
Kodak into the battery market.
3. Line extension (additions to existing product lines) – is new products that
supplements Company’s established product lines. Line extension can be copies of
existing product that contain unique features of the original product do not have.
4. Product improvements (revision of existing product)-is a new products that provide
improved performance or greater perceived value or replace existing products or
product improvements are product entrancements that improve the product’s form or
function.
5. Repositioned product (market extension) -is an existing products that are targeted to
new markets or market segments or original products positioned in new markets
without any (with minimal) changes to the product.
6. Lower priced product (Cost improvement or cost reduction)–this can be new products
that provide similar performance at lowest cost.
Rationale for New Product Development
Product innovation is essentially important for the following reasons
1. Maximum use of resources
The fact that the supply of many of our natural resources are limited and irreplaceable
points out clearly the importance of careful new product development that requires
efficient and effective use of available resources
2. Product is a basic profit determinant
New products are essential of sustaining a firm’s expected rate of profit. As the
product goes through all four stages of its life cycle, the profit starts to decline in the
late stages unit it become zero.
3. New products are essential for growth
New products are designed not only to maintain the existing profit but also to increase
their profits and have greater market share.

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Figure 4.3; - Why New Products Fail
4.2. Product development process
There are eight steps of new product development. These are:-
1. Idea generation,
2. Idea screening,
3. Concept development and testing
4. Marketing Strategy,
5. Business analysis,
6. Product development,
7. Test Marketing &
8. Commercialization

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 1. Idea Generation
New product development starts with idea generation - the systematic search for new product
idea. A company typically has to generate many ideas in order to fine a new good one.

Figure 4.3 Sources of new idea generation

Sources of new product ideas can be

 Internal sources &

 External Sources
Internal Sources
Using internal sources, the company can find new ideas through formal R&D. It can pick the
brain of its executives, scientists, engineers, manufacturing staff, and sales people.

External Sources
Good new product ideas also can come from watching and listening to customers. In this case the
company can analyze customer questions and complaints to find new products that better solve
consumer problems.
In generally, external sources are: Customers, competitors, middlemen, private research
organization and trade associations.

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 2. Idea Screening
The purpose of idea generation is to create a large number of ideas. The purpose of the screening
stage is to reduce the number of ideas.

Figure 4.4: Idea Screening

Idea screening helps to distinguish good ideas and drop poor ones as soon as possible. A
company should motivate its employees through rewards to submit their new ideas.

3. Concept development and Testing

Concept development
An attractive idea must be developed in to a product concept. It is important to distinguish
between a product idea, product concept and a product image
A product idea is an idea for a possible product that the company can see itself offering to the
market.
A product concept is a detailed description of the idea stated in the meaningful consumer terms.
Concept testing
Concept testing involves presenting the product concept to appropriate target consumers and
getting their reactions. The concept can be presented symbolically or physically.
The more tested concepts look like the final product or experience the more dependable concept
testing.
A product image is the way consumers perceive an actual or potential product. For example
observe the following situation to understand concept development. A large food processing
company gets the idea of producing a powder to add to milk to increase its nutritional value and
taste. This is the product idea, consumers do not buy product idea; they buy product concepts. A
product idea can be turned into several concepts.

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 E.g who will use this product? (Infants, adults, young people etc), when will people consume this
product? (Breakfast, lunch, evening etc)

4. Marketing Strategy
Following a successful concept test the new product manager develops a preliminary marketing
strategy plan for introducing the new product into the market.
The plan consists of three parts.
The first part describes the target market’s size, structure, and behavior; the planned product
positioning; and the sales, market share, and profit goals sought in the first few years.
The Second part outlines the planned price, distribution strategy, and market budget for the first
year.
The third part of the marketing strategy plan describes the long-run sales and profit goals and
marketing mix strategy over time.

5. Business Analysis
After management develops the product concept and marketing strategy, it can evaluate the
proposal’s business attractiveness. Management needs to prepare sales; cost and profit
projections to determine whether they satisfy company objectives.

Figure 4.5: Business Analysis

The simplest way to analyze business is break even analysis in which management estimates
how many units of the product the company would have to sell to break even with the given
price and cost structure.

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6. Product Development
Up to now, the product has existed only as a word description, a drawing, or a prototype (trial
product). At this stage the company determines whether the product idea can be translated into a
technically and commercially feasible product.

7. Test marketing
After management is satisfied with functional and psychological performance, the product is
ready to be dressed up with a brand name and packaging and put into a market taste. The new
product is introduced into an authentic setting to learn how large the market is and how
consumers and dealers react to handling, using and repurchasing the product.
Pros are:

o Can reduce the risk of product failure.

o Reduces the risk of loss of credibility or undercutting a profitable product.
o Can determine the weaknesses in the marketing management and make adjustments.

Cons are:

o Test market is expensive.

o Firm's competitors may interfere.
o Competitors may copy the product and rush it out.

8. Commercialization
Commercialization is introducing a new product into the market. Here, markets fully promote,
distribute, and sell their new products. Thus, it is a passage of presenting to consumers tangibly
with high financial company expenditure cost and trying to reach at breakeven point

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The Concept of Product Life Cycle
Product life cycle is the path of a product’s sales & profit take over its lifetime. Company’s
positioning and differentiation strategy must change as the product, market, and competitors
change over time.
The Life Cycle Concept provides a useful framework for looking at the development of either
products or services and a small business. A product or service has a life cycle of four stages.
Stage 1- Introduction
This is the stage where the product or service is introduced & encounters a certain amount of
consumer ignorance and resistance. Sales are low and growing slowly and profits are low or
negative because of the heavy expenses of product introduction. Promotional expenditures are
also highest ratio to sales because of the need to inform potential customers.
Stage 2- Growth
This is a period of rapid market acceptance and substantial profit improvement. New competitors
enter, attracted by the opportunities. Small firms maintain their promotional expenditures at the
same or slightly increased level to meet competition and to continue to educate the market.
Stage 3 – Maturity
At some point, the rate of sales growth will slow, and the product will enter a stage of relative
maturity. In this stage; the market becomes saturated and slowdown in sales growth. Profits
stabilize or decline because of increased competition. Product sales may simply be for
replacement and customers begin switching to other products.
Stage 4 – Decline
After sometimes, sales will star to decline as substitute. Improved products or services become
more attractive and the old product becomes obsolete. Sales decline for a number of reasons,
including technological advances, shifts in consumer tastes, and increased domestic and foreign
competition. Some firms withdraw from the market.
The life-cycle concept helps small firms to interpret product and market dynamics. It can be used
for planning and control, although it is useful as a forecasting tool. It can also be a competitive
device, in the sense that it allows the firm to compare its sales performance to the industry as a
whole. For some products or services the life-cycle can be counted in days. For others, it can
span a number of years. It is usually possible to extend the life of a product or service by
developing it in some way or expending the market into which it is sold.

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 Figure 4.8 Product life cycle stage

Characteristics
Growth Stage
Introduction Maturity Decline Stage
Stage Stage
Sales low sales rapidly rising sales high sales and Declining sales
starts to decline
Costs high cost per average cost per low cost per low cost per-
customer customer customers customer
Profit Negative increasing profits high profits declining profits
Customers Innovators early adopters middle majority Laggards
Competitors few competitors growing competitors stable number declining in number
beginning to
decline
Objective create product maximize market maximize profit Reduce expenditure
awareness share and milk the product
Product Offer basic Offer product Diversity Phase out weak
product extensions, service, brands and item (remove)
and warranty models
Price Charge cost -plus Price to penetrate Price to match Cut-price (reduce)
market competitors’
Distribution Selective Intensive More intensive Go selective or
distribution distribution distribution phase out
unprofitable outlets
Advertising Build product Build awareness and Stress brand Reduce advertising
awareness interest in the mass differences and cost to retain hard-

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 market benefits core loyal
Sales Use heavy sales Reduce to take Increase to Reduce to minimal
promotion promotion s advantage of heavy encourage level
consumer demand brand switching

4.3 Product protection

Most entrepreneurs will not be inventors, but all of them are concerned with protecting their
idea. When those ideas relate to new products, unusual processes, unique designs, or biological
innovations such as new plants, understanding patent law becomes paramount. When
entrepreneurs want to protect unusual brand names or establish ownership of intellectual
property, then understanding trademarks and copyrights is vital. Entrepreneurship has several
dimensions and an entrepreneur is expected to know them thoroughly. One such dimension is a
legal dimension. Thus conforming to legal requirements will be the first thing to start an
enterprise. Any enterprise (i.e., sole proprietorship, partnership or Joint Stock Company) has to
be run within the legal framework doing business according to commercial law, labor law, etc. of
the country. Therefore, an entrepreneur should be aware of such governmental legislation.
Moreover, it is important if entrepreneurs have well fledged information about the
characteristics, advantages and disadvantages of the different types of business organization.
4.3.1. Patent
A utility patent is granted for new products, processes, machines, methods, of manufacturing,
and compositions of matter. This category excludes most botanical creations related to plant and
agricultural use. The utility patent is the most common patent sought by inventors. Similar
patents can be filed in more than 80 countries, and there are joint utility patent protection rights
that can be obtained for international regions such as the European Economic Community
(EEC). All patents have the distinction of being assets with commercial value because they
provide exclusive rights of ownership to patent holders, their heirs and assigns. Patents are
exclusive property rights that can be sold, transferred, willed, licensed, or used as collateral;
much like other valuable assets. Most independent inventors do not commercialize their
inventions or create new products from their ideas. Instead, they sell or license their patents to
others who have the resources to develop products and commercial markets.

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4.3.2. Registered design- is granted for any new or original decorative design for an article of
manufacture. A design patent protects the appearance of the article, not the article itself. An
inventor could easily register both a utility patent and a design patent, but the design patent has a
limited life. Entrepreneurs can select the period of time for protection in order to commercialize
designs and to realize the benefits of their ingenuity. The benefit of a design patent is that the
ornamental nature of the patent may be a distinguishing feature that allows an individual to have
exclusive use of visual imagery, thus enhancing sales or creating brand identification.
When registered, this allows the shape, design, or decorative features of a commercial product to
be protected from copying.
4.3.3. Copyright
A copyright is that the intellectual property is protected for the life of the originator plus 50
years. This protection affords an extraordinary property right and a substantial estate. A
copyright extends protection to authors, composers, and artists, and it relates to a form of
expression rather than the subject matter. This distinction is important because most intellectual
property has proprietary information in terms of subject matter, and if that property cannot be
patented, the copyright only prevents duplicating or using the original material.
4.3.4. Trademarks
A trade mark includes any word name, symbol, or distinguishing device, or any combinations
thereof adopted and used by a manufacturer or merchant to identify their goods and distinguish
them from those manufactured or sold by others. A trade mark is granted thought the U.S patent
and trade mark office for a period of 20 years.
Examples; coke (name) for coca-cola corporation
(Symbol) apple with a bite in its side – apple Computer Corporation
Wild mustang horse-ford automobile
The intricate shield and eagle design –beer cans by Anheuser-Busch, Inc.
What can be patented?
 Process: - New method of manufacturing or new technological procedures that can be
validated as unique.
 Machine: - Products, instruments, machines and other physical objects that have proved
useful and unique.

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 Manufacturers: - Refers to physical items that have been fabricated through new
combinations of materials or technical applications.
 Composition of Matter: - relates to chemical compounds, medicines... that do not exist in
nature in an uncultivated state.
Implications for Entrepreneurs:
There are several excellent reasons why hopeful entrepreneurs should be well informed on
patents, trademarks, and copyrights. Aside from the obvious need to protect one's ideas, the
entrepreneurs must be careful not to violate on others. Being familiar with regulations is also
important for designing packaging, writing advertisement and distributing materials. But
perhaps most important, obtaining property rights (patents, trademarks, or copyrights) create
valuable assets. Patents can be sold, licensed assigned, or leveraged as assets of new enterprise.

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 Chapter Five
Marketing and new venture development
5.1 The Marketing Perspective
It is all well and good having a product or service idea, but will it prove to be a profitable
business?
Too many businesses are set up without thinking about this essential question. The answer
revolves around the most important person in any business. The customer marketing is the
process of matching the needs of the consumer to the capabilities and resources of the firm.
Marketing is about making money from satisfied customers; without satisfied customers there
can be no more future for any commercial organization, though, marketing is an attitude of mind
about satisfying the customer rather than a set of sales techniques, and to understand the
customer you need to take what is called a marketing perspective. The customer is the buyer of
the product or service. This person may not be clam person as the consumer, or user of the
product or service. Understanding customer and consumer needs and motivations in central to
marketing for small firms.
In marketing terms customers buy benefits. They do not buy features or characteristics of a
product or service. We do not buy oil for our cars because we like it, but because it makes the
engine run smoothly, extends the engine’s life and reduces our repair bills. What is more, the
benefits that customer’s value may be different to those valued by the consumers of a product or
service. Understanding the differences between the features of a product or service and the
benefits that it offers the customer is the cornerstone of marketing. The customer is really only
interested in benefits. The features simply prove to the customer that he will receive those
benefits. However, that customer is actually buying a whole package of benefits that the product
or service has to offer. That package can include things like after sales service, image, reliability,
ease of use, easy of availability, e.t.c.
It is the value to the customer of the total package that the firm is seeking to maximize in
marketing. The higher the total value to the customer, the greater their loyalty to the product or
service and the higher the price they are likely to pay for it.
5.2 The Marketing Mix

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Each element of the marketing mix is unique for every business. Indeed the development of such
a unique mix is the aim of the marketing strategy of the business. Marketing mix consists of
product, price, promotion and place (distribution) or 4P’S.
i) Product (Service)

This is often the heart of the marketing mix. However, the product or service must not be a
straight jacket constraining that mix. It must be flexible and capable of adoption to the changing
needs of the customer.
It is always important to know why customers buy products and what particular features and
benefits they value most. A particular product or service might include:- design and technical
features, performance, quality, range (size, color etc), maintenance and running cost, safety,
before and after sale, product availability and image (fashion).

Even a company selling products will have a strong service element to this component of the
marketing mix. Indeed, personal service is a vital way that any small firm can differentiate itself
from larger competitors. The personal service and personal relationship build up with the
customer is something that large firms find it difficult to replicate and offers one obvious area in
which small firms have a competitive advantage.
When translating the features of both the ‘core product’ and the ‘service’ element that
accompanies it into benefits, you may wonder whether they are real benefits of value to the
customer.
The more real, valued benefits that a firm offers, the more likely it is to attract buyers and
convert them into satisfied customers who may return for repeat purchase.
This also explains why customers may prefer a particular supplier of an apparently identical
product; despite the fact they are more expensive than Rivals. The other benefits offered, such as
service, add up to a more attractive and valued benefit package.

ii) Price

Pricing is of course, an important part of the marketing mix. Too many small firms, however,
compete primarily on price simply because the other elements in the marketing mix are

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insufficiently different from their competitors. However, price is more usually a barrier to sales
rather than a positive inducement.
The price charged for a particular product or service must to reflect the value of the ‘package of
benefits, to the customer, often the value to the customer for a product or service can be different
in different circumstances.
Many firms, of all sizes, use a ‘cost-plus’ pricing formula with this approach you simply add up
all the costs and add on a margin. The option of pricing high or ‘skimming may seem strange at
first, Higher prices implies lower volume of sales, unless you are able to offer something that is
uniquely different from the competition and highly valued by the customer.
However, for many smaller firms lower sales volume is not necessarily a bad thing. It means that
greater attention can be paid to quality, customer service and other elements of the marketing
mix, there by justifying the higher price. The price charged out to reflect what the market will
bear for that product or service. Normally, the market will bear arrange of prices, reflecting
different marketing mix offerings. The final decision on pricing, then, is a question of judgment
reflecting the value of that mix to consumers.
iii) Promotion

This is concerned with how well a firm communicates its sales message to existing and potential
customers. When products or services are very similar, this is often one of the few ways that they
can differentiated from the competition.
There are many ways of promoting a business. When a company promotes its products and
services directly to potential customers it is called direct promotion. Often this is undertaken
through the sales force. It includes:- direct face-to-face selling, telephone selling, direct mail,
exhibitions and special demonstrations but this method is expensive.
On the other hand indirect presentation is concerned with the mass techniques of communication.
One of these techniques is advertising, which seeks to inform, persuade and remained (reinforce)
messages to existing & potential customers. Most small firms start out relying heavily on
personal selling, but as they grow the real cost of this activity become more apparent. However it
is important that advertising campaigns are properly costed and planned in advance.
Public relation, or PR, is a very good way of getting publicity without paying for it. Most firms
have news worthy things happening within them, such as contracts won, new plant or equipment
installed, expansion plans, new developments, awards or even local charity work. The big

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advantage of this sort of publicity is that it is ‘editorial’ rather than advertising and therefore has
more credibility.
Another form of indirect promotion is the sales promotion. This is essentially a short term
campaign to influence customers to buy more or to motivate your sales force to sell more. There
is a wide range of sales promotions offering money, goods or services as inducements. The
essential element is that it is intended to give a short-term boost to sales.
iv) Place (distribution)

The place element of the marketing mix is about getting the goods or services to the right place
at the right time for the customer. For a shop that means location, frequently the most important
element of the mix for them. For other business it is about physical distribution (moving goods)
and distribution channels (which outlets to use). Physical distribution is concerned with transport
and it addresses the following questions.
 Should a small firm use vehicles or the train?
 Should it use its own vehicles or hire a carrier?
 How frequently should it deliver?

Distribution channels is concerned with the out-lets you use for selling to customers. Ideally, you
would seek to have channels that give you maximum control at the most reasonable cost.
However, remember that the choice of distribution channel could create a very real competitive
advantage for you.
Many small firms sick to the distribution channels they have traditionally used or know best. In
doings so they may be losing out on new market opportunities. It pays to think creativity about
all elements of the marketing mix.
5.3 Marketing research
Marketing Research: is an indispensable marketing tool for assessing buyer wants and behavior
and market size. Marketing research is a formalized means of acquiring information to assist in
the making of marketing decisions. The American Marketing Association (AMA) defines
marketing research as the function that links the consumer, customer, and public to the
marketer through information- used to identify and define marketing opportunities and problems;
generate, refine, and evaluate marketing actions; monitor marketing performance; and improve

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understanding of marketing as a process.  Marketing research is the systematic design, collection,
analysis, and reporting of data relevant to specific marketing situation facing an organization.
Market research is the first activity of marketing management process. The American marketing
association defined market research as the systematic gathering, recording and analyzing of data
about problems relating to the markets of goods and services. “The essence of marketing
research is to provide information used in decision making, and for the entrepreneur, there are
fundamental differences between market information needed prior to start up and after a firm is
established.
Prior to opening for business, the entrepreneur wants to know whether a market exists for a new
product or service, who is likely to be a primary customer, how to position the enterprise in the
market, and how the product or service is priced, promoted and distributed. Addressing these
issues becomes part of the pre-start-up planning process. Once a firm has become established,
much of this information is authenticated through actual experience, and market research
expands to include a continuous competitive analysis.
We study the market because; it can considerably reduce the risk involved in making decisions.
Facts identified from marketing research can forms the basis of planning, sales, sales promotion,
advertising and etc.

Sources of information

A low-cost approach to marketing research and data collection begins with desk research.
Personal files, company or public libraries, on-line databases, government records, and trade
associations are just a few of the data sources that can be tapped with minimal effort and often at
no cost. Data from these sources already exist. When data are not available through published
statistics or studies, direct collection is necessary. Survey research, interviews, and focus groups
are some of the tools used to collect primary market data.

By analyzing the collected data a company can gain a better picture of the size of each market
opportunities.
Marketing research gathers information about the marketing environment that is micro and
macro environment.
Understanding consumer Markets
 How many households plan to buy products?

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  Who buys and why do they buy?
 What are they looking for in the way of features and prices?
 Where do they shop?
 What are their images of different brands?

Methods of collecting market information

1. Personal interviews – these are for collecting qualitative data particularly on attitudes,
behavior and even the language the customer might use. However, interviews are time
consuming and expensive.
2. Telephone interview – there are increasingly being used simply because they are for
cheaper than personal interviews. However, the sample may be biased by considering
only telephone owners and it is difficult to contain ‘body language’ that is possible on
interview.
3. Postal questionnaires – these are quick & low cost. However, it is easy for the
respondent to refuse or forget to respond. Questionnaires are used to collect simple,
factual information.

Attention to competitors
Anticipating in competitors’ moves and knowing how to react quickly and decisively. It may
want to initiate some surprise moves; in which case it needs to anticipate how its competitors
will respond.
5.4. The Marketing Intelligence System
Whereas the internal records system supplies results data, the marketing intelligence system
supplies happenings data.
A marketing intelligence system is a set of procedures and sources used by managers to obtain
everyday information about developments in the marketing environment.
Marketing intelligence refers to any useful information that could be used by marketing
managers to enhance their competitive positions.
Marketing managers collect marketing intelligence by reading books, newspapers, and trade
publications, talking to customers, suppliers and distributors, and meeting with other company
managers.

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Marketing intelligence is systematic collection and analysis of available information about
competitors and developments in the market place (marketing environment).
Marketing intelligence can collected from people inside the company (executives, engineers, and
scientists, purchasing agents, and sales force,) and outside the company (suppliers, resellers and
key customers) or it can be get good information by observing competitors and also by buying
and analyzing competitors’ products, monitor their sales, check for new patents and examine
various types of physical evidence.
5.5. Industry and Competitive analysis
A. Industry Analysis
An industry is a group of firms producing a similar product or services. Such as soft drink or
financial services.

Porter’s Approach to Industry Analysis (The Five-Force Model of Competition)

Michael porter, in his book on competitive advantage provides a structural analysis of industries
that he claims goes some ways towards profitability.

Porter claims that five forces determine competitiveness.

a) Threat of new entrant
b) Competitive rivalry
c) Threat of substitute products
d) The bargaining power of suppliers
e) The bargaining power of buyers (customers)
a. Threat of new entrant
Entry barrier: - is an obstruction that makes it difficult for a company to enter an industry. New
entry to an industry brings new capacity, the desire to gain market and usually substantial
resource. The seriousness of the treat of an entry mainly depends on the barriers present and on
actions from existing competitors that the entrant can expect.
Some of the major barriers of entry include:
Higher capital requirement
Problems in getting distribution channels: A new entrant will likely face a problem of getting a
proper distribution channel. Since the company is new wholesalers, retailers and other
distributors may not be interested to take the responsibility the new company’s product.

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Economic of scale- indicates how the total cost per unit produced changes as more units are
produced. Economies of scale make entry difficult because they force potential competitors
either to enter on a large-scale basis (and costly method) or to accept a cost disadvantage (and
lower profitability).
Besides, The average size of business varies from industry to industry. For example, the average
size of chemical firm is very large; whereas the average size of retail firms is relatively small.
The most fundamental reason for these differences in the extent of economies of scale in an
industry: that’s how the total cost per unit produced changes as more units produced. Generally,
this can be expected to decline up to some point.
For example, as an expensive piece of machinery is used more fully. However, beyond this point
unit costs may be starting to increase. Thus the potential for economies of scale in a high capital
intensity industry like chemicals is great, where as in retailing the potential savings are much
smaller.
Government policy: in some industries the government may not allow companies to join some
industries because of many reasons. For instance, in our country the banking and insurance is
totally reserved for local investors and a foreigner is not allowed to involve in this industry.
Customer loyalty-buyers are often attached to established brands. High brand loyalty means that
a potential entrant is expected to work hard to build a network of distributors and dealer, and
then be prepared to spend enough money for promotion to overcome customer loyalties and
build its own customers.
Product Differentiation- create high entry barriers through their high level of adverting and
promotion.
b. Competitive rivalry
Competitionis normally a game in which one player loses at the expense of the other. A move on
the part of a player may cause other players to make countermoves, or initiate efforts to protect
themselves from the danger posed by the initial move.

The competition among companies in an industry will tend to be high in the following
conditions:
 When there are many competitors (compared to other industries)
 When competitors are equal in size and/or very large.
 When there is slow growth in demand.

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 When the products are similar in features.
 When there are high exit barriers.
c. Threat of substitutes products
Substitute products or services are those that apparently are different but satisfy the same set of
customers’ needs. Coffee and tea are substitute products because they satisfy similar desire.
Those industries that have no close substitutes are more attractive than those that have one or
more of such substitutes. Obviously, firms in an industry having no close substitutes can change
a higher price and earn higher returns.
d. The power suppliers /Bargaining power of suppliers/ The bargaining power of suppliers
constitutes their ability, individually or collectively, to force an increase in the price of the
products or service, or make the buyers accept a lower quality of products or service, A high
supplier bargaining power constitutes a negative impact feature for existing firms or new entrants
of an industry. A low supplier bargaining power enables a firm to negotiate price increase in its
favor or to make the suppliers offer higher quality of inputs at a lower price.
The bargaining power of suppliers is high under these conditions
 When the suppliers are few and the buyers are many.
 When the products or services are unique and are not commonly available.
 When the switching costs of a supplier from one buyer to the other is low.
 When the supplier is not critically dependent on the products or services supplied.
e. The power of Buyers (Bargaining power of buyers)
The bargaining power of buyers in an industry constitute the ability of the buyers, individually or
collectively, to force a reduction in the prices of product or services, demand a higher quality or
better services, or to seek more value for their purchase in any way. Monopsony: - a market in
which there are many suppliers and one buyer.
The bargaining power of buyers is high under the following conditions:
 When the buyers are few in number.
 When the buyers place large orders.
 When alternative suppliers are present and are willing to supply at a lower price.
 When the switching costs of buyers from one supplier to other is low.
 When the buyer itself charges a low price for its products and is sensitive to price increases.

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2. Competitors Analysis
We must consider the strategies of the firms’ competitors. A competitor analysis becomes a vital
part of strategic planning. The goals of competitors’ analysis are to understand.
 With which competitors to compete.
 Competitors’ strategies and planned actions.
 How competitors might react to firms’ actions.
Competitor analysis is the process of identifying key competitors; assessing their objectives,
strategies, strength and weaknesses, and reaction patterns; and selecting which competitors to
attack or avoid.
Steps in analyzing competitors
 Identifying the company’s competitors
 Assessing competitors’ objectives, Strategies, Strength and weakness and Reaction
patterns.
 Selecting which competitors to attack or avoid.
a. Identifying competitors
At the narrowest level, accompany can define its competitors other companies offering similar
products and services to the same customers at the same prices. The company might define
competitors as all firms making the same product or class of products. Broadly, competitors
might include all companies that compete for the same consumer dollars. Companies can identify
their competitors from the industry point of view and from a market point of view. From an
industry point of view coca-cola might see its competition as Pepsi, 7up and other soft drinks.
From a market point of view here companies can identify competitors that are trying to satisfy
the same customer need or build relationship ships with the same customer group.
b. Assessing competitors
Determining competitors’ Objectives

Each competitor has a mix of objectives. The company wants to know the relative importance
that a competitor process on current profitability, market share growth, cash flow, technological
leadership, service leadership, and other goals.
Knowing a competitor’s mix of objectives reveals whether the competitor is satisfied with its
current situation and how it might react to different competitive actions.

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A company must monitor its competitors’ objectives for various segments. If the company finds
that a competitor has discovered a new segment, this might be an opportunity.
If it finds that competitors plan new moves into Segments now served by the company, it will be
forewarned and, hopefully, forearmed.

Identifying Competitors’ strategies

In most industries, the competitors can be sorted in to groups that pursue different strategies. A
strategic group is a group of firms in an industry following the same or a similar strategy in a
given target market.
The company needs to look at all of the dimensions that identify strategic groups within the
industry. It needs to know each competitor’s product quality features, and mix; customer service;
pricing policy; distribution coverage; sales force strategy, and advertising and sales promotion
programs. And it must study the details of each competitor’s R&D, manufacturing, purchasing
financial, and strategies.
Assessing competitors’ strength & weakness
Companies learn about their competitors’ strengths and weaknesses through secondary data,
personal experience, and worth of mouth. They also can conduct primary marketing research
with customers, suppliers, and dealers or they can benchmark themselves against other firms,
comparing the company’s products and processes to those of competitors or leading firms in
other industries to find ways to improve quality and performance.
Whether competitors can carry out their strategies and reach their goals depends on their
resources and capabilities. A company needs to gather information on each competitor’s
strengths and weaknesses.
This assessment helps companies to decide whom to attack in the programmable controls market.
Estimating competitors’ Reactions
Next, the company wants to know what our competitors will do.
A competitor’s objectives, strategies and strength and weakness go along a way toward
explaining its likely actions. They also suggest its likely reactions to company moves such as
price cuts, promotion increases, or new product introductions, marketing manager need a deep
understanding of a given competitor’s mentality if they want to anticipate how the competitor
will act or react.

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c. Selecting which competitors to attack or avoid.
After the company has conducted its customer value analysis, it can focus it attack on one of the
following classes of competitors:
A. Strong versus weak competitors
B. Close versus distant competitors
C. “Good” versus “bad” competitors.
I. Strong versus Weak.
Most companies aim their shots at weak competitors, because this requires fewer resources per
share point gained. Yet, in attacking weak competitors, the firm will achieve little in the way of
improved capabilities. The firm should also compete with strong competitors to keep up with the
best. Even strong competitors have some weaknesses, and the firm may prove to be a worthy
opponent.

II. Close versus Distant.

Most companies compete with competitors who resemble them the most. At the same time, the
company should avoid trying to destroy the closest competitor.

III. “Good” versus “Bad.”

Every industry contains “good” and “bad” competitors. A company should support its good
competitors and attack its bad competitors.
Good competitors:
 Play by the industry’s rules
 Make realistic assumptions about the industry’s growth potential
 Set prices reasonable in relation to costs, they favor a healthy industry;
 Limit themselves to a portion or segment of the industry
 Motivate others to lower costs or improve differentiation, and
 Accept the general level of their share and profits.
Bad competitors try to:
 Buy share rather than earn it
 Take large risks; they invest in overcapacity, and
 Upset industrial equilibrium

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5.6 Marketing strategies and Market Segmentation
Market segmentation is breaking down a market into groups of customers with similar
characteristics. The key for most small firms is to concentrate their efforts and resources on one-
or at most two or three-clearly defined markets. In this way resources can be focused on the
needs of that group.
The purpose of segmentation is to find a way of describing groups of customers so that the firm
can better communicate with them. This allows the firm to tailor the marketing mix to the needs
of that segment and communicate the offering in an appropriate way, through an appropriate
medium.
There are many ways of Breaking down a market in to segments. For consumer markets the most
likely way of segmenting a market will be personal characteristics, called demography such as
sex, age, socio-economic group, occupation, location etc. for industrial markets the most useful
forms of classification are likely to be the type of industry, size of business, location nature of
technology, etc,..
1. Niche marketing

The policy differentiation can be followed most effectively if the product offering is focused on a
specific, narrowly defined market segment, thus allowing the elements of differentiation to be
greatest and resources to be focused on that target. This focused differentiation is called niche
marketing. It involves filling or creating markets that larger firms would find un suitable because
of their large investment capacity. It involves creating barriers to entry in that market segment
through the reputation or brand loyalty of the firm. The key to successful segmentation is the
ability to identify the unique benefits that a product or service offers to potential customers.
One apparent problem with niche strategy is that it is based on a limited market. Frequently,
entrepreneur’s pursuing niche strategies find further growth by diversification. This
diversification is particularly effective if it pursues further niche opportunities.
2. Diversification Strategies

Diversification is the process of entry in a field of business which is new to an enterprise either
in terms of the market or the technology or both. It is a strategy in which the growth objective is
sought to be achieved by adding new products or services to the existing ones.

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Diversification is possible along two separate paths, first, we can diversify the product (i.e.,
introduce new products). Second, we can diversify the market (i.e., go in to new markets). In
doing so, it is important to bear in mind the risks involved.
For example, we could introduce a new product or service related to our existing product lines,
this is a low-risk strategy. Similarly, we may decide to diversify in to completely new markets,
either geographically or by type of customer. This would be a major risk, since the business has
no experience in this area.
In search for further growth, a business has four options:
1. It can stay with its base product or service and its existing market, and simply try to
penetrate the market further. This dealing very much with the familiar and normally the
lowest risk option.
2. It can develop related or new products for its existing market and this is called product
development.
3. It can develop related or new markets for its existing products. This is called market
development.
4. It might try moving into related or new markets with related or new products this strategy
involves unfamiliar products & unfamiliar markets with high risk.

Market and product development should be incremental from the familiar to the unfamiliar.
Further it is claimed that market developments are to be preferred to product development
because new customers is less risky than developing new products. The strategies discussed
above are called ‘horizontal’ strategies. Two further strategies for growth are open to the small
firm:
First, ‘Backward Vertical integration’ – the firm becomes its own supplier of some basic raw
materials or services.
Secondly, ‘forward vertical integration’ – the firm becomes its own distributor or retailer. Both
strategies entail new product or service technologies and new customers and are therefore
relatively risky. It is generally accepted the vertical integration is not successful, for small firms
and that vertical integration should only be a reaction to competitor’s activities, for example, to
prevent them from controlling raw materials and services.
Developing marketing strategy for business organization includes:
1. Target market selection strategy

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2. Product positioning strategy
3. Price setting strategy
4. Distributions channels strategy
5. Promotion strategy
1. Target market selection strategy
Strategic decisions involving target markets includes:
I. Follow mass marketing approach:-
This is the method of producing a product in bulk amount and supply to the whole market. This
approach sometimes does not work for small business enterprises, as they do not have financial
strength to manufacture goods and services in bulk.
II. Concentrate only on the portion of the market:-
In this case a business organization produces a limited amount of product and supplies it to a
specified market segement. Compared with mass marketing, this strategy does not require large
amount of money and that is why most small business enterprises prefer this strategies.
.2. Product positioning strategy:-
Following production, the product will be introduced or offered to the market for the first time.
At this stage, the product may not be known and wanted by the customer. Thus, the product
should be promoted to get the attention of customers. In short, business enterprises should have
clear cut product positioning strategy that makes the product alive and profitable, and attract,
satisfy and retain customers at different stages of product life cycle.
3. Price setting strategy:-
The third component of business enterprise strategy is price setting. Once the product is
positioned, the next step is to set the price based on different price setting strategies
4. Distribution channel strategy:-
It is clear that, a product of any enterprises does not have value unless it is taken to the market
and reached customers. Thus, business enterprises should design and exercise a distribution their
product, services and their enterprise.

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 CHAPTER-SIX
Organizing and Financing the New venture
6.1. Entrepreneurial team and Business Formation
At the top of the success factor list is the entrepreneual team. The term team is used because
more often entrepreneurs do not start business by themselves; they have teams, partners, close
associates, or extensive net works of advisers. In major studies of entrepreneurs in the United
States, Canada, and Europe, between 60 and 70 percent of all technology based ventures were
started by founders with at least one partner or cofounder. Those in non technical enterprises
were less likely to have partners or cofounders, yet they were well networked with associates or
expert advisers.
An entrepreneurial team is usually headed by an individual who provides the critical profile for
success. This focal entrepreneur typically has an above average education, with about 35 percent
of technical entrepreneurs holding graduate degrees. Most entrepreneurs started their business
when they were in their 30s, and they had solid job experience.
6.2. Sources of financing
The financing of your business is the most fundamental aspect of its management. Get the
financing right and you will have a healthy business, positive cash flows and ultimately a
profitable enterprise.
The financing can happen at any stage of a business’s development. On commencement of your
enterprise you will need finance to start up and, later on, finance to expand. Finance can be
obtained from many different sources. Some are more obvious and well-known than others. The
following are just some of the means of finance that are open to you and with which we can help.
6.2.1. Asset Management
Small business needs money to finance a host of different requirements. In looking at the types
and adequacy of funds available it is important to match the use of the fund with appropriate
funding methods.
The principal capital needs of small business:

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1. Permanent capital-The permanent capital base of small firm usually comes from some form
of equity investment in shares in a limited company, or personal loans to or from partners or sole
traders. It is used to finance the one off start- up costs of an enterprise, or major developments
and expansions in its life cycle. It may be required for a significant innovation, such as new
product development.
2. Working capital-Most small firm need working capital to bridge the gap between when they
get paid, and when they have to pay their suppliers and their overhead costs. Requirements for
this kind of short term finance will vary considerably by business type.
3. Asset finance-The purchase of tangible assets is usually financed on a longer term basis, from
3 to 10 years, or more depending on the useful life of the asset. Plant, machinery, equipments,
fixtures, and fittings, company vehicle and buildings may all be financed by medium or long
term loan from a variety of lending bodies.
4. International trade finance-Exporting brings its own sets of money problems. Currency
fluctuations, lengthy payment terms and security of payments all give rise to the need for some
kind of specialist or export finance.
6.2.2 Equity Financing
Equity financing involves sharing of business ownership in exchange of money. In this case
money is not needed to be repaid over a specific period of time. Equity can be obtained through
non-professionals like family, friends, colleagues etc. The major disadvantage of equity
financing is possible loss of control over a business.
This is way of introducing funds to your corporate business is to issue more shares. This is
always a welcome addition to business funds and is also helpful in giving additional strength to
the company’s balance sheet. However, you need to consider where the finance is coming from
to subscribe for the new shares. If the original proprietor of the business wishes to subscribe for
these shares, then he or she may have to borrow money in a similar way to that discussed above.
Typically, however, shareholders in this position are often at the limit of funds that they can
borrow. Therefore, it may be necessary to have a third party buy those shares. This may mean a
loss of either control or influence on how the business is run. An issue of shares in this situation
can be a very difficult decision to make.

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1. Ordinary /Equity shares. A share is a part ownership of a company. Shares relate to companies
set up as private limited companies or public limited companies (plcs). There are many small
firms who decide to set themselves up as private limited companies; there are advantages and
disadvantages of doing so. It is possible, therefore, that a small business might start up and have
just two shareholders in the business. If the business wants to expand, they can issue more shares
but there are limitations on who they can sell shares to - any share issue has to have the full
backing of the existing shareholders. PLCs are different. They sell shares to the general public.
This means that anyone could buy the shares in the business.

Merrill Lynch: a merchant bank that engages in large-scale deals to acquire sources of finance.

Some firms might have started out as a private limited company and have expanded over time.
There might come a time when they cannot issue any more shares to friends or family and need
more funds to continue expanding. They might then decide to become a public limited company.
This is called 'floating the business'. It means that the business will have to go through a number
of administrative and legal procedures to allow it to be able to offer shares to the general public.

It might be that a business wants to raise £300 million to finance its expansion plans. It might
issue 300 million £1 shares in the company. The offering of these shares has to be accompanied
by a prospectus which lays out details of the business - what it is involved in, how it is
structured, how it will be managed and so on. This is so that prospective investors, people or

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institutions who might want to buy the shares, can get information about the company before
committing to buying shares.

Once the shares are sold, share owners can buy and sell their shares through the stock exchange.
Such buying and selling does not affect the business concerned directly and is one of the main
advantages of the stock exchange. There may be times in the development of a plc when it needs
to raise more funds. In this case it can issue more shares. Many firms will do this through what is
called a 'rights issue'. This occurs where new shares are issued but existing shareholders get the
right to purchase new additional shares at a reduced price. If the business is doing well and the
new finance is needed for expansion, this can be an attractive proposition for existing
shareholders. For the business it is a relatively quick and cheap way of raising new funds

Ordinary /Equity shares are issued to the owners of a company

Ordinary shareholders put funds into their company:

By paying for a new issue of shares

a) Through retained profits. Simply retaining profits, instead of paying them out in the form
of dividends, offers an important, simple low-cost source of finance, although this
method may not provide enough funds, for example, if the firm is seeking to grow.

2. Preference shares

Preference shares have a fixed percentage dividend before any dividend is paid to the ordinary
shareholders. As with ordinary shares a preference dividend can only be paid if sufficient
distributable profits are available, although with 'cumulative' preference shares the right to an
unpaid dividend is carried forward to later years. The arrears of dividend on cumulative
preference shares must be paid before any dividend is paid to the ordinary shareholders.

From the company's point of view, preference shares are advantageous in that:

 Dividends do not have to be paid in a year in which profits are poor, while this is not the
case with interest payments on long term debt (loans or debentures).
 Since they do not carry voting rights, preference shares avoid diluting the control of
existing shareholders while an issue of equity shares would not.

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  Unless they are redeemable, issuing preference shares will lower the company's gearing.
Redeemable preference shares are normally treated as debt when gearing is calculated.
 The issue of preference shares does not restrict the company's borrowing power, at least
in the sense that preference share capital is not secured against assets in the business.
 The non-payment of dividend does not give the preference shareholders the right to
appoint a receiver, a right which is normally given to debenture holders.

However, dividend payments on preference shares are not tax deductible in the way that interest
payments on debt are. Furthermore, for preference shares to be attractive to investors, the level of
payment needs to be higher than for interest on debt to compensate for the additional risks.

For the investor, preference shares are less attractive than loan stock because:

 They cannot be secured on the company's assets

 The dividend yield traditionally offered on preference dividends has been much too low
to provide an attractive investment compared with the interest yields on loan stock in
view of the additional risk involved.

6.2.3 Venture Capital

Approaching venture capital houses for finance will also mean an issue of new shares. The
advantage of going to such institutions is the amount of capital they can introduce into the
business. Because of the size of their investment, you can expect them to want a seat on your
Board. They will also make available their business expertise which will also help to strengthen
your business, although inevitably this will come with an additional pressure for growth and
profits.
Venture capital is money put into an enterprise which may all be lost if the enterprise fails. A
businessman starting up a new business will invest venture capital of his own, but he will
probably need extra funding from a source other than his own pocket. However, the term
'venture capital' is more specifically associated with putting money, usually in return for an
equity stake, into a new business, a management buy-out or a major expansion scheme. The
institution that puts in the money recognises the gamble inherent in the funding. There is a
serious risk of losing the entire investment, and it might take a long time before any profits and
returns materialise. But there is also the prospect of very high profits and a substantial return on

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the investment. A venture capitalist will require a high expected rate of return on investments, to
compensate for the high risk. A venture capital organisation will not want to retain its investment
in a business indefinitely, and when it considers putting money into a business venture, it will
also consider its "exit", that is, how it will be able to pull out of the business eventually (after
five to seven years, say) and realise its profits. Examples of venture capital organisations are:
Merchant Bank of Central Africa Ltd and Anglo American Corporation Services Ltd.
When a company's directors look for help from a venture capital institution, they must recognise
that:

 The institution will want an equity stake in the company

 It will need convincing that the company can be successful
 It may want to have a representative appointed to the company's board, to look after its
interests.

The directors of the company must then contact venture capital organisations, to try and find one
or more which would be willing to offer finance. A venture capital organisation will only give
funds to a company that it believes can succeed, and before it will make any definite offer, it will
want from the company management:

a) A business plan
b) Details of how much finance is needed and how it will be used
c) The most recent trading figures of the company, a balance sheet, a cash flow forecast and a
profit forecast
d) Details of the management team, with evidence of a wide range of management skills
e) Details of major shareholders
f) Details of the company's current banking arrangements and any other sources of finance
g) Any sales literature or publicity material that the company has issued.
A high percentage of requests for venture capital are rejected on an initial screening, and only a
small percentage of all requests survive both this screening and further investigation and result in
actual investments.
6.2.4. Debt financing
Debt – borrowing money from an outside source with the promise to return the principal, in
addition to an agreed-upon level of interest.

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  Debt is also referred to as „leverage“ in finance.
 In contrast – equity financing does not have to be repaid.
 The interest rate reflects the level of risk that the lender undertakes by providing the
money.
 Debt financing entails less risk than equity financing, thus it is usually cheaper.
Debt is borrowing money and repaying it with some interest over a period of time. In debt
financing, the only liability of the borrower is repayment of loan on and the lender does not get
any ownership. Lenders generally require the guarantee before providing loan. Debt is usually
given to a company which offers some asset that may be pledged by the lender in case of non
repayment of loan.
Debt financing can be of two types:
 Short term – In short term, full repayment of the loan should be done in less than a year.
Examples short term debt financing:
Trade credit-When one company buys a product or services from another, it pays for the
purchase either with cash at the time of delivery or with credit. Most suppliers offer trade credit
to their business customers. Trade credit means that the supplier finances the purchases by giving
the buyer 30 days or more to pay. In effect, the buyer obtains financing from the supplier rather
than from a bank.
Bank loans (overdrafts, short-term specific -The first part of call that most people think about
when trying to obtain finance is their own bank. Banks are very active in this market and seek
out businesses to whom they can lend money. Of the two methods of giving you finance, the
banks, especially in small and start-up situations, invariably prefer to give you an overdraft or
extend your limit rather than make a formal loan. Overdrafts are a very flexible form of finance
which, with a healthy income in your business, can be paid off more quickly than a formal loan.
If, during the period you are financing the overdraft, an investment opportunity arises, then you
could look to extend the options on your overdraft facility to finance the project. Many
businesses appreciate the advantages of a fixed term loan.
They have the comforting knowledge that the regular payments to be made on the loan make
cash flow forecasting and budgeting more certain. They also feel that, with a term loan, the bank
is more committed to their business for the whole term of the loan.

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An overdraft can be called in but, unless you are failing to make payments on your loan, the
banks cannot take the finance away from you.
Many smaller loans will not require any security but, if more substantial amounts of money are
required, then the bank will certainly ask for some form of security. It is common for business
owners to offer their own homes as security although more risk-averse borrowers may prefer not
to do this. Anyone offering their house as security should consult with any co-owners so that
they are fully aware of the situation and of any possible consequences.
Factoring -Factoring provides you with finance against invoices that your customers have not yet
paid. Typically you can receive up to 85% of the value of the invoice immediately and the
balance (less costs) when the customer pays.-
 Long term – Repayment of the loan can be done in more than a year
If a company has too much debt, it becomes a risky business. Also, it becomes difficult to handle
the down falls of business or any unanticipated circumstances.
The other disadvantage of debt financing is that the interest has to be paid by the company under
any circumstances. For a lender it’s important that the loan should be repaid either through
income from the business or by selling the assets.
A small scale unit as any other industrial unit requires loans for short-term and medium and
long-term. Short-term finance or working capital finance is required for day-to-day operations of
the enterprise and it is generally provided in the form of cash credit, overdraft facility and bills
purchase and discount facility.' Short-term credit is also required for stocking raw materials,
parts components, sub-assemblies required for producing /assembly of the end product. Medium
and long-term credit (also known as terra finance) is required for acquiring fixed assets including
land,. building, machinery and equipment both at the time of starting an enterprise as also its
expansion of productive capacity by replacing or adding to the existing equipment.
A number of companies in practice would always prefer to borrow for the following reasons:
• Tax deductibility of interest
• Higher return to shareholders due to gearing.
• Complicated procedure for raising equity capital
• No dilution of ownership and control
• Equity results in a permanent commitment than debt.

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 • There are, however, managers whose choice of financing depends on internal and
externalfactors.
The internal factors include purpose of financing, company's earning capacity existing capital
Structure, cash flow ability; investment plans etc. The external factors are capital and money
Market conditions, debt-equity stipulations followed by financiers, restrictions imposed etc. A
company; for example, feels
There can be no specific preference towards borrowings as a source of finance. The company's
financial requirement will vary from time to time depending on factors such as its existing
capital structure, investment plans vis-à-vis expansion, modernization and replacement as also its
margin money requirement for incremental working capital. In addition, the cost of share issue,
existing money market and banking conditions and the impact of statutory regulations would
influence the mix of finance required by a company.
• In practice, it may not be possible for a company to borrow whenever it wants. Lenders may
analyze a number of characteristics of the borrower before they decide to lend. What factors do
borrowers think are considered by lenders? Borrowing firms' managers perceive the following
factors in order of importance being considered by lenders:
a) Profitability
b) Quality of management,
c) Security;
d) Liquidity;
e) Existing debt-equity ratio,
f) Sales growth,
g) Net worth,
h) Reserve position, and
i) Fluctuations in profits.
Debt Financing – Advantages
 The lender has no say in the future or direction of the business as long as payments are
made.
 Don’t give up ownership
 Payment plan is predictable
Debt Financing – Disadvantages

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  If the loan payments are not made, the lender can force the businesses into bankruptcy.
 If not incorporated, the lender can force the owner to sell personal assets.
 Takes time to get a business going – banks want their money
 Companies relying on debt financing are leveraged.

6.2.5. Government Programs

The government provides finance to companies in cash grants and other forms of direct
assistance, as part of its policy of helping to develop the national economy, especially in small
and micro enterprises currently in Ethiopia. Government of Ethiopia having recognised the
importance of small scale industries in the overall industrial development as also overall
economic development of the country, has been engaged in formulating suitable policies and
active programmes from time to time with a view to assisting small scale units in meeting their
credit requirements.Some firms might be eligible to get funds from the government.

Other sources of finance-

1. Mortgage

A mortgage is a loan specifically for the purchase of property. Some businesses might buy
property through a mortgage. In many cases, mortgages are used as a security for a loan. This
tends to occur with smaller businesses. A sole trader, for example, running a florists shop might
want to move to larger premises. The borrower can use their own property as security for the
loan - it is often called taking out a second mortgage. If the business does not work out and the
borrower could not pay the bank the loan then the bank has the right to take the home of the
borrower and sell it to recover their money. Using a mortgage in this way is a very popular way
of raising finance for small businesses but as you can see carries with it a big risk.

2. Retained Profit

This is a source of finance that would only be available to a business that was already in
existence. Profits from a business can be used by the owners for their own personal use
(shareholders in plcs receive a share of the company profits in the form of a dividend - usually

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expressed as Xp per share) or can be used to put back into the business. This is often called
'ploughing back the profits'.

The owners of a business will have to decide what the best option for their particular business is.
In the early stages of business growth, it may be necessary to put back a lot of the profits into the
business. This finance can be used to buy new equipment and machinery as well as more stock or
raw materials and hopefully make the business more efficient and profitable in the future.

3. Selling Assets

As firms grow they build up assets. These assets could be in the form of property, machinery,
equipment, other companies or even logos. In some cases it may be appropriate for a business to
sell off some of these assets to finance other projects.
4.Hire Purchase (HP)
This is used to finance the purchase of equipment. Your business buys the equipment but
payments of capital and interest are spread over an agreed period.Guarantees to repay the bank
(or other lender) up to 75% of the loan if you default.
5.Leasing
This is a method of financing equipment you do not need to own.
It is often used for vehicle finance. The equipment is rented rather than owned and the rental
payments spread over several years .There can also be the option to fix maintenance costs as part
of the agreement (contract hire).
6. Saving and friends
When commencing a new business, very often the initial monies invested will come from the
individual’s personal savings. The tendency of business start-ups to approach relatives and
friends to help finance the venture is also a widespread practice. You should make it clear to
them that they should only invest amounts they can afford to lose. Show them your business plan
and give them time to think it over. If they decide to invest in your business, always put the
terms of any agreement in writing.

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 CHAPTER SEVEN

GROWTH STRATEGIES FOR SMALL FIRMS

7.1 Introduction
The growth of small business is similar to that of a human being who passes through the stages
of infancy, childhood, adulthood and old age. An enterprise may be considered growing when
there is a permanent increase in its sales turn over, assets, volume of output, etc. Business growth
is a natural and on -going process. Many business firms started small and have become big
through continuous growth. But growth may be restricted by constraints of market demand,
finance, technology, management skills etc. a successful new entry provides the opportunity for
the entrepreneur to grow his/her business. For example, introducing a new product into an
existing market provides the opportunity to take market share from competitors; entry into a new
market provides the opportunity to service a new group of customers, and a new organization has
a chance to make and built upon its first sales. Because growth makes a firm bigger, the firm
begins to benefit from the advantages of size. So, higher volume increases production efficiency,
makes the firm more attractive to suppliers, and therefore increases its bargaining power. Size
also enhances, the legitimacy of firms, because those firms are often perceived by customers,
financiers, and other stake holders as being more stable and prestigious.

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 7.2 Need for growth
In modern business, very few firms remain static for long. Most of the firms are in a state of
continued flux, either expanding or contracting but always changing like time. Business firms
grow on account of several factors. The important motives which drive business firms towards
growth are the advantages of growth which are;
i. Survival

Severe competition forces a firm to grow and gain competitive strength. Any business firms that
fail to grow cannot survive for long. With increasing competition and shrinking profit margins,
firms have to grow in order to maintain their existence. In a growing industry, a firm has to grow
just to retain its present position. A growing firm tends to be an innovator and it can easily face
business risks. It can easily absorb the shocks of market forces. Growth provides protection or
security against period’s adversity such as depression. By diversifying the range of its products
and markets, a firm can meet competition in the market and minimizes its risks. Thus, growth is
a means of survival in a challenging and turbulent environment.
ii. Economies of scale

Large scale operations provide several economies in production, marketing, finance, and
management. A large firm enjoys the advantages of bulk purchase of materials, strong
bargaining power, spreading of overheads, well organized promotion campaigns, cheaper
finance, automation, expert management, etc. These economies result in reduction in per unit
cost of operations and increase in profits.
iii. Expansion of market

Increase in demand for goods and services have led business firms to expand in size. Population
explosion and transportation led to widening of markets which in turn resulted in mass
production. Business firms grow to cater to larger markets and to meet the increasing demand.
Expanding markets provide opportunities for business growth.
iv. Owners mandate

The owner of a company gets the ultimate benefit of growth in the form higher dividends and
rise in the market value of shareholdings. Therefore, they may direct the management to ensure
growth of the company through continuous ploughing back of profits instead of distributing the

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entire earnings. Capable management may on its own like to take carefully calculated risks and
expand the size of the company.
v. Technology

Business firms also grow in order to reap the benefits of modern technology. Many firms invest
in research and development to develop new products and new techniques. Only a large firm can
take full advantage sophisticated machinery and equipment. Rationalization and automation
result in more efficient use of craze for power by building business enterprise. They take pride in
the growth of firms established by them. Other personal factors such as personal ambition,
exceptional organizing ability, strategic genius, etc also lead to growth of firms.
vi. Government policy

Generally, business firms operate under a plethora of government controls. Government may
provide several incentives in the form of subsidies and tax concessions to industrial units in
backward areas and those producing goods for export purposes. A firm may grow to face
government controls or to secure these incentives.
vii. Self sufficiency

Some firms grow to become independent in terms of marketing raw materials or marketing of
products. They integrate the various stages of industry or acquire other firms to gain control over
the supply of raw materials and marketing of finished products.

7.3 TYPES OF GROWTH STARTEGIES

The main strategies for growth are as follows
1. Expansion 3. Mergers and
2. Diversification 4. Sub – contracting

1. Expansion

Expansion and diversification are forms of internal growth. Internal growth implies increase in
the scale of operations without joining hands to the other firms. The firm expands its product
market scope.
Expansion may take place in the following forms;

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 i. Market penetration- is increasing the sale of existing products in the existing markets.
ii. Market development- is exploring new markets for existing products.
iii. Product development- is developing new or modified products for sale in the existing
markets.

Advantages of expansion
1) Expansion can be financed from the firm’s own funds.
2) No major changes are required in the organization structure and management system
of firms.
3) Better utilization of existing resources becomes possible.
4) The expanding firm can better face competition in the market.
5) Expansion provides economies of largo scale operations.

Limitations of expansion
1) Growth is slow and takes time
2) It is not always possible in the present product market
3) A business firm may not be able to exploit many business opportunities by confining
its operations to the existing products and markets.

Practical problems in expansion

 Scarcity of funds
 Marketing
 Risk
2. Diversification
Diversification is the process of entry in the field of business which is new to an enterprise
either in terms of markets or technology or both.
Advantages of diversification
i. Reduction in risk due to spreading
ii. Stability through capacity to absorb shocks of business cycle
iii. Wide scope for growth and profitability
iv. Better use of existing facility
v. Competitiveness

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 Disadvantages
i. Reorganization is necessary
ii. Difficulty in coordinating diverse businesses.

Diversification is suitable for the following reasons

 When the firm can’t attain its growth strategies by expansion alone.
 When diversification promises greater profitability than expansion.
 When the financial resources of the firm are much or excess of the requirement of
expansion.
Types of Diversification
There are four types of diversification
i. Horizontal integration
ii. Vertical integration
iii. Concentric diversification
iv. Conglomerate diversification
i. Horizontal integration

In this type of diversification, a company adds up some type of products at the same level of
production and marketing processes. It may happen internally or externally. Internally, a
company may decide to enter a parallel product market in addition to the existing product line.
Externally, a company may combine with competing firms. Two or more competing firms are
brought together under single ownership and control.
Advantages
a. Wasteful competition among the combining firms is eliminated.
b. It provides economies of large scale operations.
c. It provides greater control over the market and increases the competitiveness of
the company.
d. It permits the firm to influence supply and price of the product.

Disadvantages
a. The firm is not assured of supply of raw materials.
b. The company may acquire monopoly may used to exploit consumer and labor,

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 c. When several firms combine to form horizontal integration, there is danger of
over capitalization
d. The management of the firm may become bureaucratic and inflexible
ii. Vertical integration

In this type of growth strategy new products and services are added which are complementary to
the existing product or service line. It may be two types:Backward integration and Forward
integration.

A. Backward integration
It implies moving towards the source of raw materials. Also calledupstream development, it
is aimed at moving lower on the production process so that the firm is able to supply all raw
materials or basic components.
Advantage
a) It helps ensure regular supply of raw materials or components.
b) It improves ensures quality control over imports for the final product.
c) It facilitates higher return on investment for the company as a whole through better
use of overhead facilities.
d) It improves the company’s power of negotiation with suppliers on the basis of known
costs.
e) It saves indirect taxes payable on the purchase of inputs.
Disadvantages
a) The firm losses the opportunities of purchasing at a lower cost from technically more
efficient suppliers.
b) Changing economic condition affects the main product markets may cause a
magnified effect on the production of inputs.
c) When the divisions using the inputs don’t have the freedom of comparing market
conditions of supply, the problem of transfer pricing may become acute etc.
B. Forward Integration
It involves the entry of a firm into the business of finishing, distributing, or selling its
existing products. It is also known as downstream expansion. It refers to moving higher up in

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 the production or distributing processes towards the ultimate consumer. The firm develops
outlets for the use or sale of its own products.
Advantages
a) It enables the firm to gain greater control over sales and prices of its products.
b) It improves the scope of quality control because the firm’s own retail stores serve as
better source of customer feedback.
c) The firm can increase its profits by eliminating middlemen and by reducing the costs of
production, etc.

Disadvantages
a) It reduces the flexibility of operations.
b) The proportion of fixed costs in the firm’s costs increases, as a result of the firm is
exposed to greater cyclical changes in earnings Etc.
c) It is very difficult to efficiently manage an integrated firm because every business has
its own structure, technology, and problems.
d) It requires high capital investment, etc
iii. Concentric diversification
When a firm enters into some businesses, which is related with its present business in terms of
technology, marketing or both, it is called concentric diversification.
In technology related concentric diversification new product or service is provided with the help
of existing technology. In marketing related concentric diversification, new product or service is
sold through the existing distributing system. In technology and marketing related concentric
diversification, both existing technology and distributing system are used for the new product or
service.
Concentric diversification may be employed for the following purposes;
 To counteract cyclical fluctuations in the present products or services.
 To utilize the cash flows generated by the existing products or services.
 To face saturation of demand for present product or services.
 To gain managerial expertise in the new field of business and
 To capitalize on the reputation of present product or services.
iv. Conglomerate Diversification

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In this growth strategy a firm enters into business, which is unrelated to its existing business both
in terms of technology and marketing. For example, Shri Ram Fibers Ltd. (Indian) is a
conglomerate carrying on business in nylon industrial yarns, synthetic industrial fabrics,
engineering plastics, flow carbon, refrigerance, ball and needle bearings, auto electrical, hire-
purchase and leasing, and financial services.
Conglomerate diversification strategy may be adopted for the following reasons:
 To achieve a growth rate higher than what can be realized through expansion.

 To make better use of financial resources with retained profits exceeding immediate
investment needs.

 To avail of potential opportunities for profitable investment.

 To achieve distinctive competitive advantage and greater stability.

 To spread the risk, and

 To improve the price earnings ratio and market price of the company’s shares.

External Growth Strategy (Joint Ventures, Mergers, or Takeovers)

External growth occurs when two or more firms combine together in one firm. It is also called
integrate growth strategy.
Advantages
Integrative growth strategy has the following advantages:
a) Growth is very fast and quick.

b) The firm gets running business units.

c) The strategy offers economies of scale and control over the market.

d) Wasteful competition can be eliminated.

Disadvantages
Integrative growth strategy suffers from the following limitations:
a) Large amounts of financial resources are required to take over running units.

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 b) Drastic changes are required in the organization structure and management of the firm.

c) Co-ordination and control of integrated units becomes very difficult.

d) Frequent takeovers my create uncertainty and instability in the economy.

Integrated growth strategy may take the form of Joint-venture, merger or takeover.
i. Joint Ventures

When two or more independent firms together establish a new enterprise, contribute to the total
equity capital and participate in its business operations, it is known as a joint venture. A joint
venture is a temporary partnership or consortium between two or more companies for a specified
purpose. Firms within a country as well as firms in different countries may participate in a joint
venture.
Advantages
Joint ventures are set up for the following reasons:
a) A joint venture between two or more companies within the same country helps to reduce
competition or influence suppliers.

b) High risks involved in new ventures can be reduced through joint ventures.

c) Small firms can compete with large firms by joining hands.

d) The foreign partner in a joint venture can provide advanced technology and technical
knowhow not available within the country, Maruti Udyog Ltd.

e) The import content of a project can easily be financed through equity participation by the
foreign company.

f) Multinational corporations can enter a country more easily through joint ventures than by
setting up branches or subsidiaries.

g) Joint ventures help reduce production and marketing costs through higher sales volume.

h) Risk of business is shared among partners. Many joint ventures have been set up in
construction industry for this purpose.

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 i) A joint venture can provide the benefit of synergy. According to Grucker, joint venture is
the most flexible instrument for making the fits out of misfits. The distinctive competence
of two or more independent firms can be pooled together.

j) The amount of investment in joint venture is contributed by two or more firms. As a

result each partner has to contribute less than when he has to set up the venture alone

Disadvantages

The main problems of joint ventures are as follows:

a) Problems often arise in equity participation because both the local partner and the foreign
partner desire to have majority stake in the joint venture.

b) Often there are legal restrictions on foreign investment. Some countries set a limit of
permissible foreign shareholding in the local companies.

c) Differences in cultures and stages of economic development of the countries to which the
parties belong often create conflicts.

d) Joint ventures between unequal partners often tantamount to quasi mergers and may
attract anti-monopoly regulations.

e) Lack of proper coordination among partners may affect the efficient functioning of a joint
venture.

Joint ventures are likely to be more appropriate under the following conditions:
1. When an activity is uneconomical for a single firm.

2. When the risk of business has to be shared and reduced for the participating firms.

3. When the distinctive competence of two or more firms can be brought together.

4. When setting up a venture requires overcoming hurdles such as import quotas, tariffs,
nationalistic political interests, and cultural roadblocks.

Thus joint ventures are an effective growth strategy when development costs have to be shared,
risks are to be spread out and expertise has to be combined to make effective use of resources.

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Strategic issues in joint ventures
The major decisions that should be carefully taken in a joint venture are given below:
1) Objectives of joint venture: first of all the basic objective of joint venture should be
spelled out clearly. The interests of two partners may not be identical and
compatible. Therefore, basic differences in their objectives should be stated in
advance. A way to break the disagreement should be built into the joint venture from
the very start. Even provision can be made for arbitration and arbitrator acceptable to
both the parties can be named.

2) Choice of partner: several criteria may be used to select a partner for the joint
venture. These are: financial capacity, technical capacity, management competence,
etc. in addition the intention and sincerity of the partners should be considered.

3) Pattern of shareholding: an explicit provision should also be made for

disinvestment of shareholding by the government/foreign party after certain period of
time. Key consideration in dividing foreign equity participation is the inflow of
foreign technology on continuous basis and discharge of export obligation and the
government policy.

4) Management pattern: the joint venture should be autonomous. The composition of

the board of directors

5) may be decided in the light of choice of partners, shareholders pattern, etc.

ii. Merger

Merger is an external growth strategy. A merger means a combination of two or more firms into
one. It may occur in two ways:
a) Takeover or acquisition of one company by another(absorption), and

b) Creation of new company by complete consolidation of two or more units

(amalgamation).

Types of Mergers

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Mergers are of four types:
1. Horizontal mergers: these take place when there is a combination of two or more firms
engaged in the same production or marketing process. For instance, Brook Bond and
Lipton India Ltd. Merged together and formed a new company. ‘Brook Bond and Lipton
India Ltd.’ (BBIL).

2. Vertical Mergers: It takes place when the combining firms are complementary to each
other either in terms of supply of inputs pr marketing of output. For example, a footwear
company may take over a leather tannery.

3. Concentric mergers:when the combining firms are similar either in terms of technology
or marketing system there is concentric merger.

4. Conglomerate mergers:it occurs when two unrelated firms combine together, i.e., a
footwear company combining with a cement firm.

Why Mergers?
Buying Firm’s view point Selling Firm’s View Point
1. To gain quick entry into new markets 1. To turn around a sick unit.
and industries. 2. To increase the value of the owner’s
2. To achieve faster rate of growth stock.
3. To diversify quickly 3. To increase the growth rate.
4. To reduce competition and avoid 4. To acquire resources for stability
dependence operations.
5. To gain tax benefits 5. To deal with problem of top
6. To achieve synergistic advantages management succession.
7. To have quick access to research and 6. To reduce tax burden.
development and other facilities.
8. To fill the gap in the existing product
line.
9. To stabilize sales and profits
10. To increase the value of company’s
shares.

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Advantages
Mergers are used due to the following reasons:
a. A merger provides economies of large-scale operations.
b. Better utilization of funds can be made to increase profits.
c. There is possibility of diversification.
d. More efficient use of resources can be made.
e. Sick firms can be rehabilitated by merging them with strong and efficient concerns.
f. It is often cheaper to acquire an existing unit than to set up a new one.
g. It is possible to gain quick entry into new lines of business.
h. It can provide access to scarce raw materials and distribution net work and managerial
expertise.
Disadvantages
Mergers are not always successful due to the following drawbacks:
a. The combined enterprise may be unwieldy. Effective coordination and control becomes
difficult. As a result efficiency and profitability may decline.

b. Mergers give rise to monopoly and concentration of economic power, which often
operate against the interest of the society and the country.

Sub-Contracting
Sub contracting hiring another firm to perform some of the manufacturing process or to give sub
assemblies that will be included in the finished product. Such contracting is also used t describe
contractual arrangements between government agencies and industrial concerns. For example,
civic authorities enter into sub-contracts with business concerns. Under such contract business
firms carry out the specified work on roads, parks, etc. civic authorities in exchanging of
specified fee.
Large business firms similarly assign some of the jobs to small scale units. These jobs may
involve some manufacturing or office work. In case of manufacturing work, it may be industrial
sub-contracting while in the other cases it is known as commercial sub-contracting. Small-scale
firms play an important role in sub-contracting and thereby serve as feeders to large-scale
industries.

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Sub-contracting has several advantages. First, it is the fastest method of increasing output. It
enables the contractor to use technical and managerial skills already existing with the sub-
contractor. It avoids the need of setting up new plants and equipment, which involves time and
expense. Secondly, sub-contracting saves the buyer from incurring investment in specialized
machinery and equipment, which may not be required for regular production. Thirdly, sub-
contracting may enable the contractor to buy the components at a cost lesser than that of
manufacturing. Lastly, sub-contracting, checks over-expansion of productive facilities in case of
temporary demand.
Sub-contracting may, however, be unsuitable in case contractor requires the inputs on a large
scale and on regular basis. Same is the case when the contractor can manufacture the component
at a cost lesser than the price charged by the sub-contractor. Sub-contracting provides business to
small-scale firms and helps in their development.

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