By winter 2003, the company that for years had run in circles around their competition had been bumped from the top spot in worldwide sales.^{The Motorola vignette is based on the following sources: Adam Lashinsky (2006). “RAZR’s Edge.” Fortune. Retrieved from: http://archive.fortune.com/magazines/fortune/fortune_archive/2006/06/12/8379239/index.htm; Scott D. Anthony (2005). “Motorola’s Bet on the RAZR’s Edge.” HBS Working Knowledge. Retrieved from: http://hbswk.hbs.edu/archive/4992.html; Roger O. Crockett (2005). “The Leading Edge is RAZR-Thin.” Bloomberg. Retrieved from: http://www.bloomberg.com/news/articles/2005-12-04/the-leading-edge-is-razr-thin; Arik Hessedahl (2004). “Motorola vs. Nokia.” Forbes.com. Retrieved from: http://www.forbes.com/2004/01/19/cx_ah_0119mondaymatchup.html; Vlad Balan (2007). “10 Coolest Concept Phones Out There.” Cameraphones Plaza. Retrieved from: http://www.cameraphonesplaza.com/10-coolest-concept-phones-out-there/.} Motorola found itself stuck in the number-three slot. Their sales had declined because consumers were less than enthusiastic about the uninspired style of Motorola phones, and for many people, style is just as important in picking a cell phone as features. As a reviewer for one industry publication put it, “We just want to see the look on people’s faces when we slide [our phones] out of our pockets to take a call.”

Yet there was a glimmer of hope at Motorola. Despite its recent lapse in cell phone fashion sense, Motorola still maintained a concept-phone unit—a group responsible for designing futuristic new product features such as speech-recognition capability, flexible touchscreens, and touch-sensitive body covers. In every concept-phone unit, developers engage in an ongoing struggle to balance the two often-opposing demands of cell phone design: building the smallest possible phone with the largest possible screen. The previous year, Motorola had unveiled the rough model of an ultra-trim phone—at 10 millimeters, about half the width of the average flip-top or “clamshell” design. It was on this concept that Motorola decided to stake the revival of its reputation as a cell phone maker who knew how to package functionality with a wow factor.

The next step in developing a concept phone is actually building it. Teamwork becomes critical at this point. The process requires some diversity in expertise. An electronics engineer, for example, knows how to apply energy to transmit information through a system but not how to apply physics to the design and manufacture of the system; that’s the specialty of a mechanical engineer. Engineers aren’t designers—the specialists who know how to enhance the marketability of a product through its aesthetic value. Designers bring their own unique value to the team.

In addition, when you set out to build any kind of innovative high-tech product, you need to become a master of trade-offs—in Motorola’s case, compromises resulted from the demands of state-of-the-art functionality on one hand and fashionable design on the other. Negotiating trade-offs is a team process: it takes at least two people to resolve design disputes.

The responsibility for assembling and managing the Motorola “thin-clam” team fell to veteran electronic engineer Roger Jellicoe. His mission: create the world’s thinnest phone, do it in one year, and try to keep it a secret. Before the project was completed, the team had grown to more than twenty members, and with increased creative input and enthusiasm came increased confidence and clout. Jellicoe had been warned by company specialists in such matters that no phone wider than 49 millimeters could be held comfortably in the human hand. When the team had finally arrived at a satisfactory design that couldn’t work at less than 53 millimeters, they ignored the “49 millimeters warning,” built a model, passed it around, and came to a consensus: as one team member put it, “People could hold it in their hands and say, ‘Yeah, it doesn’t feel like a brick.’” Four millimeters, they decided, was an acceptable trade-off, and the new phone went to market at 53 millimeters. While small by today’s standards, at the time, 53 millimeters was a gamble.

Team members liked to call the design process the “dance.” Sometimes it flowed smoothly and sometimes people stepped on one another’s toes, but for the most part, the team moved in lockstep toward its goal. After a series of trade-offs about what to call the final product (suggestions ranged from Razor Clam to V3), Motorola’s new RAZR was introduced in July 2004. Recall that the product was originally conceived as a high-tech toy—something to restore the luster to Motorola’s tarnished image. It wasn’t supposed to set sales records, and sales in the fourth quarter of 2004, though promising, were in fact fairly modest. Back in September, however, a new executive named Ron Garriques had taken over Motorola’s cell phone division; one of his first decisions was to raise the bar for RAZR. Disregarding a 2005 budget that called for sales of two million units, Garriques pushed expected sales for the RAZR up to twenty million. The RAZR topped that target, shipped ten million in the first quarter of 2006, and hit the fifty-million mark at midyear. Talking on a RAZR, declared hip-hop star Sean “P. Diddy” Combs, “is like driving a Mercedes versus a regular ol’ ride.”^{Roger O. Crockett (2005). “The Leading Edge is RAZR-Thin.” Bloomberg. Retrieved from: http://www.bloomberg.com/news/articles/2005-12-04/the-leading-edge-is-razr-thin}

 

Jellicoe and his team were invited to attend an event hosted by top executives, receiving a standing ovation, along with a load of stock options. One of the reasons for the RAZR’s success, said Jellicoe, was that “it took the world by surprise. Very few Motorola products do that.” For a while, the new RAZR was the best-selling phone in the world.

The Team and the Organization

What Is a Team? How Does Teamwork Work?

A team (or a work team) is a group of people with complementary skills who work together to achieve a specific goal.^{This section is based in part on Leigh L. Thompson (2008). Making the Team: A Guide for Managers. Upper Saddle River, NJ: Pearson Education. p. 4.} In the case of Motorola’s RAZR team, the specific goal was to develop (and ultimately bring to market) an ultra-thin cell phone that would help restore the company’s reputation. The team achieved its goal by integrating specialized but complementary skills in engineering and design and by making the most of its authority to make its own decisions and manage its own operations.

Teams versus Groups

As Bonnie Edelstein, a consultant in organizational development suggests, “A group is a bunch of people in an elevator. A team is also a bunch of people in an elevator, but the elevator is broken.”^{Wilderdom.com (2006). “Team Building Quotes.” Retrieved from: http://www.wilderdom.com/teambuilding/Quotes.html} This distinction may be a little oversimplified, but as our tale of teamwork at Motorola reminds us, a team is clearly something more than a mere group of individuals. In particular, members of a group—or, more accurately, a working group—go about their jobs independently and meet primarily to work towards a shared objective. A group of department-store managers, for example, might meet monthly to discuss their progress in cutting plant costs. However, each manager is focused on the goals of his or her department because each is held accountable for meeting those goals.

Some Key Characteristics of Teams

To put teams in perspective, let’s identify five key characteristics. Teams:^{Adapted from Leigh L. Thompson (2008). Making the Team: A Guide for Managers. Upper Saddle River, NJ: Pearson Education. p. 4-5; C. P. Alderfer (1977). “Group and Intergroup Relations,” in Improving Life at Work. J. R. Hackman and J. L. Suttle ed. (1977). Palisades, CA: Goodyear. pp. 277–96.}

• share accountability for achieving specific common goals.
• function interdependently.
• require stability.
• hold authority and decision-making power.
• operate in a social context.

Why Organizations Build Teams

Why do major organizations now rely so much on teams to improve operations? Executives at Xerox have reported that team-based operations are 30 percent more productive than conventional operations. General Mills says that factories organized around team activities are 40 percent more productive than traditionally organized factories. FedEx says that teams reduced service errors (lost packages, incorrect bills) by 13 percent in the first year.^{Kimball Fisher (1999). Leading Self-Directed Work Teams: A Guide to Developing New Team Leadership Skills, rev. ed. New York: McGraw-Hill Professional; Jerald Greenberg and Robert A. Baron (2008). Behavior in Organizations, 9th ed. Upper Saddle River, NJ: Pearson Education. pp. 315–16.}

Today it seems obvious that teams can address a variety of challenges in the world of corporate activity. Before we go any further, however, we should remind ourselves that the data we’ve just cited aren’t necessarily definitive. For one thing, they may not be objective—companies are more likely to report successes than failures. As a matter of fact, teams don’t always work. According to one study, team-based projects fail 50–70 percent of the time.^{Jerald Greenberg and Robert A. Baron (2008). Behavior in Organizations, 9th ed. Upper Saddle River, NJ: Pearson Education. p. 316; Leigh L. Thompson (2008). Making the Team: A Guide for Managers. Upper Saddle River, NJ: Pearson Education. p. 5.}

The Effect of Teams on Performance

Research shows that companies build and support teams because of their effect on overall workplace performance, both organizational and individual. If we examine the impact of team-based operations according to a wide range of relevant criteria, we find that overall organizational performance generally improves. Figure 1.3 lists several areas in which we can analyze workplace performance and indicates the percentage of companies that have reported improvements in each area.

Figure 1.3: Performance Improvements Due to Team-Based Operations

Area of Performance	Firms Reporting Improvement
Product and service quality	70%
Customer service	67%
Worker satisfaction	66%
Quality of work life	63%
Productivity	61%
Competitiveness	50%
Profitability	45%
Absenteeism/turnover	23%

Types of Teams

Teams can improve company and individual performance in a number of areas. Not all teams, however, are formed to achieve the same goals or charged with the same responsibilities. Nor are they organized in the same way. Some, for instance, are more autonomous than others—less accountable to those higher up in the organization. Some depend on a team leader who’s responsible for defining the team’s goals and making sure that its activities are performed effectively. Others are more or less self-governing: though a leader lays out overall goals and strategies, the team itself chooses and manages the methods by which it pursues its goals and implements its strategies.^{Leigh L. Thompson (2008). Making the Team: A Guide for Managers. Upper Saddle River, NJ: Pearson Education. pp. 8-13.} Teams also vary according to their membership. Let’s look at several categories of teams.

Manager-Led Teams

As its name implies, in the manager-led team the manager is the team leader and is in charge of setting team goals, assigning tasks, and monitoring the team’s performance. The individual team members have relatively little autonomy. For example, the key employees of a professional football team (a manager-led team) are highly trained (and highly paid) athletes, but their activities on the field are tightly controlled by a head coach. As team manager, the coach is responsible both for developing the strategies by which the team pursues its goal of winning games and for the outcome of each game and season. He’s also solely responsible for interacting with managers above him in the organization. The players are responsible mainly for executing plays.^{Ibid. p. 9}

Self-Managed Teams

Self-managed teams (also known as self-directed teams) have considerable autonomy. They are usually small and often absorb activities that were once performed by traditional supervisors. A manager or team leader may determine overall goals, but the members of the self-managed team control the activities needed to achieve those goals.

Self-managed teams are the organizational hallmark of Whole Foods Market, the largest natural-foods grocer in the United States. Each store is run by 10 departmental teams, and virtually every store employee is a member of a team. Each team has a designated leader and its own performance targets. (Team leaders also belong to a store team, and store-team leaders belong to a regional team.) To do its job, every team has access to the kind of information—including sales and even salary figures—that most companies reserve for traditional managers.^{Charles Fishman (1996). “Whole Foods Is All Teams.” Fast Company. Retrieved from: http://www.fastcompany.com/26671/whole-foods-all-teams}

Not every self-managed team enjoys the same degree of autonomy. Companies vary widely in choosing which tasks teams are allowed to manage and which ones are best left to upper-level management only. As you can see in Figure 1.5 for example, self-managed teams are often allowed to schedule assignments, but they are rarely allowed to fire coworkers.

Cross-Functional Teams

Many companies use cross-functional teams—teams that, as the name suggests, cut across an organization’s functional areas (operations, marketing, finance, and so on). A cross-functional team is designed to take advantage of the special expertise of members drawn from different functional areas of the company. For example, when the Internal Revenue Service wanted to study the effects of a major change in information systems on employees, it created a cross-functional team composed of people from a wide range of departments. The final study reflected expertise in such areas as job analysis, training, change management, industrial psychology, and ergonomics.^{Human Resources Development Council (n.d.). “Organizational Learning Strategies: Cross-Functional Teams.” Getting Results through Learning. Retrieved from: http://www.humtech.com/ForestService/sites/GRTL/ols/ols3.htm}

Cross-functional teams figure prominently in the product-development process at Nike, where they take advantage of expertise from both inside and outside the company. Typically, team members include not only product designers, marketing specialists, and accountants but also sports-research experts, coaches, athletes, and even consumers. Likewise, Motorola’s RAZR team was a cross-functional team; the responsibility for developing the new product wasn’t passed along from the design team to the engineering team, but rather was entrusted to a special team composed of both designers and engineers.

Committees and task forces, both of which are dedicated to specific issues or tasks, are often cross-functional teams. Problem-solving teams, which are created to study such issues as improving quality or reducing waste, may be either intradepartmental or cross-functional.^{Stephen P. Robbins and Timothy A. Judge (2009). Organizational Behavior, 13th ed. Upper Saddle River, NJ: Pearson Education. pp. 340–42.}

Virtual Teams

Technology now makes it possible for teams to function not only across organizational boundaries like functional areas, but also across time and space. Technologies such as videoconferencing allow people to interact simultaneously and in real time, offering a number of advantages in conducting the business of a virtual team.^{Jennifer M. George and Gareth R. Jones (2008). Understanding and Managing Organizational Behavior, 5th ed. Upper Saddle River, NJ: Pearson Education. pp. 381–82.} Members can participate from any location or at any time of day, and teams can “meet” for as long as it takes to achieve a goal or solve a problem—a few days, weeks, or months. During the Covid-19 pandemic, many companies, organizations, governments and learning institutions were forced to move to virtual settings in order to curve the spread of the virus. This transition allowed for continuity of operations as best as possible.

Team size does not seem to be an obstacle when it comes to virtual-team meetings; in building the F-35 Strike Fighter, US defense contractor Lockheed Martin staked the $225 billion project on a virtual product-team of unprecedented global dimension, drawing on designers and engineers from the ranks of eight international partners from Canada, the United Kingdom, Norway, and Turkey.^{Adept Scientific (n.d.). “Lockheed Martin Chooses Mathcad as a Standard Design Package for F-35 Joint Strike Fighter Project.” Retrieved from: http://www.adeptscience.co.uk/media-room/press_room/lockheed-martin-chooses-mathcad-as-a-standard-design-package-for-f-35-joint-strike-fighter-project.html}

Why Teamwork Works

Now that we know a little bit about how teams work, we need to ask ourselves why they work. Not surprisingly, this is a fairly complex issue. In this section, we’ll explore why teams are often effective and when they ineffective.

Factors in Effective Teamwork

First, let’s begin by identifying several factors that contribute to effective teamwork. Teams are most effective when the following factors are met:

• Members depend on each other. When team members rely on each other to get the job done, team productivity and efficiency tend to be high.
• Members trust one another.
• Members work better together rather than individually. When team members perform better as a group than alone, collective performance exceeds individual performance.
• Members become boosters. When each member is encouraged by other team members to do his or her best, collective results improve.
• Team members enjoy being on the team.
• Leadership rotates.

Some of these factors may seem intuitive. Because such issues are rarely clear-cut, we need to examine the issue of group effectiveness from another perspective—one that considers the effects of factors that aren’t quite so straightforward.

Group Cohesiveness

The idea of group cohesiveness refers to the attractiveness of a team to its members. If a group is high in cohesiveness, membership is quite satisfying to its members. If it’s low in cohesiveness, members are unhappy with it and may try to leave it.^{This section based on: David A. Whetten and Kim S. Cameron (2007). Developing Management Skills, 7th ed. Upper Saddle River, NJ: Pearson Education. p. 497.}

What Makes a Team Cohesive?

Numerous factors may contribute to team cohesiveness, but in this section, we’ll focus on five of the most important:

• Size. The bigger the team, the less satisfied members tend to be. When teams get too large, members find it harder to interact closely with other members; a few members tend to dominate team activities, and conflict becomes more likely.
• Similarity. People usually get along better with people like themselves, and teams are generally more cohesive when members perceive fellow members as people who share their own attitudes and experience.
• Success. When teams are successful, members are satisfied, and other people are more likely to be attracted to their teams.
• Exclusiveness. The harder it is to get into a group, the happier the people who are already in it. Team status also increases members’ satisfaction.
• Competition. Membership is valued more highly when there is motivation to achieve common goals and outperform other teams.

Maintaining team focus on broad organizational goals is crucial. If members get too wrapped up in immediate team goals, the whole team may lose sight of the larger organizational goals toward which it’s supposed to be working. Let’s look at some factors that can erode team performance.

Groupthink

It’s easy for leaders to direct members toward team goals when members are all on the same page—when there’s a basic willingness to conform to the team’s rules. When there’s too much conformity, however, the group can become ineffective: the group may resist fresh ideas and, even worse, end up adopting its own dysfunctional tendencies as its way of doing things. Such tendencies may also encourage a phenomenon known as groupthink—the tendency to conform to group pressure in making decisions, while failing to think critically or to consider outside influences.

Groupthink is often cited as a factor in the explosion of the space shuttle Challenger in January 1986: engineers from a supplier of components for the rocket booster warned that the launch might be risky because of the weather but were persuaded to set aside their warning by NASA officials who wanted the launch to proceed as scheduled.^{John Schwartz and Matthew L. Wald (2003). “The Nation: NASA's Curse? 'Groupthink' Is 30 Years Old, And Still Going Strong.” New York Times. Retrieved from: http://www.nytimes.com/2003/03/09/weekinreview/the-nation-nasa-s-curse-groupthink-is-30-years-old-and-still-going-strong.html}

Motivation and Frustration

Remember that teams are composed of people, and whatever the roles they happen to be playing at a given time, people are subject to psychological ups and downs. As members of workplace teams, they need motivation, and when motivation is low, so are effectiveness and productivity. The difficulty of maintaining a high level of motivation is the chief cause of frustration among members of teams. As such, it’s also a chief cause of ineffective teamwork, and that’s one reason why more employers now look for the ability to develop and sustain motivation when they’re hiring new managers.^{This section is based on Jerald Greenberg and Robert A. Baron (2008). Behavior in Organizations, 9th ed. Upper Saddle River, NJ: Pearson Education. pp. 317–18.}

Other Factors that Erode Performance

Let’s take a quick look at three other obstacles to success in introducing teams into an organization:^{Leigh L. Thompson (2008). Making the Team: A Guide for Managers. Upper Saddle River, NJ: Pearson Education. pp. 323-324.}

• Unwillingness to cooperate. Failure to cooperate can occur when members don’t or won’t commit to a common goal or set of activities. What if, for example, half the members of a product-development team want to create a brand-new product and half want to improve an existing product? The entire team may get stuck on this point of contention for weeks or even months. Lack of cooperation between teams can also be problematic to an organization.
• Lack of managerial support. Every team requires organizational resources to achieve its goals, and if management isn’t willing to commit the needed resources— say, funding or key personnel—a team will probably fall short of those goals.
• Failure of managers to delegate authority. Team leaders are often chosen from the ranks of successful supervisors—first-line managers give instructions on a day-to-day basis and expect to have them carried out. This approach to workplace activities may not work very well in leading a team—a position in which success depends on building a consensus and letting people make their own decisions.

The Team and Its Members

“Life Is All About Group Work”

“I’ll work extra hard and do it myself, but please don’t make me have to work in a group.”

Like it or not, you’ve probably already noticed that you’ll have team-based assignments in college. More than two-thirds of all students report having participated in the work of an organized team, and if you’re in business school, you will almost certainly find yourself engaged in team-based activities.^{David A. Whetten and Kim S. Cameron (1991). Developing Management Skills, 7th ed. Upper Saddle River, NJ: Pearson Education. pp. 498–99; Richard S. Wellins, William C. Byham, and Jeanne M. Wilson (1991). Empowered Teams. San Francisco: Jossey-Bass.}

Why do we put so much emphasis on something that, reportedly, makes many students feel anxious and academically drained? Here’s one college student’s practical-minded answer to this question:

“In the real world, you have to work with people. You don’t always know the people you work with, and you don’t always get along with them. Your boss won’t particularly care, and if you can’t get the job done, your job may end up on the line. Life is all about group work, whether we like it or not. And school, in many ways, prepares us for life, including working with others.”^{Lauren Elrick (2015). “The Importance of Teamwork Skills in Work and School.” Rasmussen College, College Life Blog. Retrieved from: http://www.rasmussen.edu/student-life/blogs/college-life/importance-of-teamwork-skills-in-work-and-school/}

She’s right. In placing so much emphasis on teamwork skills and experience, business colleges are doing the responsible thing—preparing students for the business world. A survey of Fortune 1000 companies reveals that 79 percent use self-managing teams and 91 percent use other forms of employee work groups. Another survey found that the skill that most employers value in new employees is the ability to work in teams.^{David A. Whetten and Kim S. Cameron (1991). Developing Management Skills, 7th ed. Upper Saddle River, NJ: Pearson Education. pp. 498-499; Edward E. Lawler (2003). Treat People Right. San Francisco: Jossey-Bass.} Consider the advice of former Chrysler Chairman Lee Iacocca: “A major reason that capable people fail to advance is that they don’t work well with their colleagues.”^{Lee Iacocca and William Novak (2007). Iacocca. New York: Bantam. p. 61.} The importance of the ability to work in teams was confirmed in a survey of leadership practices of more than sixty of the world’s top organizations.^{The Hay Group (1999). "What Makes Great Leaders: Rethinking the Route to Effective Leadership: Findings from the Fortune Magazine/Hay Group 1999 Executive Survey of Leadership Effectiveness.” Retrieved from: http://www.lrhartley.com/seminars//great-leaders.pdf}

When top executives in these organizations were asked what causes the careers of high-potential leadership candidates to derail, 60 percent of the organizations cited “inability to work in teams.” Interestingly, only 9 percent attributed the failure of these executives to advance to “lack of technical ability.”

To put it in plain terms, the question is not whether you’ll find yourself working as part of a team. You will. The question is whether you’ll know how to participate successfully in team-based activities.

Will You Make a Good Team Member?

What if your instructor decides to divide the class into teams and assigns each team to develop a new product plus a business plan to get it on the market? What teamwork skills could you bring to the table, and what teamwork skills do you need to improve? Do you possess qualities that might make you a good team leader?

What Skills Does the Team Need?

Sometimes we hear about a sports team made up of mostly average players who win a championship because of coaching genius, flawless teamwork, and superhuman determination.^{Stephen P. Robbins and Timothy A. Judge (2009). Organizational Behavior, 13th ed. Upper Saddle River, NJ: Pearson Education. pp. 346-7.} But not terribly often. In fact, we usually hear about such teams simply because they’re newsworthy—exceptions to the rule. Typically a team performs well because its members possess some level of talent. Members’ talents must also be managed in a collective effort to achieve a common goal.

In the final analysis, a team can succeed only if its members provide the skills that need managing. In particular, every team requires some mixture of three sets of skills:

• Technical skills. Because teams must perform certain tasks, they need people with the skills to perform them. For example, if your project calls for a lot of math work, it’s good to have someone with the necessary quantitative skills.
• Decision-making and problem-solving skills. Because every task is subject to problems, and because handling every problem means deciding on the best solution, it’s good to have members who are skilled in identifying problems, evaluating alternative solutions, and deciding on the best options.
• Interpersonal skills. Because teams need direction and motivation and depend on communication, every group benefits from members who know how to listen, provide feedback, and resolve conflict. Some members must also be good at communicating the team’s goals and needs to outsiders.

The key is ultimately to have the right mix of these skills. Remember, too, that no team needs to possess all these skills—never mind the right balance of them—from day one. In many cases, a team gains certain skills only when members volunteer for certain tasks and perfect their skills in the process of performing them. For the same reason, effective teamwork develops over time as team members learn how to handle various team-based tasks. In a sense, teamwork is always work in progress.

What Roles Do Team Members Play?

As a student and later in the workplace, you’ll be a member of a team more often than a leader. Team members can have as much impact on a team’s success as its leaders. A key is the quality of the contributions they make in performing non-leadership roles.^{David A. Whetten and Kim S. Cameron (1991). Developing Management Skills, 7th ed. Upper Saddle River, NJ: Pearson Education. pp. 516-520.}

What, exactly, are those roles? At this point, you’ve probably concluded that every team faces two basic challenges:

• Accomplishing its assigned task
• Maintaining or improving group cohesiveness

Whether you affect the team’s work positively or negatively depends on the extent to which you help it or hinder it in meeting these two challenges.^Ibid. We can thus divide teamwork roles into two categories, depending on which of these two challenges each role addresses. These two categories (task-facilitating roles and relationship-building roles) are summarized here:

Task-facilitating roles

Task-facilitating roles address challenge number one—accomplishing the team goals. As you can see from Table P.6, such roles include not only providing information when someone else needs it but also asking for it when you need it. In addition, it includes monitoring (checking on progress) and enforcing (making sure that team decisions are carried out). Task facilitators are especially valuable when assignments aren’t clear or when progress is too slow.

Relationship-building roles

When you challenge unmotivated behavior or help other team members understand their roles, you’re performing a relationship-building role and addressing challenge number two—maintaining or improving group cohesiveness. This type of role includes activities that improve team “chemistry,” from empathizing to confronting.

Bear in mind three points about this model: (1) Teams are most effective when there’s a good balance between task facilitation and relationship-building; (2) it’s hard for any given member to perform both types of roles, as some people are better at focusing on tasks and others on relationships; and (3) overplaying any facet of any role can easily become counterproductive. For example, elaborating on something may not be the best strategy when the team needs to make a quick decision; and consensus building may cause the team to overlook an important difference of opinion.

Blocking roles

Finally, review Figure 1.8, which summarizes a few characteristics of another kind of team-membership role. So-called blocking roles consist of behavior that inhibits either team performance or that of individual members. Every member of the team should know how to recognize blocking behavior. If teams don’t confront dysfunctional members, they can destroy morale, hamper consensus building, create conflict, and hinder progress.

Class Team Projects

In your academic career you’ll participate in a number of team projects. To get insider advice on how to succeed on team projects in college, let’s look at some suggestions offered by students who have gone through this experience.^{Kristen Feenstra (n.d.). “Study Skills: Teamwork Skills for Group Projects.” Powertochange.com. Retrieved from: http://powertochange.com/students/academics/groupproject/}

• Draw up a team charter. At the beginning of the project, draw up a team charter that includes: the goals of the group; ways to ensure that each team member’s ideas are considered; timing and frequency of meeting. A more informal way to arrive at a team charter is to simply set some ground rules to which everyone agrees.
• Contribute your ideas. Share your ideas with your group. The worst that could happen is that they won’t be used (which is what would happen if you kept quiet).
• Never miss a meeting or deadline. Pick a weekly meeting time and write it into your schedule as if it were a class. Never skip it.
• Be considerate of each other. Be patient, listen to everyone, involve everyone in decision making, avoid infighting, build trust.
• Create a process for resolving conflict. Do so before conflict arises. Set up rules to help the group decide how conflict will be handled.
• Use the strengths of each team member. All students bring different strengths. Utilize the unique value of each person.
• Don’t do all the work yourself. Work with your team to get the work done. The project output is often less important than the experience.

What Does It Take to Lead a Team?

To borrow from Shakespeare, “Some people are born leaders, some achieve leadership, and some have leadership thrust upon them.” At some point in a successful career, you will likely be asked to lead a team. What will you have to do to succeed as a leader?

Like so many of the questions that we ask in this book, this question doesn’t have any simple answers. We can provide one broad answer: A leader must help members develop the attitudes and behavior that contribute to team success: interdependence, collective responsibility, shared commitment, and so forth.

Team leaders must be able to influence their team members. Notice that we say influence: except in unusual circumstances, giving commands and controlling everything directly doesn’t work very well.^{David A. Whetten and Kim S. Cameron (1991). Developing Management Skills, 7th ed. Upper Saddle River, NJ: Pearson Education. p. 520.} As one team of researchers puts it, team leaders are more effective when they work with members rather than on them.^{Kristen Feenstra (n.d.). “Study Skills: Teamwork Skills for Group Projects.” Powertochange.com. Retrieved from: http://powertochange.com/students/academics/groupproject/} Hand-in-hand with the ability to influence is the ability to gain and keep the trust of team members. People aren’t likely to be influenced by a leader whom they perceive as dishonest or selfishly motivated.

Assuming you were asked to lead a team, there are certain leadership skills and behaviors that would help you influence your team members and build trust. Let’s look briefly at some of them:

• Demonstrate integrity. Do what you say you’ll do and act in accordance with your stated values. Be honest in communicating and follow through on promises.
• Be clear and consistent. Let members know that you’re certain about what you want and remember that being clear and consistent reinforces your credibility.
• Generate positive energy. Be optimistic and compliment team members. Recognize their progress and success.
• Acknowledge common points of view. Even if you’re about to propose some kind of change, recognize the value of the views that members already hold in common.
• Manage agreement and disagreement. When members agree with you, confirm your shared point of view. When they disagree, acknowledge both sides of the issue and support your own with strong, clearly-presented evidence.
• Encourage and coach. Buoy up members when they run into new and uncertain situations and when success depends on their performing at a high level.
• Share information. Give members the information they need and let them know that you’re knowledgeable about team tasks and individual talents. Check with team members regularly to find out what they’re doing and how the job is progressing.

Image Credits: Chapter 1

Figure 1.1: Unknown author. Nappy. Public Domain. Retrieved from: https://www.nappy.co/?s=phone

Figure 1.2: Marten Bjork (2017). “iPhone X.” Unsplash. Public Domain. Retrieved from: https://unsplash.com/photos/FVtG38Cjc_k

Figure 1.3: Adapted from Edward E. Lawler, S. A. Mohman, and G. E. Ledford (1992). Creating High Performance Organizations: Practices and Results of Employee Involvement and Total Quality in Fortune 1000 Companies. San Francisco: Wiley. Reprinted with permission of John Wiley & Sons Inc.

Figure 1.4: Hokie20cr (2016). “Fuente 2016.” Wikimedia Commons. CC BY-SA 4.0. Retrieved from: https://commons.wikimedia.org/wiki/File:Fuente2016.jpg

Figure 1.6: “person” by Richa, IN from the noun project. Retrieved from: https://thenounproject.com/search/?q=person&i=1393453

Figure 1.7: Federal Government (1983). “Space Shuttle Challenger, 04-04-1983.” Wikipedia. Public Domain. Retrieved from: https://en.wikipedia.org/wiki/Space_Shuttle_Challenger#/media/File:Space_Shuttle_Challenger_(04-04-1983).JPEG

Figure 1.8: Adapted from David A. Whetten and Kim S. Cameron (2007). Developing Management Skills, 7th ed. Upper Saddle River, NJ: Pearson Education. pp. 517–⁠519.

Figure 1.9: Adapted from David A. Whetten and Kim S. Cameron (2007). Developing Management Skills, 7th ed. Upper Saddle River, NJ: Pearson Education. pp. 519–⁠20.

Learning Objectives

• Define business ethics and explain what it means to act ethically in business.
• Explain why we study business ethics.
• Identify ethical issues that you might face in business, such as insider trading, conflicts of interest, and bribery, and explain rationalizations for unethical behavior.
• Identify steps you can take to maintain your honesty and integrity in a business environment.
• Define corporate social responsibility and explain how organizations are responsible to their stakeholders, including owners, employees, customers, and the community.
• Discuss how you can identify an ethical organization, and how organizations can prevent behavior like sexual harassment.
• Learn how to avoid an ethical lapse, and why you should not rationalize when making decisions.

Introduction

“Mommy, Why Do You Have to Go to Jail?”

The one question Betty Vinson would have preferred to avoid is “Mommy, why do you have to go to jail?”^{This case is based on Susan Pullman (2003). “How Following Orders Can Harm Your Career.” Wall Street Journal. Retrieved from: http://ww2.cfo.com/human-capital-careers/2003/10/how-following-orders-can-harm-your-career/} Vinson graduated with an accounting degree from Mississippi State and married her college sweetheart. After a series of jobs at small banks, she landed a mid-level accounting job at WorldCom, at the time still a small long-distance provider. Sparked by the telecom boom, however, WorldCom soon became a darling of Wall Street, and its stock price soared. Now working for a wildly successful company, Vinson rounded out her life by reading legal thrillers and watching her daughter play soccer.

Her moment of truth came in mid-2000, when company executives learned that profits had plummeted. They asked Vinson to make some accounting adjustments to boost income by $828 million. Vinson knew that the scheme was unethical (at the very least) but she gave in and made the adjustments. Almost immediately, she felt guilty and told her boss that she was quitting. When news of her decision came to the attention of CEO Bernard Ebbers and CFO Scott Sullivan, they hastened to assure Vinson that she’d never be asked to cook any more books. Sullivan explained it this way: “We have planes in the air. Let’s get the planes landed. Once they’ve landed, if you still want to leave, then leave. But not while the planes are in the air.”^Ibid. Besides, she’d done nothing illegal, and if anyone asked, he’d take full responsibility. So Vinson decided to stay. After all, Sullivan was one of the top CFOs in the country; at age 37, he was already making $19 million a year.^{Amanda Ripley (2002). “The Night Detective.” Time. Retrieved from: http://content.time.com/time/magazine/article/0,9171,1003990,00.html} Who was she to question his judgment?^{Jeff Clabaugh (2005). “WorldCom’s Betty Vinson Gets 5 Months in Jail.” Washington Business Journal. Retrieved from: http://www.bizjournals.com/washington/stories/2005/08/01/daily51.html}

Six months later, Ebbers and Sullivan needed another adjustment—this time for $771 million. This scheme was even more unethical than the first: it entailed forging dates to hide the adjustment. Pretty soon, Vinson was making adjustments on a quarterly basis—first for $560 million, then for $743 million, and yet again for $941 million. Eventually, Vinson had juggled almost $4 billion, and before long, the stress started to get to her: she had trouble sleeping, lost weight, and withdrew from people at work. She decided to hang on when she got a promotion and a $30,000 raise.

By spring 2002, however, it was obvious that adjusting the books was business as usual at WorldCom. Vinson finally decided that it was time to move on, but, unfortunately, an internal auditor had already put two and two together and blown the whistle. The Securities and Exchange Commission charged WorldCom with fraud amounting to $11 billion—the largest in US history. Seeing herself as a valuable witness, Vinson was eager to tell what she knew. The government, however, regarded her as more than a mere witness. When she was named a co-conspirator, she agreed to cooperate fully and pleaded guilty to criminal conspiracy and securities fraud. But she won’t be the only one doing time: Scott Sullivan will be in jail for five years, and Bernie Ebbers will be locked up for 25 years. Both maintain that they are innocent.^{Scott Reeves (2005). “Lies, Damned Lies and Scott Sullivan.” Forbes. Retrieved from: http://www.forbes.com/2005/02/17/cx_sr_0217ebbers.html; David A. Andelman (2005). “Scott Sullivan Gets Slap on the Wrist—WorldCom Rate Race.” Forbes. Retrieved from: http://www.mindfully.org/Industry/2005/Sullivan-WorldCom-Rat12aug05.htm}

So where did Betty Vinson, mild-mannered midlevel executive and mother, go wrong? How did she manage to get involved in a scheme that not only bilked investors out of billions but also cost 17,000 people their jobs?^{Susan Pullman (2003). “How Following Orders Can Harm Your Career.” Wall Street Journal. Retrieved from: http://ww2.cfo.com/human-capital-careers/2003/10/how-following-orders-can-harm-your-career/} Ultimately, of course, we can only guess. Maybe she couldn’t say no to her bosses; perhaps she believed that they’d take full responsibility for her accounting “adjustments.” Possibly she was afraid of losing her job or didn’t fully understand the ramifications of what she was doing. What we do know is that she disgraced herself and went to jail.^{David Hancock (2002). “World-Class Scandal at WorldCom.” CBS News. Retrieved from: http://www.cbsnews.com/news/world-class-scandal-at-worldcom}

The WorldCom situation is not an isolated incident. Perhaps you have heard of Bernie Madoff, founder of Bernard L. Madoff Investment Securities and former chairman of the NASDAQ stock exchange.^{Time (2009). “Top 10 Crooked CEO’s.” Retrieved from: http://content.time.com/time/specials/packages/article/0,28804,1903155_1903156_1903160,00.html} Madoff is alleged to have run a giant Ponzi scheme^{Fred Langan (2008). “The -billion BMIS Debacle: How a Ponzi Scheme Works.” CBC News. Retrieved from: http://www.cbc.ca/news/business/the-50-billion-bmis-debacle-how-a-ponzi-scheme-works-1.709409} that cheated investors of up to $65 billion. His wrongdoings won him a spot at the top of Time Magazine’s Top 10 Crooked CEOs. According to the SEC charges, Madoff convinced investors to give him large sums of money. In return, he gave them an impressive 8–12 percent return a year. But Madoff never really invested their money. Instead, he kept it for himself. He got funds to pay the first investors their return (or their money back if they asked for it) by bringing in new investors. Everything was going smoothly until the fall of 2008, when the stock market plummeted and many of his investors asked for their money. As he no longer had it, the game was over and he had to admit that the whole thing was just one big lie. Thousands of investors, including many of his wealthy friends, not-so-rich retirees who trusted him with their life savings, and charitable foundations, were financially ruined. Those harmed by Madoff either directly or indirectly were likely pleased when he was sentenced to jail for 150 years.

 

Headlines from more corporate scandals since 2015:

• In 2015, Volkswagen admitted cheating the United States emissions tests for diesel engines.
• In 2016, then Wells-Fargo CEO John Stumpf was fired for a scandal that included the creation of 1.5 million fake deposit accounts and more than 500,000 fake credit cards, all in customers’ names and without their permission. This was just the beginning of more scandals to be uncovered at one of the Top 5 largest banks in the United States.^{Ethan Wolff-Mann (2019). "Wells Fargo scandals: The complete list." Yahoo! Finance. Retrieved from: https://finance.yahoo.com/news/wells-fargo-scandals-the-complete-timeline-141213414.html}
• In 2019, Facebook agrees to pay $5 billion to settle with the US Federal Trade Commission over privacy and data concerns. ^{BBC (2019). "Facebook to pay record billion to settle privacy concerns." BBC News. Retrieved from: https://www.bbc.com/news/business-49099364}

What can government, business and/or society do to reduce these types of ethical scandals?

Business Ethics

The Idea of Business Ethics

It’s in the best interest of a company to operate ethically. Trustworthy companies are better at attracting and keeping customers, talented employees, and capital. Those tainted by questionable ethics suffer from dwindling customer bases, employee turnover, and investor mistrust.

Let’s begin this section by addressing this question: What can individuals, organizations, and government agencies do to foster an environment of ethical behavior in business? First, of course, we need to define the term.

What Is Ethics?

You probably already know what it means to be ethical: to know right from wrong and to know when you’re practicing one instead of the other. We can say that business ethics is the application of ethical behavior in a business context. Acting ethically in business means more than simply obeying applicable laws and regulations: It also means being honest, doing no harm to others, competing fairly, and declining to put your own interests above those of your company, its owners, and its workers. If you’re in business you obviously need a strong sense of what’s right and wrong. You need the personal conviction to do what’s right, even if it means doing something that’s difficult or personally disadvantageous.

Why Study Ethics?

Ideally, prison terms, heavy fines, and civil suits would discourage corporate misconduct, but, unfortunately, many experts suspect that this assumption is a bit optimistic. Whatever the condition of the ethical environment in the near future, one thing seems clear: the next generation entering business—which includes most of you—will find a world much different than the one that waited for the previous generation. For example, cyberethics and how user behavior and programmed computers might impact people and society. Recent history tells us in no uncertain terms that today’s business students, many of whom are tomorrow’s business leaders, need a much sharper understanding of the difference between what is and isn’t ethically acceptable. As a business student, one of your key tasks is learning how to recognize and deal with the ethical challenges that will confront you. Asked what he looked for in a new hire, Warren Buffett, CEO of Berkshire Hathaway and one of the world’s most successful investor, replied: “I look for three things. The first is personal integrity, the second is intelligence, and the third is a high energy level.” He paused and then added, “But if you don’t have the first, the second two don’t matter.”^{Adrian Gostick and Dana Telford (2003). The Integrity Advantage. Salt Lake City: Gibbs Smith. pp. 3–4.}

Identifying Ethical Issues and Dilemmas

Ethical issues are the difficult social questions that involve some level of controversy over what is the right thing to do. Environmental protection is an example of a commonly discussed ethical issue, because there can be trade offs between environmental and economic factors.

Ethical dilemmas are situations in which it is difficult for an individual to make decisions either because the right course of action is unclear or carries some potential negative consequences for the person or people involved.

Make no mistake about it: when you enter the business world, you’ll find yourself in situations in which you’ll have to choose the appropriate behavior. How, for example, would you answer questions like the following?

1. Is it OK to accept a pair of sports tickets from a supplier?
2. Can I buy office supplies from my brother-in-law?
3. Is it appropriate to donate company funds to a local charity?
4. If I find out that a friend is about to be fired, can I warn her?

Obviously, the types of situations are numerous and varied. Fortunately, we can break them down into a few basic categories: issues of honesty and integrity, conflicts of interest and loyalty, bribes versus gifts, and whistle-blowing. Let’s look a little more closely at each of these categories.

Issues of Honesty and Integrity

Master investor Warren Buffet once told a group of business students the following: “I cannot tell you that honesty is the best policy. I can’t tell you that if you behave with perfect honesty and integrity somebody somewhere won’t behave the other way and make more money. But honesty is a good policy. You’ll do fine, you’ll sleep well at night and you’ll feel good about the example you are setting for your coworkers and the other people who care about you.”^{Ibid. p. 103.}

If you work for a company that settles for its employees’ merely obeying the law and following a few internal regulations, you might think about moving on. If you’re being asked to deceive customers about the quality or value of your product, you’re in an ethically unhealthy environment.

Think About This Story:

“A chef put two frogs in a pot of warm soup water. The first frog smelled the onions, recognized the danger, and immediately jumped out. The second frog hesitated: The water felt good, and he decided to stay and relax for a minute. After all, he could always jump out when things got too hot (so to speak). As the water got hotter, however, the frog adapted to it, hardly noticing the change. Before long, of course, he was the main ingredient in frog-leg soup.”^{Ibid. Adapted from p. 16.}

So, what’s the moral of the story? Don’t sit around in an ethically toxic environment and lose your integrity a little at a time; get out before the water gets too hot and your options have evaporated. Fortunately, a few rules of thumb can guide you.

We’ve summed them up in Figure 4.2.

 

Conflicts of Interest

Conflicts of interest occur when individuals must choose between taking actions that promote their personal interests over the interests of others or taking actions that don’t. A conflict can exist, for example, when an employee’s own interests interfere with, or have the potential to interfere with, the best interests of the company’s stakeholders (management, customers, and owners). Let’s say that you work for a company with a contract to cater events at your college and that your uncle owns a local bakery. Obviously, this situation could create a conflict of interest (or at least give the appearance of one—which is a problem in itself). When you’re called on to furnish desserts for a luncheon, you might be tempted to send some business your uncle’s way even if it’s not in the best interest of your employer. What should you do? You should disclose the connection to your boss, who can then arrange things so that your personal interests don’t conflict with the company’s.

The same principle holds that an employee shouldn’t use private information about an employer for personal financial benefit. Say that you learn from a coworker at your pharmaceutical company that one of its most profitable drugs will be pulled off the market because of dangerous side effects. The recall will severely hurt the company’s financial performance and cause its stock price to plummet. Before the news becomes public, you sell all the stock you own in the company. What you’ve done is called insider trading—acting on information that is not available to the general public, either by trading on it or providing it to others who trade on it. Insider trading is illegal, and you could go to jail for it.

Conflicts of Loyalty

You may one day find yourself in a bind between being loyal either to your employer or to a friend or family member. Perhaps you just learned that a coworker, a friend of yours, is about to be downsized out of his job. You also happen to know that he and his wife are getting ready to make a deposit on a house near the company headquarters. From a work standpoint, you know that you shouldn’t divulge the information. From a friendship standpoint, though, you feel it’s your duty to tell your friend. Wouldn’t he tell you if the situation were reversed? So what do you do? As tempting as it is to be loyal to your friend, you shouldn’t tell. As an employee, your primary responsibility is to your employer. You might be able to soften your dilemma by convincing a manager with the appropriate authority to tell your friend the bad news before he puts down his deposit.

Bribes vs. Gifts

It’s not uncommon in business to give and receive small gifts of appreciation, but when is a gift unacceptable? When is it really a bribe?

There’s often a fine line between a gift and a bribe. The following information may help in drawing it, because it raises key issues in determining how a gesture should be interpreted: the cost of the item, the timing of the gift, the type of gift, and the connection between the giver and the receiver. If you’re on the receiving end, it’s a good idea to refuse any item that’s overly generous or given for the purpose of influencing a decision. Because accepting even small gifts may violate company rules, always check on company policy.

Google’s “Code of Conduct,” for instance, has an entire section on avoiding conflicts of interest. They outline where these conflicts might occur, such as accepting gifts, personal investments, and outside employment, and provide guidelines: “In each of these situations, the rule is the same—if you are considering entering into a business situation that creates a conflict of interest, don’t. If you are in a business situation that may create a conflict of interest, or the appearance of a conflict of interest, review the situation with your manager and Ethics & Compliance.”^{Travis H. Brown (2015). "Living Wage vs. Minimum Wage: What's the Difference?" How Money Walks. Retrieved from: https://www.howmoneywalks.com/living-wage-vs-minimum-wage-whats-the-difference/}

Whistle-Blowing

As we’ve seen, the misdeeds of Betty Vinson and her accomplices at WorldCom didn’t go undetected. They caught the eye of Cynthia Cooper, the company’s director of internal auditing. Cooper, of course, could have looked the other way, but instead she summoned up the courage to be a whistle-blower—an individual who exposes illegal or unethical behavior in an organization. Like Vinson, Cooper had majored in accounting at Mississippi State and was a hard-working, dedicated employee. Unlike Vinson, however, she refused to be bullied by her boss, CFO Scott Sullivan. In fact, she had tried to tell not only Sullivan but also auditors from the Arthur Andersen accounting firm that there was a problem with WorldCom’s books. The auditors dismissed her warnings, and when Sullivan angrily told her to drop the matter, she started cleaning out her office. But she didn’t relent. She and her team worked late each night, conducting an extensive, secret investigation. Two months later, Cooper had evidence to take to Sullivan, who told her once again to back off. Again, however, she stood up to him, and though she regretted the consequences for her WorldCom coworkers, she reported the scheme to the company’s board of directors. Within days, Sullivan was fired and the largest accounting fraud in history became public.^{Susan Pulliam and Deborah Solomon (2002). “How Three Unlikely Sleuths Exposed Fraud at WorldCom.” Wall Street Journal. Retrieved from: http://www.wsj.com/articles/SB1035929943494003751}

As a result of Cooper’s actions, executives came clean about the company’s financial situation. The conspiracy of fraud was brought to an end, and though public disclosure of WorldCom’s problems resulted in massive stock-price declines and employee layoffs, investor and employee losses would have been greater without Cooper’s intervention. Even though Cooper did the right thing, and landed on the cover of Time magazine for it, the experience wasn’t exactly gratifying.

A lot of people applauded her action, but many coworkers shunned her; some even blamed her for the company’s troubles.^{Gostick and Telford (2003). The Integrity Advantage. Salt Lake City: Gibbs Smith. p. 13.}

Whistle-blowing is sometimes career suicide. A survey of 200 whistle-blowers conducted by the National Whistleblower Center found that half were fired for blowing the whistle. ^{National Whistleblower Center (2002). “Labor Day Report: The National Status of Whistleblower Protection on Labor Day 2002.” Retrieved from: https://web.archive.org/web/20060130104004/http://www.whistleblowers.org/labordayreport.htm} Even those who keep their jobs can experience repercussions. As long as they stay, some will treat them (as one whistle-blower put it) “like skunks at a picnic”; if they leave, they may be blackballed in the industry. ^{Paula Dwyer, Dan Carney et al. (2002). “Year of the Whistleblower.” BusinessWeek. Retrieved from: http://www.bloomberg.com/news/articles/2002-12-15/year-of-the-whistleblower} On a positive note, new Federal laws have been passed which are intended to protect whistle-blowers.

For her own part, Cynthia Cooper doesn’t regret what she did. As she told a group of students at Mississippi State: “Strive to be persons of honor and integrity. Do not allow yourself to be pressured. Do what you know is right even if there may be a price to be paid.” ^{Scott Waller (2003). “Whistleblower Tells Students to Have Personal Integrity.” The (Jackson, MS) Clarion-Ledger. Retrieved from: http://www.yourlawyer.com/articles/title/whistleblower-tells-students-to-have-personal-integrity} If your company tells employees to do whatever it takes, push the envelope, look the other way, and “be sure that we make our numbers,” you have three choices: go along with the policy, try to change things, or leave. If your personal integrity is part of the equation, you’re probably down to the last two choices.^{Gostick and Telford (2003). The Integrity Advantage. Salt Lake City: Gibbs Smith. pp. 98-99.}

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=52

Corporate Social Responsibility

Corporate social responsibility refers to the approach that an organization takes in balancing its responsibilities toward different stakeholders when making legal, economic, ethical, and social decisions. Remember that we previously defined stakeholders as those with a legitimate interest in the success or failure of the business and the policies it adopts. The term social responsibility refers to the approach that an organization takes in balancing its responsibilities toward their various stakeholders.

What motivates companies to be “socially responsible”? We hope it’s because they want to do the right thing, and for many companies, “doing the right thing” is a key motivator. The fact is, it’s often hard to figure out what the “right thing” is: what’s “right” for one group of stakeholders isn’t necessarily just as “right” for another. One thing, however, is certain: companies today are held to higher standards than ever before. Consumers and other groups consider not only the quality and price of a company’s products but also its character. If too many groups see a company as a poor corporate citizen, it will have a harder time attracting qualified employees, finding investors, and selling its products. Good corporate citizens, by contrast, are more successful in all these areas.

Figure 4.3 presents a model of corporate responsibility based on a company’s relationships with its stakeholders. In this model, the focus is on managers—not owners—as the principals involved in these relationships. Owners or shareholders are the stakeholders who invest risk capital in the firm in expectation of a financial return. Other stakeholders include employees, suppliers, and the communities in which the firm does business. Proponents of this model hold that customers, who provide the firm with revenue, have a special claim on managers’ attention. The arrows indicate the two-way nature of corporation-stakeholder relationships: All stakeholders have some claim on the firm’s resources and returns, and management’s job is to make decisions that balance these claims.^{David P. Baron (2003). Business and Its Environment, 4th ed. Upper Saddle River. NJ: Prentice Hall. pp. 650– 52.}

 

 

Let’s look at some of the ways in which companies can be “socially responsible” in considering the claims of various stakeholders.

Owners

Owners or shareholders invest money in companies. In return, the people who run a company have a responsibility to increase the value of owners’ investments through profitable operations. Managers also have a responsibility to provide owners (as well as other stakeholders having financial interests, such as creditors and suppliers) with accurate, reliable information about the performance of the business. Clearly, this is one of the areas in which WorldCom managers fell down on the job. Upper-level management purposely deceived shareholders by presenting them with fraudulent financial statements

Managers

Managers have what is known as a fiduciary responsibility to owners: they’re responsible for safeguarding the company’s assets and handling its funds in a trustworthy manner. Yet managers experience what is called the agency problem; a situation in which their best interests do not align with those of the owners who employ them. To enforce managers’ fiduciary responsibilities for a firm’s financial statements and accounting records, the Sarbanes-Oxley Act of 2002 requires CEOs and CFOs to attest to their accuracy. The law also imposes penalties on corporate officers, auditors, board members, and any others who commit fraud. You’ll learn more about this law in your accounting and business law courses.

Employees

Companies are responsible for providing employees with safe, healthy places to work—as well as environments that are free from sexual harassment and all types of discrimination. They should also offer appropriate wages and benefits. In the following sections, we’ll take a closer look at these areas of corporate responsibility.

Wages and Benefits

At the very least, employers must obey laws governing minimum wage and overtime pay. A minimum wage is set by the federal government, though states can set their own rates as long as they are higher. The current federal rate, for example, is $7.25, while the rate in many states is far higher. By law, employers must also provide certain benefits—social security (retirement funds), unemployment insurance (protects against loss of income in case of job loss), and workers’ compensation (covers lost wages and medical costs in case of on-the-job injury). Most large companies pay most of their workers more than minimum wage and offer broader benefits, including medical, dental, and vision care, as well as savings programs, in order to compete for talent. Companies may also pay a living wage, which is a sufficient wage that covers the basic cost of living for a specific location. ^{U.S. Department of Labor (2016). “Minimum Wage Laws in the States.” Retrieved from: https://www.dol.gov/whd/minwage/america.htm}

Safety and Health

Though it seems obvious that companies should guard workers’ safety and health, some simply don’t. For over four decades, for example, executives at Johns Manville suppressed evidence that one of its products, asbestos, was responsible for the deadly lung disease developed by many of its workers.^{Saul W. Gellerman (2003). “Why ‘Good’ Managers Make Bad Ethical Choices” in Harvard Business Review on Corporate Ethics. Boston: Harvard Business School Press. pp. 49–66.} The company concealed chest X-rays from stricken workers, and executives decided that it was simply cheaper to pay workers’ compensation claims than to create a safer work environment. A New Jersey court was quite blunt in its judgment: Johns Manville, it held, had made a deliberate, cold-blooded decision to do nothing to protect at-risk workers, in blatant disregard of their rights.^{Ibid. p. 53.}

About four in 100,000 US workers die in workplace “incidents” each year. The Department of Labor categorizes deaths caused by conditions like those at Johns Manville as “exposure to harmful substances or environments.” How prevalent is this condition as a cause of workplace deaths? See Figure 4.4, “Workplace Deaths by Event or Exposure (2018),” which breaks down workplace fatalities by cause. Some jobs are more dangerous than others. For a comparative overview based on workplace deaths by occupation, see Figure 4.5.

 

 

Figure 4.5: Workplace Deaths by Occupation, 2018.
*Data is selective. The categories listed represent the ones with the highest percentage of total workplace deaths. Percentages are rounded to the nearest whole percent.

Occupation	% of Total Workplace Deaths*
Transportation and material moving	28%
Construction and extraction	19%
Installation, maintenance, and repair	8%
Management	7%
Building and grounds cleaning/maintenance	7%
Protective service	5%
Farming, fishing, and forestry	5%
Sales	5%
Production	4%
Food preparation and serving	2%

For example, the LEGO Group consistently ranks as a top organization globally because of their commitment to Corporate Social Responsibility.  According to their website in 2020, the LEGO Group has their commitment to sustainability broken into three categories:  Children, Environment and People. Here are some examples of their specific CSR initiatives:

Ethical Organizations

How Can You Recognize an Ethical Organization?

One goal of anyone engaged in business should be to foster ethical behavior in the organizational environment. How do we know when an organization is behaving ethically? Most lists of ethical organizational activities include the following criteria:

• Treat employees, customers, investors, and the public fairly.
• Hold every member personally accountable for his or her action.
• Communicate core values and principles to all members.
• Demand and reward integrity from all members in all situations.^{LEGO. "About Us: Sustainability." Retrieved from: https://www.lego.com/en-us/aboutus/sustainability/}

Employees at companies that consistently make CR magazine’s list of the “100 Best Corporate Citizens” regard the items on the previous list as business as usual in the workplace. Companies at the top of the 2019 list include Owens Corning, Intel, General Mills, HP, and Microsoft.^{Alan Axelrod (2004). My First Book of Business Ethics. Philadelphia: Quirk Books. p. 7.}

By contrast, employees with the following attitudes tend to suspect that their employers aren’t as ethical as they should be:

• They consistently feel uneasy about the work they do.
• They object to the way they’re treated.
• They’re uncomfortable about the way coworkers are treated.
• They question the appropriateness of management directives and policies. ^{CR Magazine (2019). "100 Best Corporate Citizens." CR Magazine. Retrieved from https://www.3blassociation.com/files/yMblCg/100BestCorporateCitizens_2019.pdf}

Sexual Harassment

Sexual harassment occurs when an employee makes “unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature” to another employee. It’s also considered sexual harassment when “submission to or rejection of this conduct explicitly or implicitly affects an individual’s employment, unreasonably interferes with an individual’s work performance or creates an intimidating, hostile or offensive work environment.”^{Alan Axelrod (2004). My First Book of Business Ethics. Philadelphia: Quirk Books. p. 7.}

To prevent sexual harassment—or at least minimize its likelihood—a company should adopt a formal anti-harassment policy describing prohibited conduct, asserting its objections to the behavior, and detailing penalties for violating the policy. ^{U.S. Equal Employment Opportunity Commission (2002). “Facts about Sexual Harassment.” Retrieved from: https://www.eeoc.gov/facts/fs-sex.html} Employers also have an obligation to investigate harassment complaints. Failure to enforce anti-harassment policies can be very costly. In 1998, for example, Mitsubishi paid $34 million to more than 350 female employees of its Normal, Illinois, plant to settle a sexual harassment case supported by the Equal Employment Opportunity Commission. The EEOC reprimanded the company for permitting an atmosphere of verbal and physical abuse against women, charging that female workers had been subjected to various forms of harassment, ranging from exposure to obscene graffiti and vulgar jokes to fondling and groping.^{Joanna Grossman (2002). “Sexual Harassment in the Workplace: Do Employers’ Efforts Truly Prevent Harassment, or Just Prevent Liability.” FindLaw. Retrieved from: http://writ.news.findlaw.com/grossman/20020507.html} Since the “#MeToo” movement gained traction in late 2017, there has been widespread discussion regarding the best ways to prevent sexual harassment.^{Stefanie K. Johnson, Ksenia Keplinger, Jessica F. Kirk and Liza Barnes (2019). "Has Sexual Harassment at Work Decreased Since #MeToo?" Harvard Business Review. Retrieved from: https://hbr.org/2019/07/has-sexual-harassment-at-work-decreased-since-metoo}

Workforce Diversity

In addition to complying with equal employment opportunity laws, many companies make special efforts to recruit employees who are underrepresented in the workforce according to sex, race, or some other characteristic. In helping to build more diverse workforces, such initiatives contribute to competitive advantage for two reasons:

1. People from diverse backgrounds bring new talents and fresh perspectives to an organization, typically enhancing creativity in the development of new products.
2. By more accurately reflecting the demographics of the marketplace, a diverse workforce improves a company’s ability to serve an ethnically diverse population.

The Individual Approach to Ethics

Betty Vinson didn’t start out at WorldCom with the intention of going to jail. She undoubtedly knew what the right behavior was, but the bottom line is that she didn’t do it. How can you make sure that you do the right thing in the business world? How should you respond to the kinds of challenges that you’ll be facing? Because your actions in the business world will be strongly influenced by your moral character, let’s begin by assessing your current moral condition. Which of the following best applies to you (select one)?

1. I’m always ethical.
2. I’m mostly ethical.
3. I’m somewhat ethical.
4. I’m seldom ethical.
5. I’m never ethical.

Now that you’ve placed yourself in one of these categories, here are some general observations. Few people put themselves below the second category. Most of us are ethical most of the time, and most people assign themselves to category number two—“I’m mostly ethical.” Why don’t more people claim that they’re always ethical?

Apparently, most people realize that being ethical all the time takes a great deal of moral energy. If you placed yourself in category number two, ask yourself this question: How can I change my behavior so that I can move up a notch? The answer to this question may be simple. Just ask yourself an easier question: How would I like to be treated in a given situation?^{Joanna Grossman (2002). “Sexual Harassment in the Workplace: Do Employers’ Efforts Truly Prevent Harassment, or Just Prevent Liability.” FindLaw. Retrieved from: http://writ.news.findlaw.com/grossman/20020507.html}

Unfortunately, practicing this philosophy might be easier in your personal life than in the business world. Ethical challenges arise in business because companies, especially large ones, have multiple stakeholders who sometimes make competing demands. Making decisions that affect multiple stakeholders isn’t easy even for seasoned managers; and for new entrants to the business world, the task can be extremely daunting. You can, however, get a head start in learning how to make ethical decisions by looking at two types of challenges that you’ll encounter in the business world: ethical dilemmas and ethical decisions.

Addressing Ethical Dilemmas

An ethical dilemma is a morally problematic situation: you must choose between two or more acceptable but often opposing alternatives that are important to different groups. Experts often frame this type of situation as a “right-versus-right” decision. It’s the sort of decision that Johnson & Johnson (known as J&J) CEO James Burke had to make in 1982. ^{John C. Maxwell (2003). There’s No Such Thing as “Business Ethics”: There’s Only One Rule for Making Decisions. New York: Warner Books. pp. 19–21.} On September 30, twelve-year-old Mary Kellerman of Chicago died after her parents gave her Extra-Strength Tylenol. That same morning, 27-year-old Adam Janus, also of Chicago, died after taking Tylenol for minor chest pain. That night, when family members came to console his parents, Adam’s brother and his wife took Tylenol from the same bottle and died within 48 hours. Over the next two weeks, four more people in Chicago died after taking Tylenol. The actual connection between Tylenol and the series of deaths wasn’t made until an off-duty fireman realized from news reports that every victim had taken Tylenol. As consumers panicked, J&J pulled Tylenol off Chicago-area retail shelves. Researchers discovered Tylenol capsules containing large amounts of deadly cyanide. Because the poisoned bottles came from batches originating at different J&J plants, investigators determined that the tampering had occurred after the product had been shipped.^{Tamara Kaplan (1998). “The Tylenol Crisis: How Effective Public Relations Saved Johnson & Johnson.” Aerobiological Engineering, Inc. Retrieved from: http://www.aerobiologicalengineering.com/wxk116/TylenolMurders/crisis.html}

So J&J wasn’t at fault. But CEO Burke was still faced with an extremely serious dilemma: Was it possible to respond to the tampering cases without destroying the reputation of a highly profitable brand?

Burke had two options:

1. He could recall only the lots of Extra-Strength Tylenol that were found to be tainted with cyanide. In 1991, Perrier executives recalled only tainted product when they discovered that cases of their bottled water had been poisoned with benzine. This option favored J&J financially but possibly put more people at risk.
2. Burke could order a nationwide recall—of all bottles of Extra-Strength Tylenol. This option would reverse the priority of the stakeholders, putting the safety of the public above stakeholders’ financial interests.

Burke opted to recall all 31 million bottles of Extra-Strength Tylenol on the market. The cost to J&J was $100 million, but public reaction was quite positive. Less than six weeks after the crisis began, Tylenol capsules were reintroduced in new tamper-resistant bottles, and by responding quickly and appropriately, J&J was eventually able to restore the Tylenol brand to its previous market position. When Burke was applauded for moral courage, he replied that he’d simply adhered to the long-standing J&J credo that put the interests of customers above those of other stakeholders. His only regret was that the perpetrator was never caught.^Ibid.

If you’re wondering what your thought process should be if you’re confronted with an ethical dilemma, you might wish to remember the mental steps listed here—which happen to be the steps that James Burke took in addressing the Tylenol crisis:

1. Define the problem: How to respond to the tampering case without destroying the reputation of the Tylenol brand.
2. Identify feasible options: (1) Recall only the lots of Tylenol that were found to be tainted or (2) order a nationwide recall of all bottles of Extra-Strength Tylenol.
3. Assess the effect of each option on stakeholders: Option 1 (recalling only the tainted lots of Tylenol) is cheaper but puts more people at risk. Option 2 (recalling all bottles of Extra-Strength Tylenol) puts the safety of the public above stakeholders’ financial interests.
4. Establish criteria for determining the most appropriate action: Adhere to the J&J credo, which puts the interests of customers above those of other stakeholders.
5. Select the best option based on the established criteria: In 1982, Option 2 was selected, and a nationwide recall of all bottles of Extra-Strength Tylenol was conducted.

Making Ethical Decisions

In contrast to the “right-versus-right” problem posed by an ethical dilemma, an ethical decision entails a “right-versus-wrong” decision—one in which there is clearly a right (ethical) choice and a wrong (unethical or illegal) choice. When you make a decision that’s unmistakably unethical or illegal, you’ve committed an ethical lapse. If you’re presented with this type of choice, asking yourself the questions in Figure 4.6 “How to Avoid an Ethical Lapse” will increase your odds of making an ethical decision.

 

 

To test the validity of this approach, let’s take a point-by-point look at Betty Vinson’s decisions:

1. Her actions were clearly illegal.
2. They were unfair to the workers who lost their jobs and to the investors who suffered financial losses (and also to her family, who shared her public embarrassment).
3. She definitely felt badly about what she’d done.
4. She was embarrassed to tell other people what she had done.
5. Reports of her actions appeared in her local newspaper (and just about every other newspaper in the country).

So Vinson could have answered “yes” to all five of our test questions. To simplify matters, remember the following rule of thumb: If you answer yes to any one of these five questions, odds are that you’re about to do something you shouldn’t.

Revisiting Johnson & Johnson

As discussed earlier, Johnson & Johnson received tremendous praise for the actions taken by its CEO, James Burke, in response to the 1982 Tylenol catastrophe. However, things change. To learn how a company can destroy its good reputation, let’s fast forward to 2008 and revisit J&J and its credo, which states, “We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality.”^{Yaakov Weber (1999). “CEO Saves Company’s Reputation, Products.” New Sunday Times. Retrieved from: https://web.archive.org/web/20030712124829/http:/adtimes.nstp.com.my/jobstory/jun13.htm} How could a company whose employees believed so strongly in its credo find itself under criminal and congressional investigation for a series of recalls due to defective products?^{Yaakov Weber (1999). “CEO Saves Company’s Reputation, Products.” New Sunday Times. Retrieved from: https://web.archive.org/web/20030712124829/http:/adtimes.nstp.com.my/jobstory/jun13.htm} In a three-year period, the company recalled 24 products, including Children’s, Infants’ and Adults’ Tylenol, Motrin, and Benadryl; ^{Mina Kimes (2010). “Why J&J’s Headache Won’t Go Away.” Fortune. Retrieved from: http://archive.fortune.com/2010/08/18/news/companies/jnj_drug_recalls.fortune/index.htm} 1-Day Acuvue TruEye contact lenses sold outside the US; ^{McNeil Consumer Healthcare (2011). “Product Recall Information.” Retrieved from: http://web.archive.org/web/20110808021741/http://www.mcneilproductrecall.com} and hip replacements.^{Bill Berkrot (2010). “J&J Confirms Widely Expanded Contact Lens Recall.” Reuters. Retrieved from: http://www.reuters.com/article/us-jandj-recall-idUSTRE6B05G620101201}

Unlike the Tylenol recall, no one had died from the defective products, but customers were certainly upset to find they had purchased over-the-counter medicines for themselves and their children that were potentially contaminated with dark particles or tiny specks of metal; ^{Natasha Singer (2010). “Johnson & Johnson Recalls Hip Implants.” New York Times. Retrieved from: http://www.nytimes.com/2010/08/27/business/27hip.html} contact lenses that contained a type of acid that caused stinging or pain when inserted in the eye;^{Mina Kimes (2010). “Why J&J’s Headache Won’t Go Away.” Fortune. Retrieved from: http://archive.fortune.com/2010/08/18/news/companies/jnj_drug_recalls.fortune/index.htm} and defective hip implants that required patients to undergo a second hip replacement.^{Jonathan D. Rockoff and Jon Kamp (2010). “J&J Contact Lenses Recalled.” Wall Street Journal. Retrieved from: http://online.wsj.com/article/SB10001424052748703846604575447430303567108.html}

Who bears the responsibility for these image-damaging blunders? Two individuals who were at least partially responsible were William Weldon, CEO, and Colleen Goggins, Worldwide Chairman of J&J’s Consumer Group. Weldon has been criticized for being largely invisible and publicly absent during the recalls. ^{Natasha Singer (2010). “Johnson & Johnson Recalls Hip Implants.” New York Times. Retrieved from: http://www.nytimes.com/2010/08/27/business/27hip.html} Additionally, he admitted that he did not understand the consumer division where many of the quality control problems originated. ^{Mina Kimes (2010). “Why J&J’s Headache Won’t Go Away.” Fortune. Retrieved from: http://archive.fortune.com/2010/08/18/news/companies/jnj_drug_recalls.fortune/index.htm} Goggins was in charge of the factories that produced many of the recalled products. She was heavily criticized by fellow employees for her excessive cost-cutting measures and her propensity to replace experienced scientists with new hires. ^{Matthew Perrone (2011). “J&J CEO Gets 3% Raise, but Bonus Is Cut.” USA Today. Retrieved from: http://usatoday30.usatoday.com/money/industries/health/2011-02-25-jnj_N.htm} In addition, she was implicated in scheme to avoid publicly disclosing another J&J recall of a defective product.

After learning that J&J had released packets of Motrin that did not dissolve correctly, the company hired contractors to go into convenience stores and secretly buy up every pack of Motrin on the shelves. The instructions given to the contractors were the following: “You should simply ‘act’ like a regular customer while making these purchases. THERE MUST BE NO MENTION OF THIS BEING A RECALL OF THE PRODUCT!” ^{Mina Kimes (2010). “Why J&J’s Headache Won’t Go Away.” Fortune. Retrieved from: http://archive.fortune.com/2010/08/18/news/companies/jnj_drug_recalls.fortune/index.htm} In May 2010, when Goggins appeared before a congressional committee investigating the “phantom recall,” she testified that she was not aware of the behavior of the contractors^{Johnson and Johnson (2010). “Testimony of Ms. Colleen A. Goggins, Worldwide Chairman, Consumer Group, Johnson & Johnson, before the Committee on Oversight and Government Reform, U.S. House of Representatives.” Retrieved from: http://www.blogjnj.com/wp-content/uploads/2010/05/Testimony-of-Colleen-A-Goggins2.pdf} and that she had “no knowledge of instructions to contractors involved in the phantom recall to not tell store employees what they were doing.” In her September 2010 testimony to the House Committee on Oversight and Government Reform, she acknowledged that the company in fact wrote those very instructions. In 2020, Johnson & Johnson is discontinuing their baby powder, one of their flagship products, because of the cancer-related issues found from the talc, an ingredient in the powder. This time, they are being proactive.^{Jen Christensen (2020). "Johnson & Johnson will stop selling talc-based baby powder." CNN Health. Retrieved from: https://www.cnn.com/2020/05/20/health/johnson-and-johnson-stops-selling-talc-based-baby-powder-trnd/index.html}

Refusing to Rationalize

Despite all the good arguments in favor of doing the right thing, why do many reasonable people act unethically (at least at times)? Why do good people make bad choices? According to one study, there are four common rationalizations (excuses) for justifying misconduct: ^{Saul W. Gellerman (2003). “Why ‘Good’ Managers Make Bad Ethical Choices” in Harvard Business Review on Corporate Ethics. Boston: Harvard Business School Press. p. 59.}

1. My behavior isn’t really illegal or immoral. Rationalizers try to convince themselves that an action is OK if it isn’t downright illegal or blatantly immoral. They tend to operate in a gray area where there’s no clear evidence that the action is wrong.
2. My action is in everyone’s best interests. Some rationalizers tell themselves: “I know I lied to make the deal, but it’ll bring in a lot of business and pay a lot of bills.” They convince themselves that they’re expected to act in a certain way.^{Adrian Gostick and Dana Telford (2003). The Integrity Advantage. Salt Lake City: Gibbs Smith. p. 12.}
3. No one will find out what I’ve done. Here, the self-questioning comes down to “If I didn’t get caught, did I really do it?” The answer is yes. There’s a simple way to avoid succumbing to this rationalization: Always act as if you’re being watched.
4. The company will condone my action and protect me. This justification rests on a fallacy. Betty Vinson may honestly have believed that her actions were for the good of the company and that her boss would, therefore, accept full responsibility (as he promised). When she goes to jail, however, she’ll go on her own.

Here’s another rule of thumb: If you find yourself having to rationalize a decision, it’s probably a bad one.

What to Do When the Light Turns Yellow

Like our five questions, some ethical problems are fairly straightforward. Others, unfortunately, are more complicated, but it will help to think of our five-question test as a set of signals that will warn you that you’re facing a particularly tough decision—that you should think carefully about it and perhaps consult someone else. The situation is like approaching a traffic light. Red and green lights are easy; you know what they mean and exactly what to do. Yellow lights are trickier. Before you decide which pedal to hit, try posing our five questions. If you get a single yes, you’ll almost surely be better off hitting the brake.^{Online Ethics Center for Engineering and Science (2004). “Advice from the Texas Instruments Ethics Office: Article Number 280: What do you do when the light turns yellow?” Onlineethics.org. Retrieved from: https://web.archive.org/web/20060517161459/http://onlineethics.org/corp/help.html}

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=52

 

Chapter Video

Foxconn is a major supplier to Apple. All of its factories are in China and Taiwan, although it recently announced building a new one in the United States. Working conditions are much different than in a typical US factory. As you watch the video, think about what responsibilities Apple has in this situation. They don’t own Foxconn or its factories, yet their reputation can be nevertheless impacted.

To view this video, visit: https://www.youtube.com/watch?v=Jk-xqPKOxl4&amp=&t=39s

(Copyrighted material)

Key Takeaways

• Business ethics is the application of ethical behavior in a business context. Ethical (trustworthy) companies are better able to attract and keep customers, talented employees, and capital.
• Acting ethically in business means more than just obeying laws and regulations. It also means being honest, doing no harm to others, competing fairly, and declining to put your own interests above those of your employer and coworkers.
• In the business world, you’ll encounter conflicts of interest: situations in which you’ll have to choose between taking action that promotes your personal interest and action that favors the interest of others.
• Corporate social responsibility refers to the approach that an organization takes in balancing its responsibilities toward different stakeholders (owners, employees, customers, and the communities in which they conduct business) when making legal, economic, ethical, and social decisions.
• Managers have several responsibilities: to increase the value of owners’ investments through profitable operations, to provide owners and other stakeholders with accurate, reliable financial information, and to safeguard the company’s assets and handle its funds in a trustworthy manner.
• Companies have a responsibility to pay appropriate wages and benefits, treat all workers fairly, and provide equal opportunities for all employees. In addition, the must guard workers’ safety and health and to provide them with a work environment that’s free from sexual harassment.
• Consumers have certain legal rights: to use safe products, to be informed about products, to choose what to buy, and to be heard. Sellers must comply with these requirements.
• Businesspeople face two types of ethical challenges: ethical dilemmas and ethical decisions.
• An ethical dilemma is a morally problematic situation in which you must choose competing and often conflicting options which do not satisfy all stakeholders.
• An ethical decision is one in which there’s a right (ethical) choice and a wrong (unethical or downright illegal) choice.

Image Credits: Chapter 4

Figure 4.1: US Department of Justice (2009). “Bernie Madoff’s Mugshot.” Wikipedia. Public Domain. Retrieved from: https://en.wikipedia.org/wiki/Bernard_Madoff#/media/File:BernardMadoff.jpg

Figure 4.3: Alex Muravev. “House.” Noun Project Inc. Retrieved from: https://thenounproject.com/search/?q=house&i=983462; Graphiqu. “City Building.” Noun Project Inc. Retrieved from: https://thenounproject.com/search/?q=city building&i=2579723; Kitzsingmaniiz. “People.” Noun Project Inc. Retrieved from: https://thenounproject.com/search/?q=boss&i=1778786; Timothy Miller. “Businesswoman.” Noun Project Inc. Retrieved from: https://thenounproject.com/search/?q=boss&i=1941869

Figure 4.4: US Bureau of Labor Statistics. “Workplace deaths by event (2018).” Retrieved from: https://www.bls.gov/news.release/pdf/cfoi.pdf

Figure 4.5: US Bureau of Labor Statistics. “Workplace deaths by occupation (2018).” Retrieved from: https://www.bls.gov/news.release/pdf/cfoi.pdf

Figure 4.7: Sir James (2009). “Traffic light modern version Ireland Dublin.” Wikimedia Commons. CC BY-SA 3.0. Retrieved from: https://commons.wikimedia.org/wiki/File:Traffic_light_modern_version_Ireland_Dublin_2_yellow_2009-09-27.jpg

Video Credits: Chapter 4

ABC News (2012, February 21). “Foxconn: An Exclusive Inside Look.” YouTube. Retrieved from: https://www.youtube.com/watch?v=Jk-xqPKOxl4&amp=&t=39s

Learning Objectives

• Explain why nations and companies participate in international trade.
• Describe the concepts of absolute and comparative advantage.
• Explain how trade between nations is measured.
• Define importing and exporting.
• Explain how companies enter the international market through licensing agreements or franchises.
• Describe how companies reduce costs through contract manufacturing and outsourcing.
• Explain the purpose of international strategic alliances and joint ventures.
• Understand how US companies expand their businesses through foreign direct investments and international subsidiaries.
• Appreciate how cultural, economic, legal, and political differences between countries create challenges to successful business dealings.
• Describe the ways in which governments and international bodies promote and regulate global trade.
• Discuss the various initiatives designed to reduce international trade barriers and promote free trade.

Do you wear Nike shoes or Timberland boots? Buy groceries at Giant Stores or Stop & Shop? Listen to Halsey, Billie Eilish, or Drake on Spotify? If you answered yes to any of these questions, you’re a global business customer. Both Nike and Timberland manufacture most of their products overseas. The Dutch firm Royal Ahold owns all three supermarket chains. And Spotify is a Swedish enterprise.

Take an imaginary walk down Orchard Road, the most fashionable shopping area in Singapore. You’ll pass department stores such as Tokyo-based Takashimaya and London’s very British Marks & Spencer, both filled with such well-known international labels as Ralph Lauren Polo, Burberry, and Chanel. If you need a break, you can also stop for a latte at Seattle-based Starbucks.

 

When you’re in the Chinese capital of Beijing, don’t miss Tiananmen Square. Parked in front of the Great Hall of the People, the seat of Chinese government, are fleets of black Buicks, cars made by General Motors in Flint, Michigan. If you’re adventurous enough to find yourself in Faisalabad, a medium-size city in Pakistan, you’ll see Hamdard University, located in a refurbished hotel. Step inside its computer labs, and the sensation of being in a faraway place will likely disappear: on the computer screens, you’ll recognize the familiar Microsoft flag—the same one emblazoned on screens in Microsoft’s hometown of Seattle and just about everywhere else on the planet.

The Globalization of Business

The globalization of business is bound to affect you. Not only will you buy products manufactured overseas, but it’s highly likely that you’ll meet and work with individuals from various countries and cultures as customers, suppliers, colleagues, employees, or employers. The bottom line is that the globalization of world commerce has an impact on all of us. Therefore, it makes sense to learn more about how globalization works. Although globalization has been the trend towards increased connections and interdependence in the world’s economies, there has been talk about nationalism from the impact of COVID-19 and trade agreements. However, this has yet to be determined, therefore, this chapter will focus on globalization as defined above.

Never before has business spanned the globe the way it does today. But why is international business important? Why do companies and nations engage in international trade? What strategies do they employ in the global marketplace? How do governments and international agencies promote and regulate international trade? These questions and others will be addressed in this chapter. Let’s start by looking at the more specific reasons why companies and nations engage in international trade.

Why Do Nations Trade?

Why does the United States import automobiles, steel, digital phones, and apparel from other countries? Why don’t we just make them ourselves? Why do other countries buy wheat, chemicals, machinery, and consulting services from us? Because no national economy produces all the goods and services that its people need. In fact, countries have been trading for thousands of years. Marco Polo established trade between Europe and China in the late thirteenth century, introducing gun powder to China and citrus and spices to Europe.^{Silk Road Foundation (n.d.). "Marco Polo and His Travels." Silk Road Foundation. Retrieved from: http://www.silkroadfoundation.org/artl/marcopolo.shtml#:~:text=Marco Polo (1254-1324),predecessors, beyond Mongolia to China.} Countries are importers when they buy goods and services from other countries; when they sell products to other nations, they’re exporters. (We’ll discuss importing and exporting in greater detail later in the chapter.) The monetary value of international trade is enormous. In 2018, the total value of worldwide trade in merchandise and commercial services was $19.5 trillion. In comparison, this figure stood at around 6.45 trillion US dollars in 2000.^{Liam O'Connell (2019). "Worldwide Export Trade Volume 1950-2018." Statistica. Retrieved from: https://www.statista.com/statistics/264682/worldwide-export-volume-in-the-trade-since-1950/}

Absolute and Comparative Advantage

To understand why certain countries import or export certain products, you need to realize that every country (or region) can’t produce the same products. The cost of labor, the availability of natural resources, and the level of know-how vary greatly around the world. Most economists use the concepts of absolute advantage and comparative advantage to explain why countries import some products and export others.

Absolute Advantage

A nation has an absolute advantage if (1) it’s the only source of a particular product or (2) it can make more of a product using fewer resources than other countries. Because of climate and soil conditions, for example, France had an absolute advantage in wine making until its dominance of worldwide wine production was challenged by the growing wine industries in Italy, Spain, and the United States. Unless an absolute advantage is based on some limited natural resource, it seldom lasts. That’s why there are few, if any, examples of absolute advantage in the world today.

Comparative Advantage

How can we predict, for any given country, which products will be made and sold at home, which will be imported, and which will be exported? This question can be answered by looking at the concept of comparative advantage, which exists when a country can produce a product at a lower opportunity cost compared to another nation. But what’s an opportunity cost? Opportunity costs are the products that a country must forego making in order to produce something else. When a country decides to specialize in a particular product, it must sacrifice the production of another product. Countries benefit from specialization—focusing on what they do best, and trading the output to other countries for what those countries do best. The United States, for instance, is increasingly an exporter of knowledge-based products, such as software, movies, music, and professional services (management consulting, financial services, and so forth). America’s colleges and universities, therefore, are a source of comparative advantage, and students from all over the world come to the United States for the world’s best higher-education system.

France and Italy are centers for fashion and luxury goods and are leading exporters of wine, perfume, and designer clothing. Japan’s engineering expertise has given it an edge in such fields as automobiles and consumer electronics. And with large numbers of highly skilled graduates in technology, India has become the world’s leader in low-cost, computer-software engineering.

How Do We Measure Trade Between Nations?

To evaluate the nature and consequences of its international trade, a nation looks at two key indicators. We determine a country’s balance of trade by subtracting the value of its imports from the value of its exports. If a country sells more products than it buys, it has a favorable balance, called a trade surplus. If it buys more than it sells, it has an unfavorable balance, or a trade deficit.

For many years, the United States has had a trade deficit: we buy far more goods from the rest of the world than we sell overseas. This fact shouldn’t be surprising. With high income levels, we not only consume a sizable portion of our own domestically produced goods but enthusiastically buy imported goods. Other countries, such as China and Taiwan, which manufacture high volumes for export, have large trade surpluses because they sell far more goods overseas than they buy.

Managing the National Credit Card

Are trade deficits a bad thing? Not necessarily. They can be positive if a country’s economy is strong enough both to keep growing and to generate the jobs and incomes that permit its citizens to buy the best the world has to offer. That was certainly the case in the United States in the 1990s. Some experts, however, are alarmed at our trade deficit. Investment guru Warren Buffet, for example, cautions that no country can continuously sustain large and burgeoning trade deficits. Why not? Because creditor nations will eventually stop taking IOUs from debtor nations, and when that happens, the national spending spree will have to cease. “Our national credit card,” he warns, “allows us to charge truly breathtaking amounts. But that card’s credit line is not limitless.”^{Warren E. Buffet and Carol Loomis (2003). “America's Growing Trade Deficit Is Selling The Nation Out From Under Us. Here's A Way To Fix The Problem—And We Need To Do It Now.” Fortune. Retrieved from: http://archive.fortune.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm}

By the same token, trade surpluses aren’t necessarily good for a nation’s consumers. Japan’s export-fueled economy produced high economic growth in the 1970s and 1980s. But most domestically made consumer goods were priced at artificially high levels inside Japan itself—so high, in fact, that many Japanese traveled overseas to buy the electronics and other high-quality goods on which Japanese trade was dependent.

CD players and televisions were significantly cheaper in Honolulu or Los Angeles than in Tokyo. How did this situation come about? Though Japan manufactures a variety of goods, many of them are made for export. To secure shares in international markets, Japan prices its exported goods competitively. Inside Japan, because competition is limited, producers can put artificially high prices on Japanese-made goods. Due to a number of factors (high demand for a limited supply of imported goods, high shipping and distribution costs, and other costs incurred by importers in a nation that tends to protect its own industries), imported goods are also expensive._{Anonymous (2003). “Why Are Prices in Japan So Damn High?” The Japan FAQ.com. Retrieved from: http://www.thejapanfaq.com/FAQ-Prices.html}

Balance of Payments

The second key measure of the effectiveness of international trade is balance of payments: the difference, over a period of time, between the total flow of money coming into a country and the total flow of money going out. As in its balance of trade, the biggest factor in a country’s balance of payments is the money that flows as a result of imports and exports. But balance of payments includes other cash inflows and outflows, such as cash received from or paid for foreign investment, loans, tourism, military expenditures, and foreign aid. For example, if a US company buys some real estate in a foreign country, that investment counts in the US balance of payments, but not in its balance of trade, which measures only import and export transactions. In the long run, having an unfavorable balance of payments can negatively affect the stability of a country’s currency. The United States has experienced unfavorable balances of payments since the 1970s which has forced the government to cover its debt by borrowing from other countries.^{U.S. Census Bureau (2015). “U.S. Trade in Goods and Services—Balance of Payments (BOP) Basis, 1960 thru 2014.” Retrieved from: http://www.census.gov/foreign-trade/statistics/historical/gands.txt} Figure 5.2 provides a brief historical overview to illustrate the relationship between the United States’ balance of trade and its balance of payments.

 

Opportunities in International Business

The fact that nations exchange billions of dollars in goods and services each year demonstrates that international trade makes good economic sense. For a company wishing to expand beyond national borders, there are a variety of ways it can get involved in international business. Let’s take a closer look at the more popular ones.

 

Importing and Exporting

Importing (buying products overseas and reselling them in one’s own country) and exporting (selling domestic products to foreign customers) are the oldest and most prevalent forms of international trade. For many companies, importing is the primary link to the global market. American food and beverage wholesalers, for instance, import for resale in US supermarkets the bottled waters Evian and Fiji from their sources in the French Alps and the Fiji Islands respectively.^{Fine Waters Media (2016). “Bottled Waters of France.” Retrieved from: http://www.finewaters.com/bottled-waters-of-the-world/france/evian; Fiji Water (2016). “Fiji water history.” Retrieved from: https://store.fijiwater.com/about-fiji-water-bottle-delivery} Other companies get into the global arena by identifying an international market for their products and becoming exporters. The Chinese, for instance, are fond of fast foods cooked in soybean oil. Because they also have an increasing appetite for meat, they need high-protein soybeans to raise livestock.^{H. Frederick Gale (2003). “China’s Growing Affluence: How Food Markets Are Responding.” U.S. Department of Agriculture. Retrieved from: http://www.ers.usda.gov/amber-waves/2003-june/chinas-growing-affluence.aspx#.Vz-JUfkrIqM} American farmers exported over $9 billion worth of soybeans to China in 2010 to nearly $21 billion in 2017.^{Wall Street Journal (2019). “Farmers Built a Soybean Export Empire Around China. Now They’re Fighting to Save It.” Retrieved from: https://www.wsj.com/articles/farmers-built-a-soybean-export-empire-around-china-now-theyre-fighting-to-save-it-11562260248#:~:text=The customer is China and,obscure crop into a blockbuster.}

Licensing and Franchising

A company that wants to get into an international market quickly while taking only limited financial and legal risks might consider licensing agreements with foreign companies. An international licensing agreement allows a foreign company (the licensee) to sell the products of a producer (the licensor) or to use its intellectual property (such as patents, trademarks, copyrights) in exchange for what is known as royalty fees. Here’s how it works: You own a company in the United States that sells coffee-flavored popcorn. You’re sure that your product would be a big hit in Japan, but you don’t have the resources to set up a factory or sales office in that country. You can’t make the popcorn here and ship it to Japan because it would get stale. So you enter into a licensing agreement with a Japanese company that allows your licensee to manufacture coffee-flavored popcorn using your special process and to sell it in Japan under your brand name. In exchange, the Japanese licensee would pay you a royalty fee—perhaps a percentage of each sale or a fixed amount per unit.

 

Another popular way to expand overseas is to sell franchises. Under an international franchise agreement, a company (the franchiser) grants a foreign company (the franchisee) the right to use its brand name and to sell its products or services. The franchisee is responsible for all operations but agrees to operate according to a business model established by the franchiser. In turn, the franchiser usually provides advertising, training, and new-product assistance. Franchising is a natural form of global expansion for companies that operate domestically according to a franchise model, including restaurant chains, such as McDonald’s and Kentucky Fried Chicken, and hotel chains, such as Holiday Inn and Best Western.

Contract Manufacturing and Outsourcing

Because of high domestic labor costs, many US companies manufacture their products in countries where labor costs are lower. This arrangement is called international contract manufacturing, a form of outsourcing. A US company might contract with a local company in a foreign country to manufacture one of its products. It will, however, retain control of product design and development and put its own label on the finished product. Contract manufacturing is quite common in the US apparel business, with most American brands being made in a number of Asian countries, including China, Vietnam, Indonesia, and India.^{Gary Gereffi and Stacey Frederick (2010). “The Global Apparel Value Chain, Trade and the Crisis: Challenges and Opportunities for Developing Countries.” World Bank. Retrieved from: http://www19.iadb.org/intal/intalcdi/PE/2010/05413.pdf}

Thanks to twenty-first-century information technology, non-manufacturing functions can also be outsourced to nations with lower labor costs. US companies increasingly draw on a vast supply of relatively inexpensive skilled labor to perform various business services, such as software development, accounting, and claims processing. For years, American insurance companies have processed much of their claims-related paperwork in Ireland. With a large, well-educated population with English language skills, India has become a center for software development and customer-call centers for American companies. In the case of India, as you can see in Figure 5.4, the attraction is not only a large pool of knowledge workers but also significantly lower wages.

Figure 5.5: Selected Hourly Wages, United States and India

Occupation	US Wage per Hour (per year)	Indian Wage per Hour (per year)
Accountant	$22.12 per hour (~$44,240 per year)	$3.15 per hour (~$6,300 per year)
Information Technology Consultant	$40.70 per hour (~$81,400 per year)	$22.40 per hour (~$44,800 per year)
Cleaner	$8.70 per hour (~$17,400 per year)	$2.10 per hour (~$4,200 per year)

Strategic Alliances and Joint Ventures

What if a company wants to do business in a foreign country but lacks the expertise or resources? Or what if the target nation’s government doesn’t allow foreign companies to operate within its borders unless it has a local partner? In these cases, a firm might enter into a strategic alliance with a local company or even with the government itself.

A strategic alliance is an agreement between two companies (or a company and a nation) to pool resources in order to achieve business goals that benefit both partners. For example, Korean automaker Hyundai Motor Co agreed to jointly develop electric vehicles with California startup Canoo in addition to investing $110 million in UK startup Arrival to jointly develop electric commercial vehicles. ^{Paul Lienert and Joyce Lee (2020). "Hyundai Signs Development Deal With Another Electric Wehicle Startup." Reuters. Retrieved from: https://www.reuters.com/article/us-autos-hyundai-motor-electric-idUSKBN2052MI}

An alliance can serve a number of purposes:

• Enhancing marketing efforts
• Building sales and market share
• Improving products
• Reducing production and distribution costs
• Sharing technology

Alliances range in scope from informal cooperative agreements to joint ventures—alliances in which the partners fund a separate entity (perhaps a partnership or a corporation) to manage their joint operation. Magazine publisher Hearst, for example, has joint ventures with companies in several countries. So, young women in Israel can read Cosmo Israel in Hebrew, and Russian women can pick up a Russian-language version of Cosmo that meets their needs. The US edition serves as a starting point to which nationally appropriate material is added in each different nation. This approach allows Hearst to sell the magazine in more than 50 countries.^{Clothing, Makeup and Beauty Tips (2012). Lihi Griner Cosmopolitan Israel. Retrieved from: http://www.magxone.com/cosmopolitan/lihi-griner-cosmopolitan-israel-may-2012/attachment/lihi-griner-cosmopolitan-israel/; CountryMagazines.Blogspot.com (2015). Retrieved from: http://country-magazines.blogspot.com/2015/09/tennis-maria-sharapova-cosmopolitan.html}

Foreign Direct Investment and Subsidiaries

Many of the approaches to global expansion that we’ve discussed so far allow companies to participate in international markets without investing in foreign plants and facilities. As markets expand, however, a firm might decide to enhance its competitive advantage by making a direct investment in operations conducted in another country. Foreign direct investment (FDI) refers to the formal establishment of business operations on foreign soil—the building of factories, sales offices, and distribution networks to serve local markets in a nation other than the company’s home country. On the other hand, offshoring occurs when the facilities set up in the foreign country replace US manufacturing facilities and are used to produce goods that will be sent back to the United States for sale. Shifting production to low-wage countries is often criticized as it results in the loss of jobs for US workers.^{Michael Mandel (2007). “The Real Cost of Offshoring.” Bloomberg Businessweek. Retrieved from: http://www.bloomberg.com/news/articles/2007-06-17/the-real-cost-of-offshoring}

FDI is generally the most expensive commitment that a firm can make to an overseas market, and it’s typically driven by the size and attractiveness of the target market. For example, German and Japanese automakers, such as BMW, Mercedes, Toyota, and Honda, have made serious commitments to the US market: most of the cars and trucks that they build in plants in the South and Midwest are destined for sale in the United States.

A common form of FDI is the foreign subsidiary: an independent company owned by a foreign firm (called the parent). This approach to going international not only gives the parent company full access to local markets but also exempts it from any laws or regulations that may hamper the activities of foreign firms. The parent company has tight control over the operations of a subsidiary, but while senior managers from the parent company often oversee operations, many managers and employees are citizens of the host country. Not surprisingly, most very large firms have foreign subsidiaries. IBM and Coca-Cola, for example, have both had success in the Japanese market through their foreign subsidiaries (IBM–Japan and Coca-Cola–Japan). FDI goes in the other direction, too, and many companies operating in the United States are in fact subsidiaries of foreign firms. Gerber Products, for example, is a subsidiary of the Swiss company Novartis, while Stop & Shop and Giant Food Stores belong to the Dutch company Royal Ahold. Where does most FDI capital end up? Figure 5.5 provides an overview of amounts, destinations (high to low income countries), and trends.

All these strategies have been employed successfully in global business. But success in international business involves more than finding the best way to reach international markets. Global business is a complex, risky endeavor. Over time, many large companies reach the point of becoming truly multi-national.

Multinational Corporations

A company that operates in many countries is called a multinational corporation (MNC). Fortune magazine’s roster of the top 500 MNCs speaks for the growth of non-US businesses. Only two of the top 10 MNCs are headquartered in the US (see Figure 5.6 above): Wal-Mart (number 1) and Exxon (number 8). Four others are in the top 15: Apple, Berkshire Hathaway, Amazon, and UnitedHealth Group. The others are non-US firms. Interestingly, of the 15 top companies, seven are energy suppliers, two are motor vehicle companies, and two are consumer electronics or computer companies. Also interesting is the difference between company revenues and profits: the list would look quite different arranged by profits instead of revenues!

MNCs often adopt the approach encapsulated in the motto “Think globally, act locally.” They often adjust their operations, products, marketing, and distribution to mesh with the environments of the countries in which they operate. Because they understand that a “one-size-fits-all” mentality doesn’t make good business sense when they’re trying to sell products in different markets, they’re willing to accommodate cultural and economic differences. Increasingly, MNCs supplement their mainstream product line with products designed for local markets. Coca-Cola, for example, produces coffee and citrus-juice drinks developed specifically for the Japanese market.^{James C. Morgan and Jeffrey Morgan (1991). Cracking the Japanese Market. New York: Free Press. p. 102.} When Nokia and Motorola design cell phones, they’re often geared to local tastes in color, size, and other features. For example, Nokia introduced a cell phone for the rural Indian consumer that has a dust-resistant keypad, anti-slip grip, and a built-in flashlight.^{Case Study Inc. (2010). “Glocalization Examples—Think Globally and Act Locally.” CaseStudyInc.com. Retrieved from: http://www.casestudyinc.com/glocalization-examples-think-globally-and-act-locally} McDonald’s provides a vegetarian menu in India, where religious convictions affect the demand for beef and pork.^{McDonald’s India (n.d.). “McDonald’s India.” Retrieved from: http://www.mcdonaldsindia.com/McDonaldsinIndia.pdf} In Germany, McDonald’s caters to local tastes by offering beer in some restaurants and a Shrimp Burger in Hong Kong and Japan.^{Susan L. Nasr (2009). "10 Unusual Items from McDonald's International Menu." HowStuffWorks. Retrieved from: http://money.howstuffworks.com/10-items-from-mcdonalds-international-menu5.htm}

Likewise, many MNCs have made themselves more sensitive to local market conditions by decentralizing their decision making. While corporate headquarters still maintain a fair amount of control, home-country managers keep a suitable distance by relying on modern telecommunications. Today, fewer managers are dispatched from headquarters; MNCs depend instead on local talent. Not only does decentralized organization speed up and improve decision making, but it also allows an MNC to project the image of a local company. IBM, for instance, has been quite successful in the Japanese market because local customers and suppliers perceive it as a Japanese company. Crucial to this perception is the fact that the vast majority of IBM’s Tokyo employees, including top leadership, are Japanese nationals.^{James C. Morgan and J. Jeffrey Morgan (1991). Cracking the Japanese Market. New York: Free Press. p. 117.}

Criticism of MNCs

The global reach of MNCs is a source of criticism as well as praise. Critics argue that they often destroy the livelihoods of home-country workers by moving jobs to developing countries where workers are willing to labor under poor conditions and for less pay. They also contend that traditional lifestyles and values are being weakened, and even destroyed, as global brands foster a global culture of American movies; fast food; and cheap, mass-produced consumer products. Still others claim that the demand of MNCs for constant economic growth and cheaper access to natural resources do irreversible damage to the physical environment. All these negative consequences, critics maintain, stem from the abuses of international trade—from the policy of placing profits above people, on a global scale. These views surfaced in violent street demonstrations in Seattle in 1999 and Genoa, Italy, in 2000, and since then, meetings of the International Monetary Fund (IMF) and World Bank have regularly been assailed by protestors.

In Defense of MNCs

Supporters of MNCs respond that huge corporations deliver better, cheaper products for customers everywhere; create jobs; and raise the standard of living in developing countries. They also argue that globalization increases cross-cultural understanding. Anne O. Kruger, first deputy managing director of the IMF, says the following:

“The impact of the faster growth on living standards has been phenomenal. We have observed the increased well-being of a larger percentage of the world’s population by a greater increment than ever before in history. Growing incomes give people the ability to spend on things other than basic food and shelter, in particular on things such as education and health. This ability, combined with the sharing among nations of medical and scientific advances, has transformed life in many parts of the developing world.

Infant mortality has declined from 180 per 1,000 births in 1950 to 60 per 1,000 births. Literacy rates have risen from an average of 40 percent in the 1950s to over 70 percent today. World poverty has declined, despite still-high population growth in the developing world.”^{Anne O. Krueger (2002). “Supporting Globalization.” Eisenhower National Security Conference: “National Security for the 21st Century: Anticipating Challenges, Seizing Opportunities, Building Capabilities.” Retrieved from: http://www.imf.org/external/np/speeches/2002/092602a.htm}

The Global Business Environment

In the classic movie The Wizard of Oz, a magically misplaced Midwest farm girl takes a moment to survey the bizarre landscape of Oz and then comments to her little dog, “I don’t think we’re in Kansas anymore, Toto.” That sentiment probably echoes the reaction of many businesspeople who find themselves in the midst of international ventures for the first time. The differences between the foreign landscape and the one with which they’re familiar are often huge and multifaceted. Some are quite obvious, such as differences in language, currency, and everyday habits (say, using chopsticks instead of silverware). But others are subtle, complex, and sometimes even hidden.

Success in international business means understanding a wide range of cultural, economic, legal, and political differences between countries. Let’s look at some of the more important of these differences.

The Cultural Environment

Even when two people from the same country communicate, there’s always a possibility of misunderstanding. When people from different countries get together, that possibility increases substantially. Differences in communication styles reflect differences in culture: the system of shared beliefs, values, customs, and behaviors that govern the interactions of members of a society. Cultural differences create challenges to successful international business dealings. Let’s look at a few of these challenges.

Language

English is the international language of business. The natives of such European countries as France and Spain certainly take pride in their own languages and cultures, but nevertheless English is the business language of the European community.

Whereas only a few educated Europeans have studied Italian or Norwegian, most have studied English. Similarly, on the South Asian subcontinent, where hundreds of local languages and dialects are spoken, English is the official language. In most corners of the world, English-only speakers—such as most Americans—have no problem finding competent translators and interpreters. So why is language an issue for English speakers doing business in the global marketplace? In many countries, only members of the educated classes speak English. The larger population—which is usually the market you want to tap—speaks the local tongue. Advertising messages and sales appeals must take this fact into account. More than one English translation of an advertising slogan has resulted in a humorous (and perhaps serious) blunder. Some classics are listed on the next page in Figure 5.7.

Furthermore, relying on translators and interpreters puts you as an international businessperson at a disadvantage. You’re privy only to interpretations of the messages that you’re getting, and this handicap can result in a real competitive problem. Maybe you’ll misread the subtler intentions of the person with whom you’re trying to conduct business. The best way to combat this problem is to study foreign languages. Most people appreciate some effort to communicate in their local language, even on the most basic level. They even appreciate mistakes you make resulting from a desire to demonstrate your genuine interest in the language of your counterparts in foreign countries. The same principle goes doubly when you’re introducing yourself to non-English speakers in the United States. Few things work faster to encourage a friendly atmosphere than a native speaker’s willingness to greet a foreign guest in the guest’s native language.

Time and Sociability

Americans take for granted many of the cultural aspects of our business practices. Most of our meetings, for instance, focus on business issues, and we tend to start and end our meetings on schedule. These habits stem from a broader cultural preference: we don’t like to waste time. (It was an American, Benjamin Franklin, who coined the phrase “Time is money.”) This preference, however, is by no means universal. The expectation that meetings will start on time and adhere to precise agendas is common in parts of Europe (especially the Germanic countries), as well as in the United States, but elsewhere—say, in Latin America and the Middle East—people are often late to meetings and it is an acceptable custom.

High- and Low-Context Cultures

Likewise, don’t expect businesspeople from these regions—or businesspeople from most of Mediterranean Europe, for that matter—to “get down to business” as soon as a meeting has started. They’ll probably ask about your health and that of your family, inquire whether you’re enjoying your visit to their country, suggest local foods, and generally appear to be avoiding serious discussion at all costs. For Americans, such topics are conducive to nothing but idle chitchat, but in certain cultures, getting started this way is a matter of simple politeness and hospitality and expected.

Intercultural Communication

Different cultures have different communication styles—a fact that can take some getting used to. For example, degrees of animation in expression can vary from culture to culture. Southern Europeans and Middle Easterners are quite animated, favoring expressive body language along with hand gestures and raised voices. Northern Europeans are far more reserved. The English, for example, are famous for their understated style and the Germans for their formality in most business settings. In addition, the distance at which one feels comfortable when talking with someone varies by culture. People from the Middle East like to converse from a distance of a foot or less, while Americans prefer more personal space.

Finally, while people in some cultures prefer to deliver direct, clear messages, others use language that’s subtler or more indirect. North Americans and most Northern Europeans fall into the former category and many Asians into the latter. But even within these categories, there are differences. Though typically polite, Chinese and Koreans are extremely direct in expression, while Japanese are indirect: They use vague language and avoid saying “no” even if they do not intend to do what you ask. They worry that turning someone down will result in their “losing face,” i.e., an embarrassment or loss of credibility, and so they avoid doing this in public.

In summary, learn about a country’s culture and use your knowledge to help improve the quality of your business dealings. Learn to value the subtle differences among cultures, but don’t allow cultural stereotypes to dictate how you interact with people from any culture. Treat each person as an individual and spend time getting to know what he or she is about.

The Economic Environment

If you plan to do business in a foreign country, you need to know its level of economic development. You also should be aware of factors influencing the value of its currency and the impact that changes in that value will have on your profits.

Economic Development

If you don’t understand a nation’s level of economic development, you’ll have trouble answering some basic questions, such as: Will consumers in this country be able to afford the product I want to sell? Will it be possible to make a reasonable profit? A country’s level of economic development can be evaluated by estimating the annual income earned per citizen. The World Bank, which lends money for improvements in underdeveloped nations, divides countries into four income categories:

World Bank Country and Lending Groups (by Gross National Income per Capita 2021)^{World Bank Group (2016). “Country and Lending Groups.” Retrieved from: http://data.worldbank.org/about/country-and-lending-groups}

• High income—$12,536 or higher (United States, Germany, Japan)
• Upper-middle income—$4,046 to $12,535 (China, South Africa, Mexico)
• Lower-middle income—$1,036 to $4,045 (Kenya, Philippines, India)
• Low income—$1,035 or less (Afghanistan, South Sudan, Haiti)

Note that that even though a country has a low annual income per citizen, it can still be an attractive place for doing business. India, for example, is a lower-middle-income country, yet it has a population of a billion, and a segment of that population is well educated—an appealing feature for many business initiatives.

The long-term goal of many countries is to move up the economic development ladder. Some factors conducive to economic growth include a reliable banking system, a strong stock market, and government policies to encourage investment and competition while discouraging corruption. It’s also important that a country have a strong infrastructure—its systems of communications (telephone, Internet, television, newspapers), transportation (roads, railways, airports), energy (gas and electricity, power plants), and social facilities (schools, hospitals). These basic systems will help countries attract foreign investors, which can be crucial to economic development.

Currency Valuations and Exchange Rates

If every nation used the same currency, international trade and travel would be a lot easier. Of course, this is not the case. There are around 175 currencies in the world: Some you’ve heard of, such as the British pound; others are likely unknown to you, such as the manat, the official currency of Azerbaijan. If you were in Azerbaijan you would exchange your US dollars for Azerbaijan manats. The day’s foreign exchange rate will tell you how much one currency is worth relative to another currency and so determine how many manats you will receive. If you have traveled abroad, you already have personal experience with the impact of exchange rate movements.

The Legal and Regulatory Environment

One of the more difficult aspects of doing business globally is dealing with vast differences in legal and regulatory environments. The United States, for example, has an established set of laws and regulations that provide direction to businesses operating within its borders. But because there is no global legal system, key areas of business law—for example, contract provisions and copyright protection—can be treated in different ways in different countries. Companies doing international business often face many inconsistent laws and regulations. To navigate this sea of confusion, American business people must know and follow both US laws and regulations and those of nations in which they operate.

Business history is filled with stories about American companies that have stumbled in trying to comply with foreign laws and regulations. Coca-Cola, for example, ran afoul of Italian law when it printed its ingredients list on the bottle cap rather than on the bottle itself. Italian courts ruled that the labeling was inadequate because most people throw the cap away.^{David Ricks (1999). Blunders in International Business. Malden, MA: Blackwell. p. 137.}

One approach to dealing with local laws and regulations is hiring lawyers from the host country who can provide advice on legal issues. Another is working with local businesspeople who have experience in complying with regulations and overcoming bureaucratic obstacles.

Foreign Corrupt Practices Act

One US law that creates unique challenges for American firms operating overseas is the Foreign Corrupt Practices Act, which prohibits the distribution of bribes and other favors in the conduct of business. Unfortunately, though they’re illegal in this country, such tactics as kickbacks and bribes are business-as-usual in many nations. According to some experts, American businesspeople are at a competitive disadvantage if they’re prohibited from giving bribes or undercover payments to foreign officials or business people who expect them. In theory, because the Foreign Corrupt Practices Act warns foreigners that Americans can’t give bribes, they’ll eventually stop expecting them.

Where are American businesspeople most likely and least likely to encounter bribe requests and related forms of corruption? Transparency International, an independent German-based organization, annually rates nations according to “perceived corruption,” (see Figure 5.8) which it defines as “the abuse of entrusted power for private gain.”^{Transparency.org (2016). “What is Corruption?” Retrieved from: http://www.transparency.org/}

Case Study: Economic and International Impact of the US Hospitality & Tourism

According to the US International Trade Administration, the travel and tourism industry in the United States generated $1.6 trillion in economic output and 7.8 million US jobs in 2013, with nearly 1 in 18 Americans employed directly or indirectly in a travel or tourism-related industry.^{International Trade Administration, Industry and Analysis, National Travel and Tourism Office (2015). “Fast Facts: United States Travel and Tourism Industry 2014.” Retrieved from: http://travel.trade.gov/outreachpages/download_data_table/Fast_Facts_2014.pdf} The Bureau of Labor of Labor Statistics indicates that an even higher percentage (11 percent) of US jobs are in the Leisure and Hospitality sector.^{U.S. Department of Labor, Bureau of Labor Statistics (2015). “Employment Projections: Employment by Major Industry Sector.” Retrieved from: http://www.bls.gov/emp/ep_table_201.htm}

While the majority of travel, tourism and hospitality in the US tourism industry is domestic, the US leads the world in international travel and tourism exports (i.e., travelers from other countries visiting the United States) with 15 percent of global traveler spending. Travel and tourism ranks as the top services export, accounting for 31 percent of all US services exports in 2014.

Expenditures by international visitors in the United States translate to economic impacts and jobs: including: $220.8 billion in sales, a $75.1 billion trade surplus, and 1.1 million total jobs in 2014.^{International Trade Administration, Industry and Analysis, National Travel and Tourism Office (2015). “Fast Facts: United States Travel and Tourism Industry 2014.” Retrieved from: http://travel.trade.gov/outreachpages/download_data_table/Fast_Facts_2014.pdf} The sector is poised to grow: the latest US Commerce Department international travel forecast estimates a 20 percent increase in international visitors in 2020 in comparison to 2014.^{U.S. Department of Commerce, International Trade Administration (2015). “U.S. Commerce Department Releases Six-Year Forecast for International Travel to the United States: 2015-2020.” Retrieved from: http://travel.trade.gov/view/f-2000-99-001/forecast/Forecast_Summary.pdf}

 

Trade Controls

The debate about the extent to which countries should control the flow of foreign goods and investments across their borders is as old as international trade itself. Governments continue to control trade. To better understand how and why, let’s examine a hypothetical case. Suppose you’re in charge of a small country in which people do two things—grow food and make clothes. Because the quality of both products is high and the prices are reasonable, your consumers are happy to buy locally made food and clothes. But one day, a farmer from a nearby country crosses your border with several wagonloads of wheat to sell. On the same day, a foreign clothes maker arrives with a large shipment of clothes. These two entrepreneurs want to sell food and clothes in your country at prices below those that local consumers now pay for domestically made food and clothes. At first, this seems like a good deal for your consumers: they won’t have to pay as much for food and clothes. But then you remember all the people in your country who grow food and make clothes. If no one buys their goods (because the imported goods are cheaper), what will happen to their livelihoods? And if many people become unemployed, what will happen to your national economy? That’s when you decide to protect your farmers and clothes makers by setting up trade rules. Maybe you’ll increase the prices of imported goods by adding a tax to them; you might even make the tax so high that they’re more expensive than your homemade goods. Or perhaps you’ll help your farmers grow food more cheaply by giving them financial help to defray their costs. The government payments that you give to the farmers to help offset some of their costs of production are called subsidies. These subsidies will allow the farmers to lower the price of their goods to a point below that of imported competitors’ goods. What’s even better is that the lower costs will allow the farmers to export their own goods at attractive, competitive prices.

The United States has a long history of subsidizing farmers. Subsidy programs guarantee farmers (including large corporate farms) a certain price for their crops, regardless of the market price. This guarantee ensures stable income in the farming community but can have a negative impact on the world economy. How? Critics argue that in allowing American farmers to export crops at artificially low prices, US agricultural subsidies permit them to compete unfairly with farmers in developing countries. A reverse situation occurs in the steel industry, in which a number of countries—China, Japan, Russia, Germany, and Brazil—subsidize domestic producers.

US trade unions charge that this practice gives an unfair advantage to foreign producers and hurts the American steel industry, which can’t compete on price with subsidized imports.

Whether they push up the price of imports or push down the price of local goods, such initiatives will help locally produced goods compete more favorably with foreign goods. Both strategies are forms of trade controls—policies that restrict free trade. Because they protect domestic industries by reducing foreign competition, the use of such controls is often called protectionism. Though there’s considerable debate over the pros and cons of this practice, all countries engage in it to some extent. Before debating the issue, however, let’s learn about the more common types of trade restrictions: tariffs, quotas, and, embargoes.

Tariffs

Tariffs are taxes on imports. Because they raise the price of the foreign-made goods, they make them less competitive. The United States, for example, protects domestic makers of synthetic knitted shirts by imposing a stiff tariff of 32.5 percent on imports.^{Daniel Griswold (2009). “The Protectionist Swindle: How Trade Barriers Cheat the Poor and Middle Class.” Insider Online. Retrieved from: http://www.insideronline.org/2009/12/the-protectionist-swindle-how-trade-barriers-cheat-the-poor-and-middle-class/} Tariffs are also used to raise revenue for a government. Shoe imports alone are worth $2.7 billion annually to the federal government.^{Footwear Distributors and Retailers of America (2015). “Tariff Reduction Initiatives.” Retrieved from: http://fdra.org/key-issues-and-advocacy/legislative-initiatives/}   

In 2018 and 2019, the United States government implemented a round of four different tariffs meant to reduce the trade deficit along with punishing China for alleged unfair trading practices and intellectual property theft. The US imposed tariffs on more than $360 billion worth of Chinese goods which then triggered a similar response from the Chinese government with tariffs on more than $110 billon of US made products. This US–China trade war led to uncertainties not only in both markets but globally as well. Finally, in January 2020, the two governments reached a tentative trade agreement that still required more negotiations.

Quotas

A quota imposes limits on the quantity of a good that can be imported over a period of time. Quotas are used to protect specific industries, usually new industries or those facing strong competitive pressure from foreign firms. US import quotas take two forms. An absolute quota fixes an upper limit on the amount of a good that can be imported during the given period. A tariff-rate quota permits the import of a specified quantity and then adds a high import tax once the limit is reached.

Sometimes quotas protect one group at the expense of another. To protect sugar beet and sugar cane growers, for instance, the United States imposes a tariff-rate quota on the importation of sugar—a policy that has driven up the cost of sugar to two to three times world prices.^{Chris Edwards (2007). “The Sugar Racket.” CATO Institute Tax and Budget Bulletin. Retrieved from: http://www.cato.org/pubs/tbb/tbb_0607_46.pdf} These artificially high prices push up costs for American candy makers, some of whom have moved their operations elsewhere, taking high-paying manufacturing jobs with them. Life Savers, for example, were made in the United States for 90 years but are now produced in Canada, where the company saves $9 million annually on the cost of sugar.^{James Pritchard (2002). “Sole U.S. Life Savers plant closing, moving to Canada.” Southeast Missourian. Retrieved from: http://www.semissourian.com/story/70976.html}

An extreme form of quota is the embargo, which, for economic or political reasons, bans the import or export of certain goods to or from a specific country. The United States, for example, bans nearly every commodity originating in Cuba, although this may soon change.

Dumping

A common political rationale for establishing tariffs and quotas is the need to combat dumping: the practice of selling exported goods below the price that producers would normally charge in their home markets (and often below the cost of producing the goods). Usually, nations resort to this practice to gain entry and market share in foreign markets, but it can also be used to sell off surplus or obsolete goods. Dumping creates unfair competition for domestic industries, and governments are justifiably concerned when they suspect foreign countries of dumping products on their markets. They often retaliate by imposing punitive tariffs that drive up the price of the imported goods.

The Pros and Cons of Trade Controls

Opinions vary on government involvement in international trade. Proponents of controls contend that there are a number of legitimate reasons why countries engage in protectionism. Sometimes they restrict trade to protect specific industries and their workers from foreign competition—agriculture, for example, or steel making. At other times, they restrict imports to give new or struggling industries a chance to get established. Finally, some countries use protectionism to shield industries that are vital to their national defense, such as shipbuilding and military hardware.

Despite valid arguments made by supporters of trade controls, most experts believe that such restrictions as tariffs and quotas—as well as practices that don’t promote level playing fields, such as subsidies and dumping—are detrimental to the world economy. Without impediments to trade, countries can compete freely. Each nation can focus on what it does best and bring its goods to a fair and open world market. When this happens, the world will prosper, or so the argument goes. International trade is certainly heading in the direction of unrestricted markets.

Reducing International Trade Barriers

A number of organizations work to ease barriers to trade, and more countries are joining together to promote trade and mutual economic benefits. Let’s look at some of these important initiatives.

Trade Agreements and Organizations

Free trade is encouraged by a number of agreements and organizations set up to monitor trade policies. The two most important are the General Agreement on Tariffs and Trade and the World Trade Organization.

General Agreement on Tariffs and Trade

After the Great Depression and World War II, most countries focused on protecting home industries, so international trade was hindered by rigid trade restrictions. To rectify this situation, 23 nations joined together in 1947 and signed the General Agreement on Tariffs and Trade (GATT), which encouraged free trade by regulating and reducing tariffs and by providing a forum for resolving trade disputes.

The highly successful initiative achieved substantial reductions in tariffs and quotas, and in 1995 its members founded the World Trade Organization to continue the work of GATT in overseeing global trade.

World Trade Organization

Based in Geneva, Switzerland, with nearly 150 members, the World Trade Organization (WTO) encourages global commerce and lower trade barriers, enforces international rules of trade, and provides a forum for resolving disputes. It is empowered, for instance, to determine whether a member nation’s trade policies have violated the organization’s rules, and it can direct “guilty” countries to remove disputed barriers (though it has no legal power to force any country to do anything it doesn’t want to do). If the guilty party refuses to comply, the WTO may authorize the plaintiff nation to erect trade barriers of its own, generally in the form of tariffs.

Affected members aren’t always happy with WTO actions. For example, the European Commission is having to wait on a WTO action regarding whether it can impose tariffs against the United States over subsidies for Boeing (BA.N). They claim it is unjustified and harms the bloc’s right to retaliate.^{Philip Blenkinsop (2020). "EU is 'very concerned' by delayed WTO decision on tariffs vs US." Reuters. Retrieved from: https://www.reuters.com/article/us-usa-trade-eu/eu-is-very-concerned-by-delayed-wto-decision-on-tariffs-vs-u-s-idUSKBN23W2L7}

Financial Support for Emerging Economies: The IMF and the World Bank

A key to helping developing countries become active participants in the global marketplace is providing financial assistance. Offering monetary assistance to some of the poorest nations in the world is the shared goal of two organizations: the International Monetary Fund and the World Bank. These organizations, to which most countries belong, were established in 1944 to accomplish different but complementary purposes.

The International Monetary Fund

The International Monetary Fund (IMF) loans money to countries with troubled economies, such as Mexico in the 1980s and mid-1990s and Russia and Argentina in the late 1990s. There are, however, strings attached to IMF loans: in exchange for relief in times of financial crisis, borrower countries must institute sometimes painful financial and economic reforms. In the 1980s, for example, Mexico received financial relief from the IMF on the condition that it privatize and deregulate certain industries and liberalize trade policies. The government was also required to cut back expenditures for such services as education, health care, and workers’ benefits.^{1 Bernard Sanders (1998). “The International Monetary Fund Is Hurting You.” Z Magazine. Retrieved from: http://www.thirdworldtraveler.com/IMF_WB/IMF_Sanders.html}

The World Bank

The World Bank is an important source of economic assistance for poor and developing countries. With backing from wealthy donor countries (such as the United States, Japan, Germany, and United Kingdom), the World Bank has committed $42.5 billion in loans, grants, and guarantees to some of the world’s poorest nations.^{World Bank (2016). "Fiscal Year Data 2011-15." Retrieved from: http://www.worldbank.org/en/about/annual-report/fiscalyeardata#1} Loans are made to help countries improve the lives of the poor through community-support programs designed to provide health, nutrition, education, infrastructure, and other social services.

Trading Blocs: NAFTA and the European Union

So far, our discussion has suggested that global trade would be strengthened if there were no restrictions on it—if countries didn’t put up barriers to trade or perform special favors for domestic industries. The complete absence of barriers is an ideal state of affairs that we haven’t yet attained. In the meantime, economists and policymakers tend to focus on a more practical question: Can we achieve the goal of free trade on the regional level? To an extent, the answer is yes. In certain parts of the world, groups of countries have joined together to allow goods and services to flow without restrictions across their mutual borders. Such groups are called trading blocs. Let’s examine two of the most powerful trading blocs—NAFTA and the European Union.

North American Free Trade Association

The North American Free Trade Association (NAFTA) is an agreement among the governments of the United States, Canada, and Mexico to open their borders to unrestricted trade. The effect of this agreement is that three very different economies are combined into one economic zone with almost no trade barriers. From the northern tip of Canada to the southern tip of Mexico, each country benefits from the comparative advantages of its partners: each nation is free to produce what it does best and to trade its goods and services without restrictions.

When the agreement was ratified in 1994, it had no shortage of skeptics. Many people feared, for example, that without tariffs on Mexican goods, more US manufacturing jobs would be lost to Mexico, where labor is cheaper. Almost two decades later, most such fears have not been realized, and, by and large, NAFTA has been a success.

Since it went into effect, the value of trade between the United States and Mexico has grown substantially, and Canada and Mexico are now the United States’ top trading partners.

          Shortly after taking office in 2017, concerned with deficiencies and mistakes from the original NAFTA, President Trump and representatives from the Office of the United States Trade Representative, began negotiating a new trade agreement between the United States, Mexico and Canada. Signed in 2018 and later ratified by all three nations, the new United States–Mexico–Canada Agreement (USMCA) replaces the 25-year-old trade agreement known as NAFTA. Implemented in July 2020, the USMCA works to mutually beneficial trade between all three nations with the goal of leading to freer markets, fairer trade, and robust economic growth in North America.^{USMCA (2019). "Agreement between the United States of America, the United Mexican States, and Canada." Office of the United States Trade Representative. Retrieved from: https://ustr.gov/trade-agreements/free-trade-agreements/united-states-mexico-canada-agreement/agreement-between}

The European Union

The forty-plus countries of Europe have long shown an interest in integrating their economies. The first organized effort to integrate a segment of Europe’s economic entities began in the late 1950s, when six countries joined together to form the European Economic Community (EEC). Over the next four decades, membership grew, and in the late 1990s, the EEC became the European Union. Today, the European Union (EU) is a group of 27 countries that have eliminated trade barriers among themselves (see the map in Figure 5.10).

At first glance, the EU looks similar to NAFTA. Both, for instance, allow unrestricted trade among member nations. But the provisions of the EU go beyond those of NAFTA in several important ways. Most importantly, the EU is more than a trading organization: it also enhances political and social cooperation and binds its members into a single entity with authority to require them to follow common rules and regulations. It is much like a federation of states with a weak central government, with the effect not only of eliminating internal barriers but also of enforcing common tariffs on trade from outside the EU. In addition, while NAFTA allows goods and services as well as capital to pass between borders, the EU also allows people to come and go freely: if you possess an EU passport, you can work in any EU nation.

The Euro

A key step toward unification occurred in 1999, when most (but not all) EU members agreed to abandon their own currencies and adopt a joint currency. The actual conversion occurred in 2002, when a common currency called the euro replaced the separate currencies of participating EU countries. The common currency facilitates trade and finance because exchange-rate differences no longer complicate transactions.^{European Commission on Economic, and Financial Affairs (2015). “Why the Euro?” Retrieved from: http://ec.europa.eu/economy_finance/euro/why/index_en.htm}

Its proponents argued that the EU would not only unite economically and politically distinct countries but also create an economic power that could compete against the dominant players in the global marketplace. Individually, each European country has limited economic power, but as a group, they could be an economic superpower.^Ibid. Over time, the value of the euro has been questioned. Many of the “euro” countries (Spain, Italy, Greece, Portugal, and Ireland in particular) have been financially irresponsible, piling up huge debts and experiencing high unemployment and problems in the housing market. But because these troubled countries share a common currency with the other “euro countries,” they are less able to correct their economic woes.^{“Paul Krugman (2011). “The Economic Failure of the Euro.” National Public Radio. Retrieved from: http://www.npr.org/2011/01/25/133112932/paul-krugman-the-economic-failure-of-the-euro} Many economists fear that the financial crisis precipitated by these financially irresponsible countries threaten the very survival of the euro.^{Willem Buiter (2010). “Three Steps to Survival for Euro Zone.” Wall Street Journal. Retrieved from: http://online.wsj.com/article/SB10001424052748703766704576009423447485768.html} Keep a close eye on Greece because if an exit from the Euro occurs, it will likely start there.

Only time will tell whether the trend toward regional trade agreements is good for the world economy. Clearly, they’re beneficial to their respective participants; for one thing, they get preferential treatment from other members. But certain questions still need to be answered more fully. Are regional agreements, for example, moving the world closer to free trade on a global scale—toward a marketplace in which goods and services can be traded anywhere without barriers?

Image Credits: Chapter 5

Figure 5.1: Michael Spencer (2009). “Orchard Road, Singapore.” Flickr. CC BY 2.0. Retrieved from: https://www.flickr.com/photos/michaelspencer/4393369407

Figure 5.2: U.S. Census Bureau. “Imports, Exports, and Balance of Payments (1994–2019).” Data retrieved from: https://www.census.gov/foreign-trade/statistics/historical/goods.pdf

Figure 5.4: Eugene Chystiakov. “Tram in the Budapest.” Unsplash. Public Domain. Retrieved from: https://unsplash.com/photos/qpkKR3N6AJ0

Figure 5.5: Rick Noack (2015). “See How Much (or How Little) You’d Earn If You Did the Same Job in Another Country.” Washington Post. Retrieved from: https://www.washingtonpost.com/news/worldviews/wp/2015/03/03/chart-see-how-much-or-how-little-youd-earn-if-you-did-the-same-job-in-another-country/

Figure 5.6: United Nations Conference on Trade and Development. “Where FDI Goes (2000-2018).” Data retrieved from: http://unctadstat.unctad.org/wds/TableViewer/tableView.aspx?ReportId=96740

Figure 5.7: Fortune. “Fortune Top 15 Multinational Firms by Revenue (2019).” Data retrieved from: https://fortune.com/global500/2019/search/

Figure 5.8: Andrea Piacquadio. “Shallow Focus Photo of Man Reading Newspaper.” Pexels. Public Domain. Retrieved from: https://www.pexels.com/photo/shallow-focus-photo-of-man-reading-newspaper-3799099/

Figure 5.9: Transparency International. “Corruption Perceptions Index (2019).” Data retrieved from: http://www.transparency.org/cpi2019

Figure 5.10: Statista. “U.S. Employment by Industry Sector (2019).” Data retrieved from: https://www.statista.com/statistics/200143/employment-in-selected-us-industries/

Figure 5.11: Glentamara (2009). “Special Member State Territories In Europe and the European Union.” Wikimedia Commons. Public Domain. Retrieved from: https://commons.wikimedia.org/w/index.php?search=european union&title=Special:Search&go=Go&ns0=1&ns6=1&ns12=1&ns14=1&ns100=1&ns106=1#/media/File:Special_member_state_territories_in_Europe_and_the_European_Union.svg

Learning Objectives

• Define human resource management and explain how managers develop and implement a human resource plan.
• Explain how companies train and develop employees, and discuss the importance of a diverse workforce.
• Identify factors that make an organization a good place to work, including competitive compensation and benefits packages.
• Explain how managers evaluate employee performance and retain qualified employees.

The Grounds of a Great Work Environment

Howard Schultz,  founder and former CEO and Chairman of Starbucks Coffee Company, has vivid memories of his father slumped on the couch with his leg in a cast.^{Introductory material on Howard Schultz and Starbucks comes from Howard Schultz and Dori Jones Yang (1997). Pour Your Heart into It: How Starbucks Built a Company One Cup at a Time. New York: Hyperion. pp. 3–8.} The ankle would heal, but his father had lost another job—this time as a driver for a diaper service. It was a crummy job; still, it put food on the table, and if his father couldn’t work, there wouldn’t be any money. Howard was seven, but he understood the gravity of the situation, particularly because his mother was seven months pregnant, and the family had no insurance.

 

 

This was just one of the many setbacks that plagued Schultz’s father throughout his life—an honest, hard-working man frustrated by a system that wasn’t designed to cater to the needs of common workers. He’d held a series of blue-collar jobs (cab driver, truck driver, factory worker), sometimes holding two or three at a time. Despite his willingness to work, he never earned enough money to move his family out of Brooklyn’s federally-subsidized housing projects. Schultz’s father died never having found fulfillment in his work life—or even a meaningful job. It was the saddest day of Howard’s life.

As a kid, did Schultz ever imagine that one day he’d be the founder and chairman of an international coffee company? Of course not. But he did decide that if he was ever in a position to make a difference in the lives of people like his father, he’d do what he could. Remembering his father’s struggles and disappointments, Schultz tried to make Starbucks the kind of company where he wished his father had worked. “Without even a high school diploma,” Schultz admits, “my father probably could never have been an executive. But if he had landed a job in one of our stores or roasting plants, he wouldn’t have quit in frustration because the company didn’t value him. He would have had good health benefits, stock options, and an atmosphere in which his suggestions or complaints would receive a prompt, respectful response.”^{Ibid. p. 138.}

Schultz is motivated by both personal and business considerations: “When employees have self-esteem and self-respect,” he argues, “they can contribute so much more: to their company, to their family, to the world.”^{Ibid. pp. 6-7} His founder’s commitment continues today and is embedded in Starbucks’ values: “Creating a culture of warmth and belonging, where everyone is welcome.” ^{Starbucks (n.d.). "Mission Statement." Retrieved from https://www.starbucks.com/about-us/company-information/mission-statement Those working at Starbucks are called partners because working for Starbucks is not just a job, it’s a passion.Ibid.}

Human Resource Management

Employees at Starbucks are vital to the company’s success. They are its public face, and every dollar of sales passes through their hands.^{Howard Schultz and Dori Jones Yang (1997). Pour Your Heart into It: How Starbucks Built a Company One Cup at a Time. New York: Hyperion. p. 125.} They can make or break the company. If a customer has a positive interaction with an employee, the customer will come back. If an encounter is negative, the customer is probably gone for good. That’s why it’s crucial for Starbucks to recruit and hire the right people, train them properly, provide a motivating environment, and encourage them to stay with the company. Thus, the company works to provide satisfying jobs, a positive work environment, appropriate work schedules, and fair compensation and benefits. These activities are part of Starbucks’s strategy to deploy human resources in order to gain competitive advantage. The process is called human resource management (HRM), which consists of all actions that an organization takes to attract, develop, and retain quality employees. Each of these activities is complex. Attracting talented employees involves the recruitment of qualified candidates and the selection of those who best fit the organization’s needs. Development encompasses both new-employee orientation and the training and development of current workers. Retaining good employees means motivating them to excel, appraising their performance, compensating them appropriately, and doing what’s possible to keep them.

 

Human Resource Planning

How does Starbucks make sure that its worldwide retail locations are staffed with just the right number of committed employees? How does Norwegian Cruise Lines make certain that when the Norwegian Dawn pulls out of New York harbor, it has a complete, fully trained crew on board to feed, entertain, and care for its passengers? Managing these tasks is a matter of strategic human resource planning—the process of developing a plan for satisfying an organization’s human resources (HR) needs.

A strategic HR plan lays out the steps that an organization will take to ensure that it has the right number of employees with the right skills in the right places at the right times. HR managers begin by analyzing the company’s mission, objectives, and strategies. Starbucks’s objectives, for example, include “Creating a culture of warmth and belonging, where everyone is welcome” as well as fostering an environment in which employees treat both customers and each other with dignity and respect.^{Starbucks (2016). “Working at Starbucks.” Retrieved from: http://www.starbucks.com/careers/working-at-starbucks} Thus, the firm’s HR managers look for people who are “adaptable, self-motivated, passionate, creative team members.”^{Fortune (2007). “100 Top MBA Employers.” Retrieved from: http://archive.fortune.com/magazines/fortune/mba100/2007/full_list/index.html} The main goal of Norwegian Cruise Lines—to lavish passengers with personal attention—determines not only the type of employee desired (one with exceptionally good customer-relation skills and a strong work ethic) but also the number needed (one for every two passengers on the Norwegian Dawn).^{Cruise International (n.d.). "The Norwegian Dawn.” Retrieved from: http://www.cruise-international.com/cruise-search/ShpDetailsQuery?nShp=290&nLine=18&nOperator=Norwegian Cruise Line}

Job Analysis

To develop an HR plan, HR managers must be knowledgeable about the jobs that the organization needs performed. They organize information about a given job by performing a job analysis to identify the tasks, responsibilities, and skills that it entails, as well as the knowledge and abilities needed to perform it. Managers also use the information collected for the job analysis to prepare two documents:

• A job description, which lists the duties and responsibilities of a position
• A job specification, which lists the qualifications—skills, knowledge, and abilities—needed to perform the job

HR Supply and Demand Forecasting

Once they’ve analyzed the jobs within the organization, HR managers must forecast future hiring or job elimination needs (e.g. firings). This is the three-step process summarized below.

 

 

Starbucks, for instance, might find that it needs 300 new employees to work at stores scheduled to open in the next few months. Disney might determine that it needs 2,000 new cast members to handle an anticipated surge in visitors. Virgin Voyages might be short two dozen restaurant workers on one of its ships because of an unexpected increase in reservations.

After calculating the disparity between supply and future demand, HR managers must draw up plans for bringing the two numbers into balance. If the demand for labor is going to outstrip the supply, they may hire more workers, encourage current workers to put in extra hours, subcontract work to other suppliers, or introduce labor-saving initiatives. If the supply is greater than the demand, they may deal with overstaffing by not replacing workers who leave, encouraging early retirements, eliminating positions, or terminating employment.

Recruiting Qualified Employees

Armed with information on the number of new employees to be hired and the types of positions to be filled, the HR manager then develops a strategy for recruiting potential employees. Recruiting is the process of identifying suitable candidates and encouraging them to apply for openings in the organization.

Before going any further, we should point out that in recruiting and hiring, managers must comply with antidiscrimination laws; violations can have legal consequences. Discrimination occurs when a person is treated unfairly on the basis of a characteristic unrelated to ability. Under federal law, it’s illegal to discriminate in recruiting and hiring on the basis of race, color, religion, sex, national origin, age, or disability. (The same rules apply to other employment activities, such as promoting, compensating, and terminating employees.)^{The U.S. Equal Employment Opportunity Commission (n.d.). “Prohibited Employment Policies/Practices.” Retrieved from: https://www.eeoc.gov/laws/practices/index.cfm} The Equal Employment Opportunity Commission (EEOC) enforces a number of federal employment laws, including the following:

• Title VII of the Civil Rights Act of 1964, which prohibits employment discrimination based on race, color, religion, sex, or national origin. Sexual harassment is also a violation of Title VII.
• The Equal Pay Act of 1963, which protects both women and men who do substantially equal work from sex-based pay discrimination.
• The Age Discrimination in Employment Act of 1964, which protects individuals who are forty or older.
• Title I and Title V of the Americans with Disabilities Act of 1990, which prohibits employment discrimination against individuals with disabilities.^{The U.S. Equal Employment Opportunity Commission (n.d.). “Laws Enforced by the U.S. Equal Employment Opportunity Commission.” Retrieved from: https://www.eeoc.gov/laws/statutes/index.cfm}

In June 2020, the US Supreme Court, with a 6-3 decision, ruled that discrimination based on sex, should be understood to include sexual orientation and gender identity. This ruling provided the EEOC with additional enforcement under Title VII of the Civil Rights Act of 1964.^{Anthony Zurcher (2020). "US Supreme Court Backs Protection for LGBT workers." BBC News. Retrieved from: https://www.bbc.com/news/world-us-canada-53055632}

Where to find candidates

The first step in recruiting is to find qualified candidates. Where do you look for them, and how do you decide whether they’re qualified? Companies must assess not only the ability of a candidate to perform the duties of a job, but also whether he or she is a good “fit” for the company—i.e., how well the candidate’s values and interpersonal style match the company’s values and culture.

Internal versus external recruiting

Where do you find people who satisfy so many criteria? Basically, you can look in two places: inside and outside your own organization. Both options have pluses and minuses. Hiring internally sends a positive signal to employees that they can move up in the company—a strong motivation tool and a reward for good performance. In addition, because an internal candidate is a known quantity, it’s easier to predict his or her success in a new position. Finally, it’s cheaper to recruit internally. On the other hand, the company will probably have to fill the promoted employee’s position. Going outside gives the hiring manager an opportunity to bring fresh ideas and skills into the company. In any case, it’s often the only alternative, especially if no one inside the company has just the right combination of skills and experiences. Entry-level jobs are usually filled from the outside.

How to find candidates

Searching for new employees means publicizing the position. If looking internally in a small organization, employees can be alerted informally. In larger organizations, HR managers generally post openings on the internal corporate website or seek direct recommendations from various supervisors.

Recruiting people from outside is more complicated. Like marketing a product to buyers, the company promotes the virtues of working for the organization. Starbucks uses the following outlets to advertise openings:

• A dedicated section of the corporate web site (“Job Center,” which lists openings, provides information about the Starbucks experience, and facilitates the submission of online applications)
• College campus recruiting (holding on-campus interviews and information sessions and participating in career fairs)
• Internships designed to identify future talent among college students
• Announcements on employment web sites like Monster.com, Vault.com, Glassdoor.com, and SimplyHired.com
• Newspaper classified ads
• Facebook and Twitter
• Local job fairs
• In-store recruiting posters
• Informative “business cards” for distribution to customers^{Carolyn B. Thompson (n.d.). “In Focus: Target Your Recruitment Market.” NetTemps.com. Retrieved from: http://www.net-temps.com/recruiters/infocus/article.htm?op=view&id=662#axzz4BVFt5rJY}

Everything Starbucks does as a company bears on its ability to attract talent. Accordingly, everyone is responsible for recruiting, not just HR specialists. In fact, the best source of quality applicants is often the company’s own labor force.^{David Lee (2006). “Your First Task as a Recruiter: Recruit Senior Management Onto Your Team.” Humannature@work.com. Retrieved from: https://web.archive.org/web/20130529204750/http://www.humannatureatwork.com/Recruiting-Employees.htm}

The selection process

Recruiting gets people to apply for positions, but once you’ve received applications, you still have to select the best candidate—another complicated process.

The selection process entails gathering information on candidates, evaluating their qualifications, and choosing the right one. At the very least, the process can be time-consuming—particularly when you’re filling a high-level position—and often involves several members of an organization.

Let’s examine the selection process more closely by describing the steps that you’d take to become a special agent for the Federal Bureau of Investigation (FBI).^{Federal Bureau of Investigation (n.d.). “Special Agents.” FBI Jobs. Retrieved from: https://www.fbijobs.gov/special-agents; Federal Bureau of Investigation (n.d.). “How to Become a Special Agent.” FBI Jobs. Retrieved from: https://www.fbijobs.gov/special-agents/how-become-special-agent} Most business students don’t generally aspire to become FBI agents, but the FBI is quite interested in business graduates—especially if you have a major in accounting or finance. With one of these backgrounds, you’ll be given priority in hiring. Why?

Unfortunately, there’s a lot of white-collar crime that needs to be investigated, and people who know how to follow the money are well suited for the task.

Application

The first step in a new graduate being hired as an FBI accountant is applying for the job. Make sure you meet the minimum qualifications they advertise. To provide factual information on your education and work background, you’ll submit an application, which the FBI will use as an initial screening tool.

Employment Tests

Next comes a battery of tests (a lot more than you’d take in applying for an everyday business position). Like most organizations, the FBI tests candidates on the skills and knowledge entailed by the job. Unlike most businesses, however, the FBI will also measure your aptitude, evaluate your personality, and assess your writing ability. You’ll have to take a polygraph (lie-detector) test to determine the truthfulness of the information you’ve provided, uncover the extent of any drug use, and disclose potential security problems.

Interview

If you pass all these tests (with sufficiently high marks), you’ll be granted an interview. It serves the same purpose as it does for business recruiters: it allows the FBI to learn more about you and gives you a chance to learn more about your prospective employer and your possible future in the organization. The FBI conducts structured interviews—a series of standard questions. You’re judged on both your answers and your ability to communicate orally.

Physical Exam and Reference Checks

Let’s be positive and say you passed the interview. What’s next? You still have to pass a rigorous physical examination (including a drug test), as well as background and reference checks. Given its mission, the FBI sets all these hurdles a little higher than the average employer. Most businesses will ask you to take a physical exam, but you probably won’t have to meet the fitness standards set by the FBI. Likewise, many businesses check references to verify that applicants haven’t lied about (or exaggerated) their education and work experience. The FBI goes to great lengths to ensure that candidates are suitable for law-enforcement work.

Final Decision

The last stage in the process is out of your control. Will you be hired or not? This decision is made by one or more people who work for the prospective employer. For a business, the decision maker is generally the line manager who oversees the position being filled. At the FBI, the decision is made by a team at FBI headquarters.

Contingent Workers

Though most people hold permanent, full-time positions, there’s a growing number of individuals who work at temporary or part-time jobs. Many of these are contingent workers hired to supplement a company’s permanent workforce. Most of them are independent contractors, consultants, or freelancers who are paid by the firms that hire them. Others are on-call workers who work only when needed, such as substitute teachers. Still others are temporary workers (or “temps”) who are employed and paid by outside agencies or contract firms that charge fees to client companies.

The Positives and Negatives of Temp Work

The use of contingent workers provides companies with a number of benefits. Because they can be hired and terminated easily, employers can better control labor costs. When things are busy, they can add temps, and when business is slow, they can release unneeded workers. Temps are often less expensive to employ than permanent workers, particularly because they rarely receive costly benefits. Employers can also bring in people with specialized skills and talents to work on special projects without entering into long-term employment relationships. Finally, companies can “try out” temps: if someone does well, the company can offer permanent employment; if the fit is less than perfect, the employer can easily terminate the relationship. There are downsides to the use of contingent workers, including increased training costs and decreased loyalty to the company. Also, many employers believe that because temps are usually less committed to company goals than permanent workers, productivity suffers.

 

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=116

Developing Employees

Because companies can’t survive unless employees do their jobs well, it makes economic sense to train them and develop their skills. This type of support begins when an individual enters the organization and continues as long as he or she stays there.

New-Employee Orientation

Have you ever started your first day at a new job feeling upbeat and optimistic only to walk out at the end of the day thinking that maybe you’ve taken the wrong job? If this happens too often, your employer may need to revise its approach to orientation—the way it introduces new employees to the organization and their jobs. Starting a new job is a little like beginning college; at the outset, you may be experiencing any of the following feelings:

• Somewhat nervous but enthusiastic
• Eager to impress but not wanting to attract too much attention
• Interested in learning but fearful of being overwhelmed with information
• Hoping to fit in and worried about looking new or inexperienced^{Adapted from Alan Price (2004). Human Resource Management in a Business Context. Hampshire, U.K.: Cengage EMEA. Retrieved from: http://www.bestbooks.biz/learning/induction.html}

The employer who understands these common feelings help newcomers adjust and avoid the pitfalls often associated with new-employee orientation:

• Failing to have a workspace set up for you
• Ignoring you or failing to supervise you
• Neglecting to introduce you to coworkers
• Swamping you with facts about the company^{Susan M. Heathfield (2015). “Top Ten Ways to Turn Off a New Employee.” About Money. Retrieved from: http://humanresources.about.com/library/weekly/aa022601a.htm}

A good employer will take things slowly, providing you with information about the company and your job on a need-to-know basis while making you feel as comfortable as possible. You’ll get to know the company’s history, traditions, policies, and culture over time. You’ll learn more about salary and benefits and how your performance will be evaluated. Most importantly, you’ll find out how your job fits into overall operations and what’s expected of you.

Training and Development

It would be nice if employees came with all the skills they need to do their jobs. It would also be nice if job requirements stayed the same: once you’ve learned how to do a job, you’d know how to do it forever. In reality, new employees must be trained; moreover, as they grow in their jobs or as their jobs change, they’ll need additional training. Unfortunately, training is costly and time-consuming.

How costly? Training magazine reported that businesses spent over $83 billion in 2019.^{Training Magazine (2019). "2019 Training Industry Report." Retrieved from https://trainingmag.com/trgmag-article/2019-training-industry-report/.}  At Darden Restaurants, the parent company to restaurants such as Olive Garden and Red Lobster, training focuses on diversity skills.^{Training magazine (2014). “2014 Top 125.” Retrieved from: https://trainingmag.com/sites/default/files/2014_01_Training_Top_125_1.pdf} What’s the payoff? Why are such companies willing to spend so much money on their employees? Darden has been recognized by Fortune magazine as a “Diversity Champion,” ranking it as one of the Top 20 employers on their list of diverse workforces.^{Ibid. p. 73.}At Booz Allen Hamilton, consultants specialize in finding innovative solutions to client problems, and their employer makes sure that they’re up-to-date on all the new technologies by maintaining an Innovation Center to enable great ideas to converge and advance how they build value. They incorporate the community from design thinkers to entrepreneurs to engineers, crafting the insights and technology to solve the toughest problems of today and the future. This and their Ideas Festival and Innovation Hub allow the employees a chance to receive off-the-job training. This approach allows them to focus on learning without the distractions that would occur in the office. ^{Booz Allen Hamilton (n.d.). "Innovation Center." Retrieved from https://www.boozallen.com/about/innovation/washington-dc-innovation-center.html}

At Booz Allen Hamilton’s technology “petting zoo,” employees are receiving off-the-job training. This approach allows them to focus on learning without the distractions that would occur in the office. More common, however, is informal on-the-job training, which may be supplemented with formal training programs. This is the method, for example, by which you’d move up from mere coffee maker to a full-fledged “barista” if you worked at Starbucks.^{Brooke Locascio (2004). “Working at Starbucks: More Than Just Pouring Coffee.” Tea and Coffee Trade Online. Retrieved from: http://www.teaandcoffee.net/0104/coffee.htm} You’d begin by reading a large spiral book (titled Starbucks University) on the responsibilities of the barista, pass a series of tests on the reading, then get hands-on experience in making drinks, mastering one at a time.^{Howard Schultz and Dori Jones Yang (1997). Pour Your Heart into It: How Starbucks Built a Company One Cup at a Time. New York: Hyperion. pp. 250-251.} Doing more complex jobs in business will likely require even more training than is required to be a barista.

Diversity in the Workplace

The makeup of the US workforce has changed dramatically over the past 50 years. In the 1950s, more than 60 percent was composed of white males.^{Judith Lindenberger and Marian Stoltz-Loike (2015). “Diversity in the Workplace.” Zeromillion.com. Retrieved from: http://www.zeromillion.com/econ/workplace-diversity.html} Today’s workforce reflects the broad range of differences in the population—differences in gender, race, ethnicity, age, physical ability, religion, education, and lifestyle. As you can see in Figure 12.5, more women and minorities have entered the workforce, and white males now make up only 36 percent of the workforce.^{Bureau of Labor Statistics (2016). “Labor Force Statistics from the Current Population Survey: Table 10 Employed Persons by Occupation, Race, Hispanic or Latino Ethnicity, and Aex.” Retrieved from: http://www.bls.gov/cps/cpsaat10.pdf}

 

 

Most companies today strive for diverse workforces. HR managers work hard to recruit, hire, develop, and retain a diverse workforce. In part, these efforts are motivated by legal concerns: discrimination in recruiting, hiring, advancement, and firing is illegal under federal law and is prosecuted by the EEOC.^{U.S. Equal Employment Opportunity Commission (2009). “Federal Laws Prohibiting Job Discrimination: Questions and Answers.” Retrieved from: http://www.eeoc.gov/facts/qanda.html} Companies that violate anti-discrimination laws are subject to severe financial penalties and also risk reputation damage. In November 2004, for example, the EEOC charged that recruiting policies at Abercrombie & Fitch, a national chain of retail clothing stores, had discriminated against minority and female job applicants between 1999 and 2004. The EEOC alleged that A&F had hired a disproportionate number of white salespeople, placed minorities and women in less visible positions, and promoted a virtually all-white image in its marketing efforts. Six days after the EEOC filed a lawsuit, the company settled the case at a cost of $50 million, but the negative publicity may hamper both recruitment and sales for some time.^{U.S. Equal Employment Opportunity Commission (2004). “EEOC Agrees to Landmark Resolution of Discrimination Case Against Abercrombie & Fitch.” Retrieved from: https://www.eeoc.gov/eeoc/newsroom/release/11-18-04.cfm}

Reasons for building a diverse workforce go well beyond mere compliance with legal standards. It even goes beyond commitment to ethical standards. It’s good business. People with diverse backgrounds bring fresh points of view that can be invaluable in generating ideas and solving problems. In addition, they can be the key to connecting with an ethnically diverse customer base. If a large percentage of your customers are Hispanic, it might make sense to have a Hispanic marketing manager. In short, capitalizing on the benefits of a diverse workforce means that employers should view differences as assets rather than liabilities.

Forbes Magazine published ‘America’s Best Employers for Diversity 2020 List’ and included the following:^{Ruth Omoh (2020). "America's Best Employers for Diversity 2020." Forbes. Retrieved from https://www.forbes.com/best-employers-diversity/#45aead599b9e}

What Makes a Great Place to Work?

Every year, the Great Places to Work Institute analyzes comments from thousands of employees and compiles a list of “The 100 Best Companies to Work for in America®,” which is published in Fortune magazine. Having compiled its list for more than 20 years, the institute concludes that the defining characteristic of a great company to work for is trust between managers and employees. Employees overwhelmingly say that they want to work at a place where employees “trust the people they work for, have pride in what they do, and enjoy the people they work with.”^{Great Place to Work Institute (2016). “What Is a Great Workplace?” Retrieved from: http://www.greatplacetowork.com/our-trust-approach/what-is-a-great-workplace} They report that they’re motivated to perform well because they’re challenged, respected, treated fairly, and appreciated. They take pride in what they do, are made to feel that they make a difference, and are given opportunities for advancement.^{Jessica Rohman (2015). “15 Practice Areas Critical to Achieving a Great Workplace.” Great Place to Work Institute. Retrieved from: http://www.greatplacetowork.com/events-and-insights/blogs-and-news/3040-15-practice-areas-critical-to-achieving-a-great-workplace} The most effective motivators, it would seem, are closely aligned with Maslow’s higher-level needs and Herzberg’s motivating factors. The top ten companies are listed in Figure 12.7.

 

Figure 12.7: Top 10 from the 2020 Fortune ‘Best Companies to Work For’ (2020)

Rank	Company
1	Hilton
2	Ultimate Software
3	Wegmans Food Markets
4	Cisco
5	Workday
6	Salesforce
7	Edward Jones
8	Stryker
9	American Express
10	Kimpton Hotels & Restaurants

Job Redesign

The average employee spends more than 2,000 hours a year at work. If the job is tedious, unpleasant, or otherwise unfulfilling, the employee probably won’t be motivated to perform at a very high level. Many companies practice a policy of job redesign to make jobs more interesting and challenging. Common strategies include job rotation, job enlargement, and job enrichment.

Job Rotation

Specialization promotes efficiency because workers get very good at doing particular tasks. The drawback is the tedium of repeating the same task day in and day out. The practice of job rotation allows employees to rotate from one job to another on a systematic basis, often but not necessarily cycling back to their original tasks. A computer maker, for example, might rotate a technician into the sales department to increase the employee’s awareness of customer needs and to give the employee a broader understanding of the company’s goals and operations. A hotel might rotate an accounting clerk to the check-in desk for a few hours each day to add variety to the daily workload. Through job rotation, employees develop new skills and gain experience that increases their value to the company. So great is the benefit of this practice that many companies have established rotational training programs that include scheduled rotations during the first 2-3 years of employment. Companies benefit because cross-trained employees can fill in for absentees, thus providing greater flexibility in scheduling, offer fresh ideas on work practices, and become promotion-ready more quickly.

Job Enlargement

Instead of a job in which you performed just one or two tasks, wouldn’t you prefer a job that gave you many different tasks? In theory, you’d be less bored and more highly motivated if you had a chance at job enlargement—the policy of enhancing a job by adding tasks at similar skill levels. The job of sales clerk, for example, might be expanded to include gift-wrapping and packaging items for shipment. The additional duties would add variety without entailing higher skill levels.

Job Enrichment

Merely expanding a job by adding similar tasks won’t necessarily “enrich” it by making it more challenging and rewarding. Job enrichment is the practice of adding tasks that increase both responsibility and opportunity for growth. It provides the kinds of benefits that, according to Maslow and Herzberg, contribute to job satisfaction: stimulating work, sense of personal achievement, self-esteem, recognition, and a chance to reach your potential.

Consider, for example, the evolving role of support staff in the contemporary office. Today, employees who used to be called “secretaries” assume many duties previously in the domain of management, such as project coordination and public relations. Information technology has enriched their jobs because they can now apply such skills as word processing, desktop publishing, creating spreadsheets, and managing databases. That’s why we now use a term such as administrative assistant instead of secretary.^{Sandra Kerka (1995). “The Changing Role of Support Staff.” ERIC Clearinghouse on Adult, Career, and Vocational Education (ACVE) ARCHIVE Trends and Issues Alerts. Retrieved from: http://www.calpro-online.org/eric/docgen.asp?tbl=archive&ID=A019}

Work/Life Quality

Building a career requires a substantial commitment in time and energy, and most people find that they aren’t left with much time for non-work activities. Fortunately, many organizations recognize the need to help employees strike a balance between their work and home lives.^{Jeffrey Greenhaus, Karen Collins, and Jason Shaw (2003). “The Relationship between Work-Family Balance and Quality of Life.” Journal of Vocational Behavior. Vol. 63. pp. 510–31.} By helping employees combine satisfying careers and fulfilling personal lives, companies tend to end up with a happier, less-stressed, and more productive workforce. The financial benefits include lower absenteeism, turnover, and health care costs.

Alternative Work Arrangements

The accounting firm KPMG, which has made the list of the “100 Best Companies for Working Mothers” for 19 years,^{KPMG Today (2012). “KPMG on Working Mother’s Top Ten Again.” KPMG Campus. Retrieved from: http://kpmgcampus.com/news/KPMGonWorkingMothersTopTenAgain.pdf} is committed to promoting a balance between its employees’ work and personal lives. KPMG offers a variety of work arrangements designed to accommodate different employee needs and provide scheduling flexibility.^{For further information or details about KPMG benefits, please visit http://us-jobs.kpmg.com/en/why-kpmg/benefits}

Flextime

Employers who provide for flextime set guidelines that allow employees to designate starting and quitting times. Guidelines, for example, might specify that all employees must work eight hours a day (with an hour for lunch) and that four of those hours must be between 10 a.m. and 3 p.m. Thus, you could come in at 7 a.m. and leave at 4 p.m., while coworkers arrive at 10 a.m. and leave at 7 p.m. With permission you could even choose to work from 8 a.m to 2 p.m., take two hours for lunch, and then work from 4 p.m. to 6 p.m.

Compressed Workweeks

Rather than work eight hours a day for five days a week, you might elect to earn a three-day weekend by working ten hours a day for four days a week.

Job Sharing

Under job sharing, two people share one full-time position, splitting the salary and benefits of the position as each handles half the job. Often they arrange their schedules to include at least an hour of shared time during which they can communicate about the job.

Telecommuting

Telecommuting means that you regularly work from home (or from some other non-work location). You’re connected to the office by computer, fax, and phone. You save on commuting time, enjoy more flexible work hours, and have more opportunity to spend time with your family. A study of 5,500 IBM employees (one-fifth of whom telecommute) found that those who worked at home not only had a better balance between work and home life but also were more highly motivated and less likely to leave the organization.^{WFC Resources Inc. (n.d.). “The Business Case for Telecommuting.” Career/Life Alliances Services Inc. Retrieved from: http://www.clalliance.com/EXPO/docs/The_Business_Case_for_Telecommuting-WFCResources.pdf}

Though it’s hard to count telecommuters accurately, Global Workplace Analytics estimates that, in 2016, “at least 3.7 million people (2.8 percent of the workforce) work from home at least half the time.”^{Kate Lister (2016). “Latest Telecommuting Statistics.” Global Workplace Analytics. Retrieved from: http://globalworkplaceanalytics.com/telecommuting-statistics} Telecommuting isn’t for everyone. Working at home means that you have to discipline yourself to avoid distractions, such as TV, personal phone calls, and home chores and also not be impacted by feeling isolated from the social interaction in the workplace.

Family-Friendly Programs

In addition to alternative work arrangements, many employers, including KPMG, offer programs and benefits designed to help employees meet family and home obligations while maintaining busy careers. KPMG offers each of the following benefits.^{For further information or details about KPMG benefits, please visit http://us-jobs.kpmg.com/en/why-kpmg/benefits}

Dependent Care

Caring for dependents—young children and elderly parents—is of utmost importance to some employees, but combining dependent-care responsibilities with a busy job can be particularly difficult. KPMG provides on-site child care during tax season (when employees are especially busy) and offers emergency backup dependent care all year round, either at a provider’s facility or in the employee’s home. To get referrals or information, employees can call KPMG’s LifeWorks Resource and Referral Service.

KPMG is by no means unique in this respect: more than 7 percent of US companies maintained on-site day care in 2012,^{Rana Florida (2012). “The Case For On-Site Day Care.” Fast Company. Retrieved from: http://www.fastcompany.com/3036419/second-shift/the-case-for-onsite-daycare} and 17 percent of all US companies offered child-care resources or referral services.^{Katherine Reynolds Lewis (2015). “What It Takes: Parental Support Trends at the Best Companies.” Working Mother Magazine. Retrieved from: http://www.workingmother.com/what-it-takes-parental-support-trends-at-best-companies}

Paid Parental Leave

The United States is one of only two countries in the world that does not guarantee paid leave to new mothers (or fathers), although California, Rhode Island and New Jersey are implementing state programs, and many employers offer paid parental leave as an employee benefit.^{Kate Gibson (2016). “Paid Parental Leave: Finally Coming to America?” CBS News Moneywatch. Retrieved from: http://www.cbsnews.com/news/paid-parental-leave-finally-coming-to-america/} Any KPMG employee (whether male or female) who becomes a parent can take two weeks of paid leave. New mothers may also get time off through short-term disability benefits.

Caring for Yourself

Like many companies, KPMG allows employees to aggregate all paid days off and use them in any way they want. In other words, instead of getting, say, ten sick days, five personal days, and 15 vacation days, you get a total of 30 days to use for anything. If you’re having personal problems, you can contact the Employee Assistance Program. If staying fit makes you happier and more productive, you can take out a discount membership at one of more than 9,000 health clubs. In fact, many employers, like North Carolina software company SAS, now have on-site fitness centers for employee use.^{Morley Safer and Rebecca Leung (2003). “Working The Good Life: SAS Provides Employees With Generous Work Incentives." CBS News/60 Minutes. Retrieved from: http://www.cbsnews.com/news/working-the-good-life/}

Unmarried without Children

You’ve undoubtedly noticed by now that many programs for balancing work and personal lives target married people, particularly those with children. Single individuals also have trouble striking a satisfactory balance between work and non-work activities, but many single workers feel that they aren’t getting equal consideration from employers.^{Karen Collins and Elizabeth Hoover (1995). “Addressing the Needs of the Single Person in Public Accounting.” Pennsylvania CPA Journal. p. 16.} They report that they’re often expected to work longer hours, travel more, and take on difficult assignments to compensate for married employees with family commitments.

Needless to say, requiring singles to take on additional responsibilities can make it harder for them to balance their work and personal lives. It’s harder to plan and keep personal commitments while meeting heavy work responsibilities. Frustration can lead to increased stress and job dissatisfaction. In several studies of stress in the accounting profession, unmarried workers reported higher levels of stress than any other group, including married people with children.^{Karen Collins and Larry Killough (1989). “Managing Stress in Public Accounting.” Journal of Accountancy. Vol. 167. No.5. p. 92.}

With singles, as with married people, companies can reap substantial benefits from programs that help employees balance their work and non-work lives. PepsiCo, for example, offers a “concierge service,” which maintains a dry cleaner, travel agency, convenience store, and fitness center on the premises of its national office in Purchase, New York.^{Glenn Withiam (1993). “American Concierges Set Service Standards.” The Cornell Hotel and Restaurant Administration Quarterly. Vol. 34. No. 4. p. 26.} Single employees seem to find these services helpful, but what they value most of all is control over their time. In particular, they want predictable schedules that allow them to plan social and personal activities. They don’t want employers assuming that being single means that they can change plans at the last minute. It’s often more difficult for singles to deal with last-minute changes because, unlike married coworkers, they don’t have the at-home support structure to handle such tasks as tending to elderly parents or caring for pets.

 

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=116

Compensation and Benefits

Though paychecks and benefits packages aren’t the only reasons why people work, they do matter. Competitive pay and benefits also help organizations attract and retain qualified employees. Companies that pay their employees more than their competitors generally have lower turnover. Consider, for example, The Container Store, which has appeared on Fortune magazine’s list of “The 100 Best Companies to Work For.”^{Great Place to Work Institute (2016). “Announcing the 2016 Fortune Best Companies to Work For.” Retrieved from: http://reviews.greatplacetowork.com/rankings/2016-fortune-100-best-companies-to-work-for-list} The retail chain staffs its stores with fewer employees than its competitors but pays them more—in some cases, three times the industry average for retail workers. This strategy allows the company to attract extremely talented workers who, moreover, aren’t likely to leave the company. Low turnover is particularly valuable in the retail industry because it depends on service-oriented personnel to generate repeat business. In addition to salary and wages, compensation packages often include other financial incentives, such as bonuses and profit-sharing plans, as well as benefits, such as medical insurance, vacation time, sick leave, and retirement accounts.

Wages and Salaries

The largest, and most important, component of a compensation package is the payment of wages or salary. If you’re paid according to the number of hours you work, you’re earning wages. Counter personnel at McDonald’s, for instance, get wages, which are determined by multiplying an employee’s hourly wage rate by the number of hours worked during the pay period. On the other hand, if you’re paid for fulfilling the responsibilities of a position—regardless of the number of hours required to do it—you’re earning a salary. The McDonald’s manager gets a salary for overseeing the operations of the restaurant. He or she is expected to work as long as it takes to get the job done, without any adjustment in compensation.

Piecework and Commissions

Sometimes it makes more sense to pay workers according to the quantity of product that they produce or sell. Byrd’s Seafood, a crab-processing plant in Crisfield, Maryland, pays workers on piecework: workers’ pay is based on the amount of crabmeat that’s picked from recently cooked crabs. (A good picker can produce 15 pounds of crabmeat an hour and earn about $100 a day.)^{Neil Learner (2000). “Ashore, a Way of Life Built Around the Crab.” The Christian Science Monitor. Retrieved from: http://www.csmonitor.com/2000/0626/p15s1.html} On the other hand, if you’re working on commission, you’re probably getting paid a percentage of the total dollar amount you sell. If you were a sales representative for an insurance company, like The Hartford, you’d get a certain amount of money for each automobile or homeowner policy you sold.^{The Hartford (2016). “Total Rewards: Competitive Compensation.” Retrieved from: https://www.thehartford.com/careers/benefits}

Incentive Programs

In addition to regular paychecks, many people receive financial rewards based on performance, whether their own, their employer’s, or both. Other incentive programs designed to reward employees for good performance include bonus plans and stock options.

Bonus plans

Texas Instruments’ (TI) year-end bonuses—annual income given in addition to salary—are based on individual and company-wide performance. If the company has a profitable year, and if you contributed to that success, you’ll get a bonus.^{Texas Instruments (2012). “2012 Corporate Citizenship Report: Compensation.” Retrieved from: http://www.ti.com/corp/docs/csr/2012/empwellbeing/payandbenefits/compensation.shtml} If the company doesn’t do well, you may be out of luck—regardless of your personal performance, you might not receive a bonus.

Bonus plans have become quite common, and the range of employees eligible for bonuses has widened in recent years. In the past, bonus plans were usually reserved for managers above a certain level. Today, companies have realized the value of extending plans to include employees at virtually every level. The magnitude of bonuses still favors those at the top. High-ranking officers often get bonuses ranging from 30 percent to 50 percent of their salaries. Upper-level managers may get from 15 percent to 25 percent and middle managers from 10 percent to 15 percent. At lower levels, employees may expect bonuses from 3 percent to 5 percent of their annual compensation.^{Jeff D. Opdyke (2004). “Getting a Bonus Instead of a Raise.” Wall Street Journal. Retrieved from: http://www.wsj.com/articles/SB110427526449111461}

Profit-sharing plans

Delta Airlines^{Kristen Leigh Painter (2016). “Delta distributes .5 billion in profits to employees.” Star Tribune. Retrieved from: http://www.startribune.com/delta-distributes-1-5-billion-in-profits-to-employees/368656151/} and General Motors^{Greg Gardner (2016). “GM UAW workers to receive profit-sharing up to ,000.” Detroit Free Press. Retrieved from: http://www.freep.com/story/money/cars/general-motors/2016/02/03/gm-uaw-workers-receive-profit-sharing-up-11000/79708340/} both have profit-sharing arrangements with employees. Today, about 40 percent of all US companies offer some type of profit-sharing program.^{Lee Ann Obringer (2003). "How Employee Compensation Works." HowStuffWorks.com. Retrieved from: http://money.howstuffworks.com/benefits.htm}

TI’s plan is also pretty generous—as long as the company has a good year. Here’s how it works. An employee’s profit share depends on the company’s operating profit for the year. If profits from operations reach 10 percent of sales, the employee gets a bonus worth 2 percent of his or her salary. In 2011, TI’s operating profit was 22 percent, and employee bonuses were 7.9 percent of salary. But if operating profits are below 10 percent, nobody gets anything.^{Texas Instruments (2012). “2012 Proxy Statement: Compensation discussion and analysis.” p. 69. Retrieved from: http://www.ti.com/corp/docs/investor/proxy12/compensation_discussion_and_analysis.htm}

Stock-option plans

The TI compensation plan also gives employees the right to buy shares of company stock at a 15 percent discount four times a year.^{Texas Instruments (2012). “2012 Corporate Citizenship Report: Compensation.” Retrieved from: http://www.ti.com/corp/docs/csr/2012/empwellbeing/payandbenefits/compensation.shtml} So, if the price of the stock goes up, the employee benefits. Say, for example, that the stock was selling for $30 a share when the option was granted in 2007. The employee would be entitled to buy shares at a price of $25.50, earning them an immediate 15 percent gain in value. Any increase in share price would add to that gain.^Ibid.

At TI, stock options are used as an incentive to attract and retain top people.^Ibid. Starbucks, by contrast, isn’t nearly as selective in awarding stock options. At Starbucks, all employees can earn “Bean Stock”—the Starbucks employee stock-option plan. Both full- and part-time employees get Starbucks shares based on their earnings and their time with the company. If the company does well and its stock goes up, employees make a profit. Starbucks believes that Bean Stock pays off because employees are rewarded when the company does well, they have a stronger incentive to add value to the company (and so drive up its stock price). Starbucks has a video explaining their employee stock option program on this webpage.^{Starbucks (2016). “About Bean Stock.” Retrieved from: http://starbucksbeanstock.com/en-us/welcome-en-us/about-bean-stock-en-us/}

Benefits

Another major component of an employee’s compensation package is benefits— compensation other than salaries, hourly wages, or financial incentives. Types of benefits include the following:

• Legally required benefits (Social Security and Medicare, unemployment insurance, workers’ compensation)
• Paid time off (vacations, holidays, sick leave)
• Insurance (health benefits, life insurance, disability insurance)
• Retirement benefits

The cost of providing benefits is staggering. According to the US Bureau of Labor Statistics, it costs an average employer about 30 percent of a worker’s salary to provide the same worker with benefits. If you include pay for time not worked (while on vacation or sick and so on), the percentage increases to 37 percent. The most money goes for paid time off (6.9 percent of salary costs), health care (8.1 percent), and retirement benefits (3.8 percent).^{Bureau of Labor Statistics (2016). “Employer Costs for Employee Compensation News Release.” Retrieved from: http://www.bls.gov/news.release/ecec.nr0.htm}

Some workers receive only the benefits required by law while part-timers often receive no benefits at all.^{Bureau of Labor Statistics (2016). “Employee Benefits Survey, Private Industry Tables.” Retrieved from: http://www.bls.gov/ncs/ebs/benefits/2015/ownership/prvt_all.pdf} Again, Starbucks is generous in offering benefits. The company provides benefits even to the part-timers who make up two-thirds of the company’s workforce; anyone working at least 20 hours a week is eligible to participate in group medical coverage.^{Starbucks (2016). “Working at Starbucks.” Retrieved from: http://www.starbucks.com/careers/working-at-starbucks}

Performance Appraisal

Employees generally want their managers to tell them three things: what they should be doing, how well they’re doing it, and how they can improve their performance. Good managers address these issues on an ongoing basis. On a semiannual or annual basis, they also conduct formal performance appraisals to discuss and evaluate employees’ work performance.

The Basic Three-Step Process

Appraisal systems vary both by organization and by the level of the employee being evaluated, but as you can see in Figure 12.8, it’s generally a three-step process:

1. Before managers can measure performance, they must set goals and performance expectations and specify the criteria (such as quality of work, quantity of work, dependability, initiative) that they’ll use to measure performance.
2. At the end of a specified time period, managers complete written evaluations that rate employee performance according to the predetermined criteria.
3. Managers then meet with each employee to discuss the evaluation. Jointly, they suggest ways in which the employee can improve performance, which might include further training and development.

 

It sounds fairly simple, but why do so many managers report that, except for firing people, giving performance appraisals is their least favorite task?^{Susan Heathfield (2015). “Performance Appraisals Don't Work: The Traditional Performance Appraisal Process.” About Money. Retrieved from: http://humanresources.about.com/od/performanceevals/a/perf_appraisal.htm} To get some perspective on this question, we’ll look at performance appraisals from both sides, explaining the benefits and identifying potential problems with some of the most common practices.

Among other benefits, formal appraisals provide the following:

• An opportunity for managers and employees to discuss an employee’s performance and to set future goals and performance expectations.
• A chance to identify and discuss appropriate training and career-development opportunities for an employee.
• Formal documentation of the evaluation that can be used for salary, promotion, demotion, or dismissal purposes.^{Bob Nelson and Peter Economy (2003). Managing for Dummies, 2nd ed. New York: Wiley. p. 140.}

As for disadvantages, most stem from the fact that appraisals are often used to determine salaries for the upcoming year. Consequently, meetings to discuss performance tend to take on an entirely different dimension: the manager may appear judgmental (rather than supportive), and the employee may get defensive. This adversarial atmosphere can make many managers not only uncomfortable with the task but also less likely to give honest feedback. (They may give higher marks in order to avoid delving into critical evaluations.) HR professionals disagree about whether performance appraisals should be linked to pay increases. Some experts argue that the connection eliminates the manager’s opportunity to use the appraisal to improve an employee’s performance. Others maintain that it increases employee satisfaction with the process and distributes raises on the basis of effort and results.^{Archer North & Associates (2010). “Reward Issues.” Performance-Appraisal.com. Retrieved from: http://www.performance-appraisal.com/rewards.htm}

360-Degree and Upward Feedback

Instead of being evaluated by one person, how would you like to be evaluated by several people—not only those above you in the organization but those below and beside you? The approach is called 360-degree feedback, and the purpose is to ensure that employees (mostly managers) get feedback from all directions—from supervisors, reporting subordinates, coworkers, and even customers. If it’s conducted correctly, this technique furnishes managers with a range of insights into their performance in a number of roles.

Some experts, however, regard the 360-degree approach as too cumbersome. An alternative technique, called upward feedback, requires only the manager’s subordinates to provide feedback. Computer maker Dell uses this approach as part of its manager-development plan. Every year, 40,000 Dell employees complete a survey in which they rate their supervisors on a number of dimensions, such as practicing ethical business principles and providing support in balancing work and personal life. Dell uses survey results for development purposes only, not as direct input into decisions on pay increases or promotions.^{Dell, Inc. (2011). “2011 Corporate Responsibility Report: Listening, Inspiring, Sharing: Tell Dell.” p. 37. Retrieved from: http://i.dell.com/sites/content/corporate/corp-comm/en/Documents/dell-fy11-cr-report.pdf}

Retaining Valuable Employees

When a valued employee quits, the loss to the employer can be serious. Not only will the firm incur substantial costs to recruit and train a replacement, but it also may suffer temporary declines in productivity and lower morale among remaining employees who have to take on heavier workloads. Given the negative impact of turnover—the permanent separation of an employee from a company—most organizations do whatever they can to retain qualified employees. Compensation plays a key role in this effort: companies that don’t offer competitive compensation packages tend to lose employees. Other factors also come into play, such as training and development, as well as helping employees achieve a satisfying work/non-work balance. In the following sections, we’ll look at a few other strategies for reducing turnover and increasing productivity.^{Gregory P. Smith (n.d.) “5 Tips to Attract, Keep and Motivate Your Employees.” Businessknowhow.com. Retrieved from: http://www.businessknowhow.com/manage/attractworkforce.htm}

Creating a Positive Work Environment

Employees who are happy at work are more productive, provide better customer service, and are more likely to stay with the company. A study conducted by Sears, for instance, found a positive relationship between customer satisfaction and employee attitudes on ten different issues: a 5 percent improvement in employee attitudes results in a 1.3 percent increase in customer satisfaction and a 0.5 percent increase in revenue.^{Sue Shellenbarger (1998). “Companies Find It Pays To Be Nice to Employees.” The Wall Street Journal. Retrieved from: http://www.wsj.com/articles/SB901063646490891000}

Employee-Friendly Workplace

What sort of things improve employee attitudes? The 12,000 employees of software maker SAS Institute fall into the category of “happy workers.” They choose the furniture and equipment in their offices, eat subsidized meals at one of three on-site restaurants, and enjoy other amenities like a 77,000 square-foot fitness center. They also have job security: no one’s ever been laid off because of an economic downturn. The employee-friendly work environment helps SAS employees focus on their jobs and contribute to the attainment of company goals.^{Morley Safer and Rebecca Leung (2003). “Working The Good Life: SAS Provides Employees With Generous Work Incentives." CBS News/60 Minutes. Retrieved from: http://www.cbsnews.com/news/working-the-good-life/} Not surprisingly, it also results in very low 3 percent turnover.

Recognizing Employee Contributions

Thanking people for work done well is a powerful motivator. People who feel appreciated are more likely to stay with a company than those who don’t.^{Robert McGarvey (2004). “A Tidal Wave of Turnover.” American Way. pp. 32–36.} While a personal thank-you is always helpful, many companies also have formal programs for identifying and rewarding good performers. The Container Store rewards employee accomplishments in a variety of ways. For example, employees with 20 years of service are given a “dream trip”—one employee went on a seven day Hawaiian cruise.^{The Container Store (2013). “What We Stand For: Organization with Heart—My 20-Year Trip.” Retrieved from: http://standfor.containerstore.com/my-20-year-trip-2} The company is known for its supportive environment and in 2016 celebrated its seventeenth year on Fortune’s 100 Best Companies to Work For®.^{The Container Store (2016). “What We Stand For: Organization with Heart—17 Years on FORTUNE’s '100 Best' List.” Retrieved from: http://standfor.containerstore.com/17-years-on-fortunes-100-best-list}

Involving Employees in Decision Making

Companies have found that involving employees in decisions saves money, makes workers feel better about their jobs, and reduces turnover. Some have found that it pays to take their advice. When General Motors asked workers for ideas on improving manufacturing operations, management was deluged with more than 44,000 suggestions during one quarter. Implementing a few of them cut production time on certain vehicles by 15 percent and resulted in sizable savings.^{Freda Turner (2002). “An Effective Employee Suggestion Program Has a Multiplier Effect.” TheCEORefresher.com. Retrieved from: http://www.refresher.com/Archives/!ftmultiplier.html}

Similarly, in 2001, Edward Jones, a personal investment company, faced a difficult situation during the stock-market downturn. Costs had to be cut, and laying off employees was one option. Instead, however, the company turned to its workforce for solutions. As a group, employees identified cost savings of more than $38 million. At the same time, the company convinced experienced employees to stay with it by assuring them that they’d have a role in managing it.^{Richard L. Daft and Dorothy Marcic (2006). Understanding Management, 6th Edition. Florence KY: Cengage Learning. p. 219.}

Why People Quit

As important as such initiatives can be, one bad boss can spoil everything. The way a person is treated by his or her boss may be the primary factor in determining whether an employee stays or goes. People who have quit their jobs cite the following behavior by superiors:

• Making unreasonable work demands
• Refusing to value their opinions
• Failing to be clear about what’s expected of subordinates
• Showing favoritism in compensation, rewards, or promotions^{Gregory P. Smith (n.d.). “Top Ten Reasons Why People Quit Their Jobs.” Businessknowhow.com. Retrieved from: http://www.businessknowhow.com/manage/whyquit.htm}

Holding managers accountable for excessive turnover can help alleviate the “bad-boss” problem, at least in the long run. In any case, whenever an employee quits, it’s a good idea for someone—other than the individual’s immediate supervisor—to conduct an exit interview to find out why. Knowing why people are quitting gives an organization the opportunity to correct problems that are causing high turnover rates.

Involuntary Termination

Some companies employ a process called Forced Ranking to manage out their under-performers. In this approach, only a certain percentage of employees can receive a particular performance evaluation score, which forces some employees to the bottom of the distribution—sort of the opposite of a curved exam score. The employee pool in question is typically made up of those who do similar kinds of work. Ideally after being given some amount of time to improve, those who remain at the bottom of the performance distribution are then separated from the company. As you can imagine, this practice has caused a fair amount of controversy!

Before we leave this section, we should say a word or two about termination—getting fired. Though turnover—voluntary separations—can create problems for employers, they’re not nearly as devastating as the effects of involuntary termination on employees. Losing your job is what psychologists call a “significant life change,” and it’s high on the list of “stressful life events” regardless of the circumstances. Sometimes, employers lay off workers because revenues are down and they must resort to downsizing—to cutting costs by eliminating jobs. Sometimes a particular job is being phased out, and sometimes an employee has simply failed to meet performance requirements.

Employment at Will

Is it possible for you to get fired even if you’re doing a good job and there’s no economic justification for your being laid off? In some cases, yes—especially if you’re not working under a contract. Without a formal contract, you’re considered to be employed at will, which means that both you and your employer have the right to terminate the employment relationship at any time. You can quit whenever you want, but your employer can also fire you whenever they want.

Fortunately for employees, over the past several decades, the courts have made several decisions that created exceptions to the employment-at-will doctrine.^{Charles Muhl (2001). “The Employment-at-Will Doctrine: Three Major Exceptions.” Bureau of Labor Statistics Monthly Labor Review. Retrieved from: http://www.bls.gov/opub/mlr/2001/01/art1full.pdf} Since managers generally prefer to avoid the expense of fighting wrongful discharge claims in court, many no longer fire employees at will. A good practice in managing terminations is to maintain written documentation so that employers can demonstrate just cause when terminating an employee. If it’s a case of poor performance, the employee would be warned in advance that his or her current level of performance could result in termination and then be permitted an opportunity to improve performance. When termination is necessary, communication should be handled in a private conversation, with the manager explaining precisely why the action is being taken.

 

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=116

 

Key Takeaways

• The process of human resource management consists of actions that an organization takes to attract, develop, and retain quality employees.
• Human resource managers engage in strategic human resource planning—the process of developing a plan for satisfying the organization’s human resource needs.
• The HR manager forecasts future hiring needs and begins the recruiting process to fill those needs.
• In recruiting and hiring, managers must comply with anti-discrimination laws enforced by the Equal Employment Opportunity Commission (EEOC). They cannot treat people unfairly on the basis of a characteristic unrelated to ability, such as race, color, religion, sex, national origin, age, or disability.
• HR managers also oversee employee training, from the first orientation to continuing on– or off-the-job training.
• Attracting a diverse workforce goes beyond legal compliance and ethical commitments, because a diverse group of employees can offer perspectives that may be valuable in generating ideas, solving problems, and connecting with an ethnically diverse customer base.
• Employees are motivated to perform well when they’re challenged, respected, treated fairly, and appreciated.
• Some other factors that contribute to employee satisfaction include job redesign to make jobs more interesting and challenging, job rotation, which allows employees to rotate from one job to another, job enlargement, which enhances a job by adding tasks at similar skill levels, and job enrichment, which adds tasks that increase both responsibility and opportunity for growth.
• Many organizations recognize the need to help employees strike a balance between their work and home lives and offer a variety of work arrangements to accommodate different employee needs, such as flextime (flexible scheduling), job sharing (when two people share a job), and telecommuting (working from outside the office).
• Compensation includes pay and benefits. Workers who are paid by the hour earn wages, while those who are paid to fulfill the responsibilities of the job earn salaries. Some people receive commissions based on sales or are paid for output, based on a piecework approach.
• In addition employees can may receive year-end bonuses, participate in profit-sharing plans, or receive stock options.
• Managers conduct performance appraisals to evaluate work performance.
• Turnover is the permanent separation of an employee from a company and may happen if an employee is unsatisfied with their job, or because the organization is not satisfied with the employee. Sometimes, firms lay off workers, or downsize, to cut costs.

Image Credits: Chapter 12

Figure 12.1: Adam Bielawski (2011). “Howard Schultz.” Wikimedia Commons. CC BY-SA 3.0. Retrieved from: https://commons.wikimedia.org/wiki/File:Howard-Schultz_2011-04-12_photoby_Adam-Bielawski.jpg

Figure 12.2: Dmitriy Nushtaev (2019). Unsplash. Public Domain. Retrieved from: https://unsplash.com/photos/wIBhj3G3hPA

Figure 12.4: University of Michigan School for Environment and Sustainability (2019). “2019 University of Michigan Green Career Fair.” Flickr. CC BY 2.0. Retrieved from: https://flic.kr/p/2heTunw

Figure 12.5: U.S. Bureau of Labor Statistics. “Employment by gender and ethnic group (2019).” Data retrieved from: https://www.bls.gov/cps/cpsaat10.pdf

Figure 12.7: Fortune. “Top 10 from the 2020 Fortune ‘Best Companies to Work For’ (2020).” Data retrieved from: https://fortune.com/best-companies/

Learning Objectives

• Develop strategies to avoid being burdened with debt.
• Explain how to manage monthly income and expenses.
• Define personal finances and financial planning.
• Explain the financial planning life cycle.
• Discuss the advantages of a college education in meeting short- and long-term financial goals.
• Explain compound interest and the time value of money.
• Discuss the value of getting an early start on your plans for saving.

The World of Personal Credit

Do you sometimes wonder where your money goes? Do you worry about how you’ll pay off your student loans? Would you like to buy a new car or even a home someday and you’re not sure where you’ll get the money? If these questions seem familiar to you, you could benefit from help in managing your personal finances, which this chapter will seek to provide.

 

 

Let’s say that you’re 28 and single. You have a good education and a good job—you’re pulling down $60,000 working with a local accounting firm. You have $6,000 in a retirement savings account, and you carry three credit cards. You plan to buy a condo in two or three years, and you want to take your dream trip to the world’s hottest surfing spots within five years. Your only big worry is the fact that you’re $70,000 in debt, due to student loans, your car loan, and credit card debt. In fact, even though you’ve been gainfully employed for a total of six years now, you haven’t been able to make a dent in that $70,000. You can afford the necessities of life and then some, but you’ve occasionally wondered if you’re ever going to have enough income to put something toward that debt.^{This vignette is adapted from a series titled USA TODAY’s Financial Diet. Go to http://usatoday30.usatoday.com/money/perfi/basics/financial-diet-digest-2005.htm and use the embedded links to follow the entire series.}

Now let’s suppose that while browsing through a magazine in the doctor’s office, you run across a short personal-finances self-help quiz. There are six questions:

 

 

You took the quiz and answered with a B or C to a few questions, and are thereby informed that you’re probably jeopardizing your entire financial future.

Personal-finances experts tend to utilize the types of questions on the quiz: if you answered B or C to any of the first three questions, you have a problem with splurging; if any questions from four through six got a B or C, your monthly bills are too high for your income.

Building a Good Credit Rating

So, you have a financial problem. According to the quick test you took, you splurge and your bills are too high for your income. If you get in over your head and can’t make your loan or rent payments on time, you risk hurting your credit rating—your ability to borrow in the future.

How do potential lenders decide whether you’re a good or bad credit risk? If you’re a poor credit risk, how does this affect your ability to borrow, or the rate of interest you have to pay? Whenever you use credit, those from whom you borrow (retailers, credit card companies, banks) provide information on your debt and payment habits to three national credit bureaus: Equifax, Experian, and TransUnion. The credit bureaus use the information to compile a numerical credit score, called a FICO score; it ranges from 300–850, with the majority of people falling in the 600–700 range. In compiling the score, the credit bureaus consider five criteria: payment history—paying your bills on time (the most important), total amount owed, length of your credit history, amount of new credit you have, and types of credit you use. The credit bureaus share their score and other information about your credit history with their subscribers.^{Colin Robertson (2015). “Credit Score Range – Where Do You Fit In?” Thetruthaboutcreditcards.com. Retrieved from: http://www.thetruthaboutcreditcards.com/credit-score-range/.}

 

 

So what does this do for you? It depends. If you pay your bills on time and don’t borrow too heavily, you’d likely have a high FICO score and lenders would like you, probably giving you reasonable interest rates on the loans you requested. But if your FICO score is low, lenders won’t likely lend you money (or would lend it to you at high interest rates). A low FICO score can even affect your chances of renting an apartment or landing a particular job. So it’s very important that you do everything possible to earn and maintain a high credit score.

As a young person, though, how do you build a credit history that will give you a high FICO score? Based on feedback from several financial experts, Emily Starbuck Gerson and Jeremy Simon of CreditCards.com compiled the list in Figure 18.4 of ways students can build good credit.^{Emily Starbuck Gerson and Jeremy M. Simon (2016). “10 Ways Students Can Build Good Credit.” CreditCards.com. Retrieved from: http://www.creditcards.com/credit-card-news/help/10-ways-students-get-good-credit-6000.php}

 

 

If you meet the qualifications to obtain your own credit card, look for a card with a low interest rate and no annual fee.

 

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=183

Secured vs. Unsecured Credit

On some types of loans, the lender (likely a bank) will require the borrower to offer collateral in order to be approved for the loan. Anyone who has taken out a car loan or bought a house using a mortgage loan has likely pledged the car or the home as a way to ensure the bank that they will be repaid—if the borrower fails to repay, the bank can repossess the car or foreclose on the house, taking ownership of it temporarily and reselling it in order to recover the amount of the loan. In these cases, the car or the house serve as collateral—security pledged to the lender in order to make it more likely that the amount of the loan will be repaid. Loans that involve this type of security are referred to as secured loans or secured credit.

Not all types of loans involve collateral. For example, many families take out student loans when their children go off to college. Credit cards are a form of loan as well. Neither case involves collateral; the lender makes the loans based, at least in part, on the credit worthiness of the borrower. When no collateral is involved, the loans are called unsecured. Since the bank takes more risk in lending when no collateral can be pledged, unsecured loans will often require higher interest rates in order for it to be worth the bank taking the risk in making this type of loan.

A Few More Words about Debt

What should you do to turn things around—to start getting out of debt? According to many experts, you need to take two steps:

1. Cut up your credit cards and start living on a cash-only basis.
2. Do whatever you can to bring down your monthly bills.

Although credit cards can be an important way to build a credit rating, many people simply lack the financial discipline to handle them well. If you see yourself in that statement, then moving to a pay-as-you go basis, i.e., cash or debit card only, may be for you. Be honest with yourself; if you can’t handle credit, then don’t use it.

Bringing Down Those Monthly Bills

So what can you can to bring down your monthly bills? If you want to take a gradual approach, one financial planner suggests that you perform the following “exercises” for one week:^{USA Today and Elissa Buie (2005). “Exercise 1: Start Small, Watch Progress Grow.” USA Today. Retrieved from: http://usatoday30.usatoday.com/money/perfi/basics/2005-04-14-financial-diet-excercise1_x.htm}

• Keep a written record of everything you spend and total it at week’s end.
• Keep all your ATM receipts and count up the fees.
• Take $100 out of the bank and don’t spend a penny more.
• Avoid gourmet coffee shops.

You’ll probably be surprised at how much of your money can quickly become somebody else’s money. If, for example, you spend $3 every day for one cup of coffee at a coffee shop, you’re laying out nearly $1,100 a year just for coffee. If you use your ATM card at a bank other than your own, you’ll probably be charged a fee that can be as high as $3. The average person pays more than $60 a year in ATM fees. If you withdraw cash from an ATM twice a week, you could be racking up $300 in annual fees.^{Mindy Fetterman (2005). “You'll Be Amazed Once You Fix the Leak in Your Wallet.” USA Today.com. Retrieved from: http://usatoday30.usatoday.com/money/perfi/basics/2005-04-14-financial-diet-little-things_x.htm} Another idea—eat out as a reward, not as a rule. A sandwich or leftovers from home can be just as tasty and can save you $6 to $10 a day, even more than our number for coffee! In 2013, the website DailyWorth asked three women to try to cut their spending in half. After tracking her spending, one participant discovered that she had spent $175 eating out in just one week; do that for a year and you’d spend over $9,000!^{Cynthia Ramnarace (2013). “Could You Cut Your Spending in Half?” Daily Worth. Retrieved from: https://www.dailyworth.com/posts/2046-could-you-cut-your-spending-in-half/2} If you think your cable bill is too high, consider alternatives like PlaystationVue or Sling. Changing channels is a bit different, but the savings can be substantial.

 

 

You may or may not be among the American consumers who buy 35 million cans of Bud Light each day, or 150,000 pounds of Starbucks coffee, or 2.4 million Burger King hamburgers. Yours may not be one of the 70 percent of US households with an unopened consumer-electronics product lying around.^{Michael Arrington (2008). “Ebay Survey Says Americans Buy Crap They Don't Want.” Tech Crunch. Retrieved from: https://techcrunch.com/2008/08/21/ebay-survey-says-americans-buy-crap-they-dont-want/} Bottom line: If at age 28 you have a good education and a good job, a $60,000 income, and a $70,000 debt (by no means an implausible scenario) there’s a very good reason why you should think hard about controlling your debt. Your level of indebtedness will be a key factor in your ability—or inability—to reach your long-term financial goals, such as home ownership, a dream trip, and, perhaps most importantly, a reasonably comfortable retirement.

Financial Planning

Before we go any further, we need to nail down a couple of key concepts. First, just what, exactly, do we mean by personal finances? Finance itself concerns the flow of money from one place to another, and your personal finances concern your money and what you plan to do with it as it flows in and out of your possession. Essentially, then, personal finance is the application of financial principles to the monetary decisions that you make either for your individual benefit or for that of your family.

Second, as we suggested earlier, monetary decisions work out much more beneficially when they’re planned rather than improvised. Thus our emphasis on financial planning—the ongoing process of managing your personal finances in order to meet goals that you’ve set for yourself or your family.

Financial planning requires you to address several questions, some of them relatively simple:

• What’s my annual income?
• How much debt do I have, and what are my monthly payments on that debt?

Others will require some investigation and calculation:

• What’s the value of my assets?
• How can I best budget my annual income?

Still others will require some forethought and forecasting:

• How much wealth can I expect to accumulate during my working lifetime?
• How much money will I need when I retire?

The Financial Planning Life Cycle

Another question that you might ask yourself—and certainly would do if you worked with a professional in financial planning—is, “How will my financial plans change over the course of my life?” Figure 18.6 illustrates the financial life cycle of a typical individual—one whose financial outlook and likely outcomes are probably a lot like yours.^{Timothy J. Gallager and Joseph D. Andrews Jr. (2003). Financial Management: Principles and Practice, 3rd ed. Upper Saddle River, NJ: Prentice Hall. pp. 34, 196.} As you can see, our diagram divides this individual’s life into three stages, each of which is characterized by different life events (such as beginning a family, buying a home, planning an estate, retiring).

 

 

At each stage, there are recommended changes in the focus of the individual’s financial planning:

• Stage 1 focuses on building wealth.
• Stage 2 shifts the focus to the process of preserving and increasing wealth that one has accumulated and continues to accumulate.
• In Stage 3, the focus turns to the process of living on (and, if possible, continuing to grow) one’s saved wealth after retirement.

At each stage, of course, complications can set in—changes in such conditions as marital or employment status or in the overall economic outlook, for example. Finally, as you can also see, your financial needs will probably peak somewhere in stage 2, at approximately age 55, or 10 years before typical retirement age.

 

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=183

Choosing a Career

Until you’re on your own and working, you’re probably living on your parents’ wealth right now. In our hypothetical life cycle, financial planning begins in the individual’s early 20s. If that seems like rushing things, consider a basic fact of life: this is the age at which you’ll be choosing your career—not only the sort of work you want to do during your prime income-generating years, but also the kind of lifestyle you want to live. What about college? Most readers of this book, of course, have decided to go to college. If you haven’t yet decided, you need to know that college is an extremely good investment of both money and time.

Figure 18.7 summarizes the findings of a study conducted by the US Census Bureau.^{U.S. Census Bureau (2015). “PINC-03. Educational Attainment-People 25 Years Old and Over, by Total Money Earnings, Work Experience, Age, Race, Hispanic Origin, and Sex.” Retrieved from: http://www.census.gov/data/tables/time-series/demo/income-poverty/cps-pinc/pinc-03.html} A quick review shows that people who graduate from high school can expect to enjoy average annual earnings about 28 percent higher than those of people who don’t, and those who go on to finish college can expect to generate 76 percent more annual income than high school graduates who didn’t attend college. Over the course of the financial life cycle, families headed by those college graduates will earn about $1.6 million more^{Katherine Hansen (2016). “What Good is a College Education Anyway? The Value of a College Education.” Quintessential Live Career. Retrieved from: https://www.livecareer.com/quintessential/college-education-value} than families headed by high school graduates. (With better access to health care—and, studies show, with better dietary and health practices—college graduates will also live longer. And so will their children.)^Ibid.

Figure 18.7: Average Earnings by Education Level

Education	Average income	Percentage increase over previous level
High school dropout	$30,612	–
High school diploma	$41,829	37%
Associate’s degree	$49,966	20%
Bachelor’s degree	$73,880	48%
Master’s degree	$87,570	19%
Doctorate degree	$125,331	43%
Professional degree	$150,215	20%

What about the student-loan debt that so many people accumulate? For every $1 that you spend on your college education, you can expect to earn about $35 during the course of your financial life cycle.^Ibid. At that rate of return, you should be able to pay off your student loans (unless, of course, you fail to practice reasonable financial planning).

Naturally, there are exceptions to these average outcomes. You’ll find some college graduates stocking shelves at 7-Eleven, and you’ll find college dropouts running multibillion-dollar enterprises. Microsoft cofounder Bill Gates dropped out of college after two years, as did his founding partner, Paul Allen. Though exceptions to rules (and average outcomes) certainly can be found, they fall far short of disproving them: in entrepreneurship as in most other walks of adult life, the better your education, the more promising your financial future. One expert in the field puts the case for the average person bluntly: educational credentials “are about being employable, becoming a legitimate candidate for a job with a future. They are about climbing out of the dead-end job market.”^Ibid.

Time Is Money

The fact that you have to choose a career at an early stage in your financial life cycle isn’t the only reason that you need to start early on your financial planning. Let’s assume, for instance, that it’s your eighteenth birthday and that on this day you take possession of $10,000 that your grandparents put in trust for you. You could, of course, spend it; in particular, it would probably cover the cost of flight training for a private pilot’s license—something you’ve always wanted but were convinced that you couldn’t afford right away. Your grandfather, of course, suggests that you put it into some kind of savings account. If you just wait until you finish college, he says, and if you can find a savings plan that pays 5 percent interest, you’ll have the $10,000 plus about another $2,000 for something else or to invest.

The total amount you’ll have—$12,000—piques your interest. If that $10,000 could turn itself into $12,000 after sitting around for four years, what would it be worth if you actually held on to it until you did retire—say, at age 65? A quick trip to the Internet to find a compound-interest calculator informs you that, 47 years later, your $10,000 will have grown to $104,345 (assuming a 5 percent interest rate). That’s not really enough for retirement on, but it would be a good start. On the other hand, what if that four years in college had paid off the way you planned, so that once you get a good job you’re able to add, say, another $10,000 to your retirement savings account every year until age 65? At that rate, you’ll have amassed a nice little nest egg of slightly more than $1.6 million.

Compound Interest

In your efforts to appreciate the potential of your $10,000 to multiply itself, you have acquainted yourself with two of the most important concepts in finance. As we’ve already indicated, one is the principle of compound interest, which refers to the effect of earning interest on your interest.

Let’s say, for example, that you take your grandfather’s advice and invest your $10,000 (your principal) in a savings account at an annual interest rate of 5 percent. Over the course of the first year, your investment will earn $500 in interest and grow to $10,500. If you now reinvest the entire $10,500 at the same 5 percent annual rate, you’ll earn another $525 in interest, giving you a total investment at the end of year 2 of $11,025. And so forth. And that’s how you can end up with $81,496.67 at age 65.

Time Value of Money

You’ve also encountered the principle of the time value of money—the principle whereby a dollar received in the present is worth more than a dollar received in the future. If there’s one thing that we’ve stressed throughout this chapter so far, it’s the fact that most people prefer to consume now rather than in the future. If you borrow money from me, it’s because you can’t otherwise buy something that you want at the present time. If I lend it to you, I must forego my opportunity to purchase something I want at the present time. I will do so only if I can get some compensation for making that sacrifice, and that’s why I’m going to charge you interest. And you’re going to pay the interest because you need the money to buy what you want to buy now. How much interest should we agree on? In theory, it could be just enough to cover the cost of my lost opportunity, but there are, of course, other factors. Inflation, for example, will have eroded the value of my money by the time I get it back from you. In addition, while I would be taking no risk in loaning money to the US government, I am taking a risk in lending it to you. Our agreed-on rate will reflect such factors.^{Timothy J. Gallager and Joseph D. Andrews Jr. (2003). Financial Management: Principles and Practice, 3rd ed. Upper Saddle River, NJ: Prentice Hall. pp. 34, 196.}

Finally, the time value of money principle also states that a dollar received today starts earning interest sooner than one received tomorrow. Let’s say, for example, that you receive $2,000 in cash gifts when you graduate from college. At age 23, with your college degree in hand, you get a decent job and don’t have an immediate need for that $2,000. So you put it into an account that pays 10 percent compounded and you add another $2,000 ($167 per month) to your account every year for the next 11 years.^{The 10 percent rate is not realistic in today’s economic market and is used for illustrative purposes only.} The blue line in Figure 18.8 graphs how much your account will earn each year and how much money you’ll have at certain ages between 24 and 67.

As you can see, you’d have nearly $52,000 at age 36 and a little more than $196,000 at age 50; at age 67 you’d be just a bit short of $1 million. The yellow line in the graph shows what you’d have if you hadn’t started saving $2,000 a year until you were age 36. As you can also see, you’d have a respectable sum at age 67, but less than half of what you would have accumulated by starting at age 23. More important, even to accumulate that much, you’d have to add $2,000 per year for a total of 32 years, not just 12.

Here’s another way of looking at the same principle. Suppose that you’re 20 years old, don’t have $2,000, and don’t want to attend college full-time. You are, however, a hard worker and a conscientious saver, and one of your financial goals is to accumulate a $1 million retirement nest egg. As a matter of fact, if you can put $33 a month into an account that pays 12 percent interest compounded,^{Again, this interest rate is unrealistic in today’s market and is used for illustrative purposes only.} you can have your $1 million by age 67. That is, if you start at age 20. As you can see from Figure 18.9, if you wait until you’re 21 to start saving, you’ll need $37 a month. If you wait until you’re 30, you’ll have to save $109 a month, and if you procrastinate until you’re 40, the ante goes up to $366 a month.^{Arthur J. Keown (2007). Personal Finance: Turning Money into Wealth, 4th ed. Upper Saddle River, NJ: Pearson Education. p. 23.} Unfortunately in today’s low interest rate environment, finding 10⁠–12 percent return is not likely. Nevertheless, these figures illustrate the significant benefit of saving early.

 

 

The reason should be fairly obvious: a dollar saved today not only starts earning interest sooner than one saved tomorrow (or 10 years from now) but also can ultimately earn a lot more money in the long run. Starting early means in your 20s—early in stage 1 of your financial life cycle. As one well-known financial advisor puts it, “If you’re in your 20s and you haven’t yet learned how to delay gratification, your life is likely to be a constant financial struggle.”^{AllFinancialMatters (2006). “An Interview with Jonathan Clements – Part 2.” Retrieved from: http://allfinancialmatters.com/2006/02/10/an-interview-with-jonathan-clements-part-2/}

Figure 18.9: What Does It Take to Save a Million Dollars?

How to save a million dollars by age 67
Make your first payment at age:	And this is what you’ll have to save each month:
20	$33
21	$42
23	$47
24	$53
25	$60
26	$67
27	$76
28	$85
30	$109
35	$199
40	$366
50	$1,319
60	$6,253

Suppose you want to save or invest—do you know how or where to do so? You probably know that your branch bank can open a savings account for you, but interest rates on such accounts can be pretty unattractive. Investing in individual stocks or bonds can be risky, and usually require a level of funds available that most students don’t have. In those cases, mutual funds can be quite interesting. A mutual fund is a professionally managed investment program in which shareholders buy into a group of diversified holdings, such as stocks and bonds. Companies like Vanguard and Fidelity offer a range of investment options including indexed funds, which track with well-known indices such as the Standard & Poors 500, a.k.a. the S&P 500. Minimum investment levels in such funds can actually be within the reach of many students, and the funds accept electronic transfers to make investing more convenient. One key to keep in mind when investing is diversification—a fancy way of saying not to put all your eggs in one basket. We’ll leave a more detailed discussion of investment vehicles to your more advanced courses.

 

An interactive or media element has been excluded from this version of the text. You can view it online here:
https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=183

 

Chapter Video 

If you ask graduates who came before you what they wish they had known when they were first out of school, many would probably say, “how to handle my personal finances.” While these two videos and this chapter won’t make you financially literate, hopefully they will whet your appetite to learn more.

A YouTube element has been excluded from this version of the text. You can view it online here: https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=183

(Copyrighted material)

A YouTube element has been excluded from this version of the text. You can view it online here: https://pressbooks.lib.vt.edu/fundamentalsofbusiness3e/?p=183

(Copyrighted material)