TERM PAPER

CourseMGT 480

Submitted ToMohammad Sazzad Hossain

LecturerDepartment Of Business Administration

Submitted By

Jisan Rumon Islam ID # 2008-2-10-146Arpita Chakraborty ID # 2008-2-10-247Sadia Afrin Choudhury ID # 2008-2-10-098Dibyendu Das Sourav ID# 2008-2-10-039Faisal Amin Sarker ID# 2008-2-10-102

Syed toufique Bishaka ID#2008-1-10-077 Imran Al Arefen ID# 2008-3-10-041

Muhammed Mobasher Hossain ID# 2008-2-10-041Shirin Islam ID#2007-2-10-042

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Table of Content

No. Topic Title ` Pg. No.

1. Porter’s five competitive forces

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2. Key Ratio 7

3. Product life-cycle (PLC)

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4. BCG Matrix

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5. SWOT Analysis 16

6. The Fishbone Diagram

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7. Key Macroeconomic Factors through understanding

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8. Cost-push inflation and Demand-pull inflation

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9. References

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Porter’s five competitive forces

A means of providing corporations with an analysis of their competition and determining strategy, Porter's five-forces model looks at the strength of five distinct competitive forces, which, when taken together, determine long-term profitability and competition. Porter's work has had a greater influence on business strategy than any other theory in the last half of the twentieth century, and his more recent work may have a similar impact on global competition. The model of pure competition implies that risk-adjusted rates of return should be constant across firms and industries. However, numerous economic studies have affirmed that different industries can sustain different levels of profitability; part of this difference is explained by industry structure. Michael Porter provided a framework that models an industry as being influenced by five forces. The strategic business manager seeking to develop an edge over rival firms can use this model to better understand the industry context in which the firm operates.

Porter's five forces analysis is a framework for industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979. It draws upon industrial organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. An "unattractive" industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven to normal profit. Three of Porter's five forces refer to competition from external sources. The remainders are internal threats.

Porter referred to these forces as the micro environment, to contrast it with the more general term macro environment. They consist of those forces close to a company that affect its ability to serve its customers and make a profit. A change in any of the forces normally, requires a business unit to re-assess the marketplace given the overall change in industry information. The overall industry attractiveness does not imply that every firm in the industry will return the same profitability. Firms are able to apply their core competencies, business model or network to achieve a profit above the industry average. A clear example of this is the airline industry. As an industry, profitability is low and yet individual companies, by applying unique business models, have been able to make a return in excess of the industry average.

Porter's five forces include - three forces from 'horizontal' competition: threat of substitute products, the threat of established rivals, and the threat of new entrants; and two forces from 'vertical' competition: the bargaining power of suppliers and the bargaining power of customers. This five forces analysis is just one part of the complete Porter strategic models. The other elements are the value chain and the generic strategies. Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis, which he found un-rigorous and Porter's five forces is based on the Structure-Conduct-Performance paradigm in industrial organizational

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economics. It has been applied to a diverse range of problems, from helping businesses become more profitable to helping governments stabilize industries.

Figure: Porter’s five competitive forces

I. Rivalry

In the traditional economic model, competition among rival firms drives profits to zero. But competition is not perfect and firms are not unsophisticated passive price takers. Rather, firms strive for a competitive advantage over their rivals. The intensity of rivalry among firms varies across industries, and strategic analysts are interested in these differences. If rivalry among firms in an industry is low, the industry is considered to be disciplined. This discipline may result from the industry's history of competition, the role of a leading firm, or informal compliance with a generally understood code of conduct. Explicit collusion generally is illegal and not an option; in low-rivalry industries competitive moves must be constrained informally. However, a maverick firm seeking a competitive advantage can displace the otherwise disciplined market.

When a rival acts in a way that elicits a counter-response by other firms, rivalry intensifies. The intensity of rivalry commonly is referred to as being cutthroat, intense, moderate, or weak, based on the firms' aggressiveness in attempting to gain an advantage. In pursuing an advantage over its rivals, a firm can choose from several competitive moves:

Changing prices - raising or lowering prices to gain a temporary advantage. Improving product differentiation - improving features, implementing innovations in the

manufacturing process and in the product itself.

Creatively using channels of distribution - using vertical integration or using a distribution channel that is novel to the industry. For example, with high-end jewelry

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stores reluctant to carry its watches, Timex moved into drugstores and other non-traditional outlets and cornered the low to mid-price watch market.

Exploiting relationships with suppliers - for example, from the 1950's to the 1970's Sears, Roebuck and Co. dominated the retail household appliance market. Sears set high quality standards and required suppliers to meet its demands for product specifications and price.

II. Threat of Substitutes

In Porter's model, substitute products refer to products in other industries. To the economist, a threat of substitutes exists when a product's demand is affected by the price change of a substitute product. A product's price elasticity is affected by substitute products - as more substitutes become available, the demand becomes more elastic since customers have more alternatives. A close substitute product constrains the ability of firms in an industry to raise prices.

The competition engendered by a Threat of Substitute comes from products outside the industry. The price of aluminum beverage cans is constrained by the price of glass bottles, steel cans, and plastic containers. These containers are substitutes, yet they are not rivals in the aluminum can industry. To the manufacturer of automobile tires, tire retreads are a substitute. Today, new tires are not so expensive that car owners give much consideration to retreading old tires. But in the trucking industry new tires are expensive and tires must be replaced often. In the truck tire market, retreading remains a viable substitute industry. In the disposable diaper industry, cloth diapers are a substitute and their prices constrain the price of disposables.

While the threat of substitutes typically impacts an industry through price competition, there can be other concerns in assessing the threat of substitutes. Consider the substitutability of different types of TV transmission: local station transmission to home TV antennas via the airways versus transmission via cable, satellite, and telephone lines. The new technologies available and the changing structure of the entertainment media are contributing to competition among these substitute means of connecting the home to entertainment. Except in remote areas it is unlikely that cable TV could compete with free TV from an aerial without the greater diversity of entertainment that it affords the customer.

III. Buyer Power

The power of buyers is the impact that customers have on a producing industry. In general, when buyer power is strong, the relationship to the producing industry is near to what an economist terms a monopsony - a market in which there are many suppliers and one buyer. Under such market conditions, the buyer sets the price. In reality few pure monopsonies exist, but frequently there is some asymmetry between a producing industry and buyers.

IV. Supplier Power

A producing industry requires raw materials - labor, components, and other supplies. This requirement leads to buyer-supplier relationships between the industry and the firms that provide

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it the raw materials used to create products. Suppliers, if powerful, can exert an influence on the producing industry, such as selling raw materials at a high price to capture some of the industry's profits.

V. Threat of New Entrants and Entry Barriers

It is not only incumbent rivals that pose a threat to firms in an industry; the possibility that new firms may enter the industry also affects competition. In theory, any firm should be able to enter and exit a market, and if free entry and exit exists, then profits always should be nominal. In reality, however, industries possess characteristics that protect the high profit levels of firms in the market and inhibit additional rivals from entering the market. These are barriers to entry. Barriers to entry are more than the normal equilibrium adjustments that markets typically make. For example, when industry profits increase, we would expect additional firms to enter the market to take advantage of the high profit levels, over time driving down profits for all firms in the industry. When profits decrease, we would expect some firms to exit the market thus restoring market equilibrium. Falling prices, or the expectation that future prices will fall, deters rivals from entering a market. Firms also may be reluctant to enter markets that are extremely uncertain, especially if entering involves expensive start-up costs. These are normal accommodations to market conditions. But if firms individually (collective action would be illegal collusion) keep prices artificially low as a strategy to prevent potential entrants from entering the market, such entry-deterring pricing establishes a barrier.

Usage of this model

Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a firm's strategic position. However, for most consultants, the framework is only a starting point or "checklist." They might use “Value Chain" afterward. According to Porter, the five forces model should be used at the line-of-business industry level; it is not designed to be used at the industry group or industry sector level. An industry is defined at a lower, more basic level: a market in which similar or closely related products and/or services are sold to buyers. (See industry information.) A firm that competes in a single industry should develop, at a minimum, one five forces analysis for its industry. Porter makes clear that for diversified companies, the first fundamental issue in corporate strategy is the selection of industries (lines of business) in which the company should compete; and each line of business should develop its own, industry-specific, five forces analysis. The average Global 1,000 company competes in approximately 52 industries (lines of business).

Criticisms of this model

Porter's framework has been challenged by other academics and strategists such as Stewart Neill. Similarly, the likes of Kevin P. Coyne and Somu Subramaniam have stated that three dubious assumptions underlie the five forces:

That buyers, competitors, and suppliers are unrelated and do not interact and collude.

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That the source of value is structural advantage (creating barriers to entry).

That uncertainty is low, allowing participants in a market to plan for and respond to competitive behavior.

An important extension to Porter was found in the work of Adam Brandenburger and Barry Nalebuff in the mid-1990s. Using game theory, they added the concept of complementors (also called "the 6th force"), helping to explain the reasoning behind strategic alliances. The idea that complementors are the sixth force has often been credited to Andrew Grove, former CEO of Intel Corporation. According to most references, the sixth force is government or the public. Martyn Richard Jones, whilst consulting at Groupe Bull, developed an augmented 5 forces model in Scotland in 1993. It is based on Porter's model and includes Government (national and regional) as well as Pressure Groups as the notional 6th force. This model was the result of work carried out as part of Group Bull's Knowledge Asset Management Organization initiative.

Key ratios

Ratio analysis, a method of expressing the relationships between any two accounting elements, provides a convenient technique for performing financial analysis. It is an indication of the Health of Your Business.

Ratio analysis is the study of relationships among and between various financial statement accounts. The following are extracted from chapter 6, "Fundamentals of Investing" by Gitman and Joehnk, 1993. This extract should be viewed along side the attached computations for EMC Corporation, a company that BAB's has interest in and therefore should make the study more interesting, if in deed looking at numbers can be interesting.

Short Term Activity Ratios:

1. Inventory Turnover Ratio

A ratio showing how many times a company's inventory is sold and replaced over a period. the The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or "inventory turnover days". 

Inventory Turnover Ratio = Cogs / Avg. Inventory

2. Receivables Turnover

An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts. The receivables turnover ratio is an activity ratio, measuring how efficiently a firm uses its assets.

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Some companies' reports will only show sales - this can affect the ratio depending on the size of cash sales.

3. Working Capital Turnover

A measurement comparing the depletion of working capital to the generation of sales over a given period. This provides some useful information as to how effectively a company is using its working capital to generate sales.

Long-term Activity Ratio:

These ratios measure the efficiency of long term capital investment in generating sales. These ratios indicate the level of utilization of fixed assets to generate certain level of sales. Trend of this ratios indicates how efficient the company in utilizing its fixed assets.

4. Fixed Assets Turnover

This ratio measures using the fixed asset how much sales the company generates. Higher the ratio is better for the company, because higher the ratio indicates that the company is efficient to utilize the fixed assets in case of generating sales.

Fixed Assets Turnover = Sales/Avg. Fixed Assets

5. Total Assets Turnover

This ratio measures by utilizing its total assets how much sales the company generates. Higher the ratio is better for the company, because higher the ratio indicates that the company is efficient to utilize the assets in case of generating sales.

Total Assets Turnover = Sales/Avg. Total Assets

LIQUIDITY RATIOS:

Liquidity means the ability of the company to use its Current Assets to pay its Short Term obligations. ST lenders and ST creditors are more concern about the liquidity analysis of a company, because they want to know that whether a company has ability to pay its short term obligation in-time or not.

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1. Current Ratio

Current ratio indicates the company’s ability to pay its short term obligation with its short term assets.

Current assets

Current Ratio = ---------------    

Current liabilities

2. Quick Ratio

Since not all the elements of current asset of a firm can’t be readily converted into cash, quick ratio eliminates those components which can’t be converted into cash i.e. prepaid expenses and depreciation

Current assets minus inventory

Ratio = ---------------------------------------  

Current Liabilities

3. Cash Ratio

Cash ratio is the most conservative measuring tool of liquidity position of the company.

The cash ratio measures liquidity depending only on cash and marketable securities

excluding inventory and prepaid expense.

Cash + Marketable Securities

Cash Ratio = ---------------------------------------  

Current Liabilities

Long-term Debt and Solvency Ratio:

The analysis of firm capital structure is necessary to understand long term risk and return prospect. The following table shows some important ratios that shades some light into the firm’s capital structure.

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1. Debt to Total Capital Ratio

This ratio explains the proportion of External claim over firm’s total assets or total

capital. Lower the Ratio is better for company’s shareholder, because it indicates that the

shareholder of the firm have more claim over firm’s total assets than the external claims.

Debt to Total Capital Ratio = Total Debt(Current + Long-Term)/Total Capital(Debt +

Equity)

2. Debt to Equity Ratio:

Debt to Equity ratio talks about the claim of equity holder after paying the Debt’s claim.

Lower ratio is better, that means the equity holders will bear lower liability.

Debt to Equity Ratio = Total Debt/Total Equity

Gross Margin

A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The gross margin represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services sold by a company. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and obligations.

Return on Assets Analysis:This is an important ratio for companies deciding whether or not to initiate a new project. The basis of this ratio is that if a company is going to start a project they expect to earn a return on it, ROA is the return they would receive. Simply put, if ROA is above the rate that the company borrows at then the project should be accepted, if not then it is rejected.

Return on Assets Analysis = (Net Income + After Tax Interest) / Average Total Assets

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Product life-cycle (PLC)

Like human beings, products also have a life cycle. From birth to death, human beings pass through various stages e.g. birth, growth, maturity, decline and death. A similar life-cycle is seen in the case of products. The product life cycle goes through multiple phases, involves many professional disciplines, and requires many skills, tools and processes. Product life cycle (PLC) has to do with the life of a product in the market with respect to business/commercial costs and sales measures. One product passes through four stages, which are:

Market introduction stage Growth stage Maturity stage and Decline

Introduction stage:

At the Introduction (or development) Stage market size and growth is slight. It is possible that substantial research and development costs have been incurred in getting the product to this stage. In addition, marketing costs may be high in order to test the market, undergo launch promotion and set up distribution channels. It is highly unlikely that companies will make profits on products at the Introduction Stage. Products at this stage have to be carefully monitored to ensure that they start to grow. Otherwise, the best option may be to withdraw or to end the product.

Growth Stage:

The Growth Stage is characterized by rapid growth in sales and profits. Profits arise due to an increase in output (economies of scale) and possibly better prices. At this stage, it is cheaper for businesses to invest in increasing their market share as well as enjoying the overall growth of the market. Accordingly, significant promotional resources are traditionally invested in products that are firmly in the Growth Stage.

Maturity Stage:

The Maturity Stage is, perhaps, the most common stage for all the markets. It is in this stage that competition is most intense as companies fight to maintain their market share. Here, both marketing and finance become key activities. Marketing spend has to be monitored carefully,

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since any significant moves are likely to be copied by competitors. The Maturity Stage is the time when most profit is earned by the market as a whole. Any expenditure on research and development is likely to be restricted to product modification and improvement and perhaps to improve production efficiency and quality.

Decline Stage:

In the Decline Stage, the market is shrinking, reducing the overall amount of profit that can be shared amongst the remaining competitors. At this stage, great care has to be taken to manage the product carefully. It may be possible to take out some production cost, to transfer production to a cheaper facility, sell the product into other, cheaper markets. Care should be taken to control the amount of stocks of the product. Ultimately, depending on whether the product remains profitable, a company may decide to end the product.

For example we can consider the product life cycle of Maggi Instant Noodle by Nestle. In India, Nestle India Ltd introduced Maggi noodle in 1982 and after that the company paid a lot to promote Maggi throughout Indian market. Now Nestle has several products under the brand name Maggi and owns about 90% of the market share in this segment.

At the Introductory stage of Maggi's launch throughout India there were no competitor in the Instant Noodle segment. Nestle wanted to explore potential for such an instant food among the Indian market. The project was limited distribution in certain places to understand the customer's response and frequent modification. As for that, Nestle faced high marketing and production cost.

But for the First mover advantage by Nestle India Ltd, the company gained a huge market and managed to retain the leadership in instant noodle category. The company decided to proceed to producing Maggi noodle for the segment of kids, youth, office goers, working women and health conscious people in Indian market and moved on to the Growth stage.

In the Growth stage the company had enjoyed huge sales and around 50% of the market share in this segment. In 10 years, Nestle India Ltd's share for Maggi instant noodle was valued around 250 cores. The company recovered development cost and also the company lowered the price of the product. Within time the company faced competitors like Top Ramen. In 1997, to improve sales Nestle changed the formulation of Maggi, which was considered to be a mistake as consumers did not like the taste of the new Maggi. Again in March 1999, the company reintroduced the old formulation by which the sales revived. Nestle also introduced soup and other cooking aids under the brand name Maggi to revive sales.

Now Maggi instant noodle is in the maturity stage. The market is now saturated; there is extended product line of Maggi and Nestle is doing heavy promotion to dealers and consumers to buy their product. The company is making packaging changes throughout the years for sustaining sales. In 2003, Hindustan Lever introduced Soupy Snax to take down Maggi. The company was very much successful as it gained a segment of Maggi lovers by aggressive pricing.

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Soupy Snax targeted the same market segment of Maggi noodle which are kids, youth and office goers.

At present time there are many competitors of instant noodle in India but still Nestle managed to make Maggi noodle in the maturity stage. Still Maggi itself holds the larger portion of Instant noodle market share.

BCG Matrix

The BCG model is a well-known portfolio management tool used in product life cycle theory which is related to marketing. The BCG Matrix is a business method that was created by the Boston Consulting Group in the 1970’s. This matrix is also known as the Boston Box or Grid. BCG matrix is often used to prioritize which products within company product mix get more funding and attention. The BCG model is based on classification of products as well as company business units into four categories based on combinations of market growth and market share

relative to the largest competitor. This helps the company allocate resources and is used as an analytical tool in brand marketing, product management, strategic management, and portfolio analysis.

Each product has its product life cycle, and each stage in product's life-cycle represents a different profile of risk and return. In general, a company should maintain a balanced portfolio

of products. Having a balanced product portfolio includes both high-growth products as well as low-growth products.

A high-growth product is for example a new one that we are trying to get to some market. It takes some effort and resources to market it, to build distribution channels, and to build sales infrastructure, but it is a product that is expected to bring the gold in the future. An example of this product would be TATA Nano car.

A low-growth product is for example an established product known by the market. Characteristics of this product do not change much, customers know what they are getting, and the price does not change much either. This product has only limited budget for marketing. This is the milking cow that brings in the constant flow of cash. An example of this product would be regular Colgate toothpaste.

So the companies need to find out the phase of their product in product life cycle. Companies need to classify the sales and promotional strategy. The BCG matrix helps to find out the

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position of the product in the market. The BCG matrix reaches further behind product mix. It helps managers to make decisions about what priorities to assign to not only products but also company departments and business units.

To use the chart, analysts plot a scatter graph to rank the business units or products on the basis of their relative market shares and growth rates. Placing products in the BCG matrix results in 4 categories in a portfolio of a company:

BCG STARS (high growth, high market share):

1. Stars are defined by having high market share in a growing market.2. Stars are the leaders in the business but still need a lot of support for promotion a

placement.

3. If market share is kept, Stars are likely to grow into cash cows.

4. Any attempt should be made to maintain the market share

BCG QUESTION MARKS (high growth, low market share):

1. These products are in growing markets but have low market share.2. Question marks are essentially new products where buyers have yet to discover them.

3. The marketing strategy is to get markets to adopt these products.

4. Question marks have high demands and low returns due to low market share.

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5. These products need to increase their market share quickly or they become dogs.

6. The best way to handle Question marks is to either invest heavily in them to gain market share or to sell them or invest nothing and enjoy whatever cash it is generating.

BCG CASH COWS (low growth, high market share):

1. Cash cows are in a position of high market share in a mature market.2. If competitive advantage has been achieved, cash cows have high profit margins and

generate a lot of cash flow.

3. Because of the low growth, promotion and placement investments are low.

4. Investments into supporting infrastructure can improve efficiency and increase cash flow more.

5. Cash cows are the products that businesses strive for.

BCG DOGS (low growth, low market share):

1. Dogs are in low growth markets and have low market share.2. Dogs should be avoided and minimized.

3. Expensive turn-around plans usually do not help so liquidation of business can be considered.

Limitation of BCG matrix:

Some limitations of the BCG matrix model include:

1. A high market share does not necessarily lead to profitability at all times2. The model employs only two dimensions – market share and product or service growth

rate

3. Low share or niche businesses can be profitable too (some Dogs can be more profitable than cash Cows)

4. The model does not reflect growth rates of the overall market5. The model neglects the effects of synergy between business units

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6. Market growth is not the only indicator for attractiveness of a market

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S W O T a n a l y s i s

SWOT analysis is a method for analyzing a business, its resources, and its environment. It is a strategic planning method used to evaluate the Strengths, Weaknesses/Limitations, Opportunities, and Threats involved in a project or in a business venture. It involves specifying the objective of the business venture or project and identifying the internal and external factors that are favorable and unfavorable to achieve that objective. The technique is credited to Albert Humphrey, who led a convention at Stanford University in the 1960s and 1970s using data from Fortune 500 companies.

SWOT is commonly used as part of strategic planning and looks at:

Internal strengths Internal weaknesses

Opportunities in the external environment

Threats in the external environment

SWOT can help management in a business discover:

What the business does better than the competition What competitors do better than the business

Whether the business is making the most of the opportunities available

How a business should respond to changes in its external environment

Setting the objective should be done after the SWOT analysis has been performed. This would allow achievable goals or objectives to be set for the organization.

Strengths: characteristics of the business, or project team that give it an advantage over others

Weaknesses (or Limitations): are characteristics that place the team at a disadvantage relative to others

Opportunities: external chances to improve performance (e.g. make greater profits) in the environment

Threats: external elements in the environment that could cause trouble for the business or project

Identification of SWOTs is essential because subsequent steps in the process of planning for achievement of the selected objective may be derived from the SWOTs.

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The result of the analysis is a matrix of positive and negative factors for management to address:

Positive factors Negative factors

Internal factors

Strengths Weaknesses

External factors

Opportunities Threats

The key point to remember about SWOT is that:

Strengths and weaknesses

Are internal to the business Relate to the present situation

Opportunities and threats

Are external to the business Relate to changes in the environment which will impact the business

Use of SWOT Analysis:

The usefulness of SWOT analysis is not limited to profit-seeking organizations. SWOT analysis may be used in any decision-making situation when a desired end-state (objective) has been defined. Examples include: non-profit organizations, governmental units, and individuals. SWOT analysis may also be used in pre-crisis planning and preventive crisis management. SWOT analysis may also be used in creating a recommendation during a viability study/survey.

Example SWOT Analysis:

A start-up small consultancy business might draw up the following SWOT Analysis:Strengths: We are able to respond very quickly as we have no red tape, and no need for higher

management approval.

We are able to give really good customer care, as the current small amount of work means we have plenty of time to devote to customers.

Our lead consultant has strong reputation in the market.

We can change direction quickly if we find that our marketing is not working.

We have low overheads, so we can offer good value to customers.

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Weaknesses: Our company has little market presence or reputation.

We have a small staff, with a shallow skills base in many areas.

We are vulnerable to vital staff being sick, and leaving.

Our cash flow will be unreliable in the early stages.

Opportunities: Our business sector is expanding, with many future opportunities for success.

Local government wants to encourage local businesses.

Our competitors may be slow to adopt new technologies.

Threats: Developments in technology may change this market beyond our ability to adapt.

A small change in the focus of a large competitor might wipe out any market position we achieve.

As a result of their SWOT Analysis, the consultancy may decide to specialize in rapid response, good value services to local businesses and local government.Marketing would be in selected local publications to get the greatest possible market presence for a set advertising budget, and the consultancy should keep up-to-date with changes in technology where possible.

The Fishbone Diagram

The Fishbone Diagram (G) is a tool for analyzing process dispersion. It is also referred to as the "Ishikawa diagram," because Kaoru Ishikawa developed it, and the "fishbone diagram," because the complete diagram resembles a fish skeleton. The diagram illustrates the main causes and sub causes leading to an effect (symptom).

It is a team brainstorming tool used to identify potential root causes (G) to problems. Because of its function it may be referred to as a cause-and-effect diagram.

In a typical Fishbone diagram, the effect is usually a problem needs to be resolved, and is placed at the "fish head". The causes of the effect are then laid out along the "bones", and classified into different types along the branches. Further causes can be laid out alongside further side branches. So the general structure of a fishbone diagram is presented below.

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Figure 1: Fishbone Diagram – Structure

Objectives:

The main goal of the Fishbone diagram is to illustrate in a graphical way the relationship between a given outcome and all the factors that influence this outcome. The main objectives of this tool are:

Determining the root causes (G) of a problem.

focusing on a specific issue without resorting to complaints and irrelevant discussion

Identifying areas where there is a lack of data.

Field of Application:

The Fishbone diagram could be applied when it is wanted to:

focus attention on one specific issue or problem.

Focus the team on the causes (G), not the symptoms.

Organize and display graphically the various theories about what the root causes (G) of a problem may be.

Show the relationship of various factors influencing a problem.

Reveal important relationships among various variables and possible causes (G).

Provide an additional insight into process behaviors.

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The steps for constructing and analyzing a Cause-and-Effect Diagram are outlined below:

Step 1 - Identify and clearly define the outcome or effect to be analyzed:

Formulate the problem and write it in a box on the right side of the diagram. Everyone must clearly understand the nature of the problem and the process/product being discussed. If everyone is not clear on the purpose of the session, the session will not resolve the problem. In this step the following rules have to be applied:

Decide on the effect to be examined. Effects are stated as particular quality characteristics, problems resulting from work, planning objectives, and the like.

Use Operational Definitions: Develop an Operational Definition of the effect to ensure that it is clearly understood.

Remember, an effect may be positive (an objective) or negative (a problem), depending upon the issue that’s being discussed.

using a positive effect which focuses on a desired outcome tends to foster pride and ownership over productive areas. This may lead to an upbeat atmosphere that encourages the participation of the group. When possible, it is preferable to phrase the effect in positive terms.

Focusing on a negative effect can sidetrack the team into justifying why the problem occurred and placing blame. However, it is sometimes easier for a team to focus on what causes a problem than what causes an excellent outcome. While you should be cautious about the fallout that can result from focusing on a negative effect, getting a team to concentrate on things that can go wrong may foster a more relaxed atmosphere and sometimes enhances group participation.

Step 2 - Use a chart pack positioned so that everyone can see it, draw the spine and create the effect box.

Draw a horizontal arrow pointing to the right. This is the spine.

to the right of the arrow, write a brief description of the effect or outcome which results from the process.

Draw a box around the description of the effect

Step 3 - Identify the main causes (G) contributing to the effect being studied. These are the labels for the major branches of your diagram and become categories under which to list the many causes related to those categories.

Establish the major causes, or categories, under which other possible causes will be listed. You should use category labels that make sense for the diagram you are creating.

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Write the main categories your team has selected to the left of the effect box, some above the spine and some below it.

Draw a box around each category label and use a diagonal line to form a branch connecting the box to the spine.

Step 4 - For each major branch, identify other specific factors which may be the causes of the effect

Identify as many causes or factors as possible and attach them as sub branches of the major branches.

Fill in detail for each cause. If a minor cause applies to more than one major cause, list it under both.

Step 5 - Identify increasingly more detailed levels of causes and continue organizing them under related causes or categories. You can do this by asking a series of why questions.

You may need to break your diagram into smaller diagrams if one branch has too many sub branches. Any main cause (3Ms and P, 4Ps, or a category you have named) can be reworded into an effect.

Step 6 - Analyze the diagram. Analysis helps you identify causes that warrant further investigation. Since Cause-and-Effect Diagrams identify only Possible Causes, you may want to use a Pareto Chart to help your team determine the cause to focus on first.

Look at the “balance” into the diagram, checking for comparable levels of detail for most of the categories.

a thick cluster of items in one area may indicate a need for further study.

a main category having only a few specific causes may indicate a need for further identification of causes.

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if several major branches have only a few sub branches, you may need to combine them under a single category.

Look for causes that appear repeatedly. These may represent root causes.

Look for what you can measure in each cause so you can quantify the effects of any changes you make.

Fishbone Diagram Example:

This fishbone diagram was drawn by a manufacturing team to try to understand the source of periodic iron contamination. The team used the six generic headings to prompt ideas. Layers of branches show thorough thinking about the causes of the problem.

Fishbone Diagram Example

For example, under the heading “Machines,” the idea “materials of construction” shows four kinds of equipment and then several specific machine numbers.

Note that some ideas appear in two different places. “Calibration” shows up under “Methods” as a factor in the analytical procedure, and also under “Measurement” as a cause of lab error. “Iron tools” can be considered a “Methods” problem when taking samples or a “Manpower” problem with maintenance personnel.

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Benefit:

helps determine root causes

Encourages group participation

uses an orderly, easy-to-read format to diagram cause-effect relationships

indicates possible causes of variation

Key Macroeconomic Factors through understanding

A factor that is pertinent to a broad economy at the regional or national level and affects a large population rather than a few select individuals. Macroeconomic factors such as Economic Output, Unemployment, Inflation Rates, GDP, Savings and Investment are key indicators of economic performance and are closely monitored by Governments, Businesses and Consumers. These factors seem to summarize the picture of economy.

Factors:

Unemployment:

Unemployment or Joblessness, as defined by the International Labour Organization, occurs when people are without jobs and they have actively sought work within the past four weeks. The unemployment rate is a measure of the prevalence of unemployment and it is calculated as a percentage by dividing the number of unemployed individuals by all individuals currently in the labour force. In a 2011 news story, BusinessWeek reported, "More than 200 million people globally are out of work, a record high, as almost two-thirds of advanced economies and half of developing countries are experiencing a slowdown in employment growth, the group said."

As defined by the International Labour Organization, "unemployed workers" are those who are currently not working but are willing and able to work for pay, currently available to work, and have actively searched for work. Individuals who are actively seeking job placement must make the effort to: be in contact with an employer, have job interviews, contact job placement

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agencies, send out resumes, submit applications, respond to advertisements, or some other means of active

job searching within the prior four weeks. Simply looking at advertisements and not responding will not count as actively seeking job placement. Since not all unemployment may be "open" and counted by government agencies, official statistics on unemployment may not be accurate

Relationship Between Inflation Rate and Unemployment Rate:

Inflation rate has an inverse relationship with unemployment rate. While the unemployment rate is getting higher, then the inflation rate is getting less. Similarly when the Inflation rate is getting higher, then the unemployment rate is getting lower. So controlling the employment is objectively keeping the inflation rate at a stable platform.

Inflation Rates:

In economics, the inflation rate is a measure of inflation, the rate of increase of a price index, for example, a consumer price index. It is the percentage rate of change in price level over time. The rate of decrease in the purchasing power of money is approximately equal to the inflation rates.

The rate is usually expressed in annualized terms, though measurement periods are not usually one year. Inflation rates are often given in seasonally adjusted terms, removing quarter-to-quarter variation.

If  P0 is the current average price level and P − 1 is the price level a year ago, the rate of inflation during the year might be measured as follows

Gross Domestic Product:

Gross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living; GDP per capita is not a measure of personal income. See Standard of living and GDP.

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GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach.

The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors ("producers," colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.

Example: The Expenditure Method

GDP = Private Consumption (C) + Gross Investment (I) + Government Spending (G) + (Exports − Imports)

GDP = C + I + G + (X – M)

Analysis:

The view that a stable macroeconomic framework is conducive to growths also supported by much striking non-regression evidence, In Latin America, the recovery of economic growth in Chile and Mexico was preceded by the restoration of budget discipline and the reduction of inflation. By contrast, the ongoing growth crisis in Brazil coincides with high inflation punctuated by stabilization attempts and continued macroeconomic instability. The fast growing countries of East Asia have generally maintained single or tow double-digit inflation, have for the most part avoided balance of payments crises, and when they have had them as for instance, in Korea in 1980 moved swiftly to deal with them. The lessons of the case study evidence messed in the major World Bank research project headed by Little, Cooper, Corden and Rajapatirana (1992), summarized in Corden (1991) supported the conventional view. The notion that macroeconomic stability is not sufficient for growth is supported by evidence from Africa, where most of the countries of the franc zone have grown slowly since 1980 despite low inflation.

In practice the concept of a stable macroeconomic framework is used to mean a macroeconomic policy environment that is conducive to growth. The macroeconomic framework can be described as stable when inflation is low and predictable, real interest rates are appropriate, fiscal policy is stable and sustainable, the real exchange rate is competitive and predictable, and the balance of payments situation is perceived as viable. This definition goes beyond the stability of macroeconomic policy variables to include also the criterion that policy related variables are at levels conducive to growth. Of the mentioned criteria specified in the preceding definition, only low and stable inflation is readily quantifiable. None of the specified variables is directly controllable by policy, and each should optimally vary in response to shocks. Given the practical difficulty of defining and measuring the stability of the macroeconomic framework, or the optimal or appropriate inflation rate, low interest rate, low exchange rate and so forth, I instead proceed by specifying indicators of macroeconomic policy. The basic indicators of

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macroeconomic policy are the inflation rate, the budget surplus or deficit, and the black market exchange premium. I shall use the inflation rate as the best single indicator of the conduciveness of macroeconomic policies to growth and the budget surplus as the second basic indicator. In essence, the inflation rate serves as an indicator of the overall ability of the government to manage the economy. Since there are no good arguments for very high rates of inflation, a

government that is producing high inflation is a government that has lost control. All governments announce that they aim for low inflation, and the macroeconomic situation in any medium or high inflation economy can therefore be expected to change. While there are economies in which inflation remains at moderate levels for prolonged periods (Dornbusch and Fischer, 1993), economic agents in a high or medium inflation economy have to expect an attack, typically many attacks on inflation at some points. Countries may for a long time succeed in maintaining low and stable inflation through policies that are not ultimately sustainable. Such countries, for instance those in the franc zone, may face fiscal or balance of payments crises that could necessitate sharp changes in macroeconomic policy and that certainty increase macroeconomic uncertainty. The fiscal deficit is a good, though imperfect, indicator of such an unsustainable situation. In addition, as discussed below, the deficit is likely to affect growth through its effects on capital accumulation.

We can use the black market premium on foreign exchange as an indicator of the sustainability and appropriateness of the exchange rate. The black market premium is a good indicator of a distorted or controlled market for foreign exchange, but is less good as an indicator of the unsustainability of the exchange rate, since an exchange rate may be overvalued and unsustainable even when there is no block market premium. Most developing countries experienced major terms of trade shocks during the period over which the regressions in this paper are estimated. The terms of trade are included as a separate exogenous determinant of macroeconomic performance.

Savings and Investment:

Saving is income not spent, or deferred consumption. Methods of saving include putting money aside in a bank or pension plan. Saving also includes reducing expenditures, such as recurring costs. In terms of personal finance, saving specifies low-risk preservation of money, as in a deposit account, versus investment, wherein risk is higher.

There is some disagreement about what counts as saving. For example, the part of a person's income that is spent on mortgage loan repayments is not spent on present consumption and is therefore saving by the above definition, even though people do not always think of repaying a loan as saving. However, in the U.S. measurement of the numbers behind its gross national product (i.e., the National Income and Product Accounts), personal interest payments are not treated as "saving" unless the institutions and people who receive them save them.

Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected

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period of time. In contrast putting money into something with an expectation of gain without thorough analysis, without security of principal, and without security of return is speculation or gambling. As such, those shareholders who fail to thoroughly analyze their stock purchases, such as owners of mutual funds, could well be called speculators. Indeed, given

the efficient market hypothesis, which implies that a thorough analysis of stock data is irrational, all rational shareholders are, by definition, not investors, but speculators.

Investment is related to saving or deferring consumption. Investment is involved in many areas of the economy, such as business management and finance whether for households, firms, or governments.

In economic theory or in macroeconomics, investment is the amount purchased per unit time of goods which are not consumed but are to be used for future production. Examples include railroad or factory construction. Investment in human capital includes costs of additional schooling or on-the-job training. Inventory investment refers to the accumulation of goods inventories; it can be positive or negative, and it can be intended or unintended. In measures of national income and output, "Gross Investment" (represented by the variable I) is also a component of Gross Domestic product (GDP), given in the formula GDP = C + I + G +NX, where C is consumption, G is government spending, and NX is net exports. Thus investment is everything that remains of total expenditure after consumption, government spending, and net exports are subtracted (i.e. I = GDP - C - G - NX).

Cost-push inflation and Demand-pull inflation

This increase in the general price level of goods and services in an economy is inflation, measured by the Consumer Price Index and the Producer Price Index. There are different types of inflation, depending on its cause.

What is Inflation

Inflation is a sustained increase in the general price level leading to a fall in the purchasing power of money. Inflationary pressures can come from domestic and external sources and from both the supply and demand side of the economy.Inflation is defined as the rate (%) at which the general price level of goods and services is rising, causing purchasing power to fall. This is different from a rise and fall in the price of a particular good or service. Individual prices rise and fall all the time in a market economy, reflecting consumer choices or preferences and changing costs. So if the cost of one item, say a particular model car, increases because demand for it is high, this is not considered inflation. Inflation occurs when most prices are rising by some degree across the whole economy.

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Factors of Inflation:

This is caused by four possible factors, each of which is related to basic economic principles of changes in supply and demand: 

1. Increase in the money supply. 2. Decrease in the demand for money.

3. Decrease in the aggregate supply of goods and services.

4. Increase in the aggregate demand for goods and services.

In this look at what inflation is and how it works, we will ignore the effects of money supply on inflation and concentrate specifically on the effects of aggregate supply and demand: cost-push and demand-pull inflation.    Here I will examine cost-push inflation and demand-pull inflation.  

Cost-Push Inflation:

Aggregate supply is the total volume of goods and services produced by an economy at a given price level. When there is a decrease in the aggregate supply of goods and services stemming from an increase in the cost of production, we have cost-push inflation. Cost-push inflation basically means that prices have been “pushed up” by increases in costs of any of the four factors of production (labor, capital, land or entrepreneurship) when companies are already running at full production capacity. With higher production costs and productivity maximized, companies cannot maintain profit margins by producing the same amounts of goods and services. As a result, the increased costs are passed on to consumers, causing a rise in the general price level (inflation).  

Production Costs

To understand better their effect on inflation, let’s take a look into how and why production costs can change. A company may need to increases wages if laborers demand higher salaries (due to increasing prices and thus cost of living) or if labor becomes more specialized. If the cost of labor, a factor of production, increases, the company has to allocate more resources to pay for the creation of its goods or services. To continue to maintain (or increase) profit margins, the company passes the increased costs of production on to the consumer, making retail prices higher. Along with increasing sales, increasing prices is a way for companies to constantly increase their bottom lines and essentially grow. Another factor that can cause increases in production costs is a rise in the price of raw materials. This could occur because of scarcity of raw materials, an increase in the cost of labor and/or an increase in the cost of importing raw materials and labor (if the they are overseas), which is caused by a depreciation in their home

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currency. The government may also increase taxes to cover higher fuel and energy costs, forcing companies to allocate more resources to paying taxes.   

Putting It Together

To visualize how cost-push inflation works, we can use a simple price-quantity graph showing what happens to shifts in aggregate supply. The graph below shows the level of output that can be achieved at each price level. As production costs increase, aggregate supply decreases from

AS1 to AS2 (given production is at full capacity), causing an increase in the price level from P1 to P2. The rationale behind this increase is that, for companies to maintain (or increase) profit margins, they will need to raise the retail price paid by consumers, thereby causing inflation.

Demand-Pull Inflation

Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by the four sections of the macro economy: households, businesses, governments and foreign buyers. When these four sectors concurrently want to purchase more output than the economy can produce, they compete to purchase limited amounts of goods and services. Buyers in essence “bid prices up”, again, are causing inflation. This excessive demand, also referred to as “too much money chasing too few goods”, usually occurs in an expanding economy.  

Factors Pulling Prices Up

The increase in aggregate demand that causes demand-pull inflation can be the result of various economic dynamics. For example, an increase in government purchases can increase aggregate demand, thus pulling up prices. Another factor can be the depreciation of local exchange rates, which raises the price of imports and, for foreigners, reduces the price of exports. As a result, the purchasing of imports decreases while the buying of exports by foreigners increases, thereby

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raising the overall level of aggregate demand (we are assuming aggregate supply cannot keep up with aggregate demand as a result of full employment in the economy). Rapid overseas growth can also ignite an increase in demand as more exports are consumed by foreigners.   Finally, if government reduces taxes, households are left with more disposable income in their pockets. This in turn leads to increased consumer spending, thus increasing aggregate demand and eventually causing demand-pull inflation. The results of reduced taxes can lead also to growing consumer confidence in the local economy, which further increases aggregate demand.

Putting It Together

Demand-pull inflation is a product of an increase in aggregate demand that is faster than the corresponding increase in aggregate supply. When aggregate demand increases without a change in aggregate supply, the ‘quantity supplied’ will increase (given production is not at full capacity). Looking again at the price-quantity graph, we can see the relationship between aggregate supply and demand. If aggregate demand increases from AD1 to AD2, in the short run, this will not change (shift) aggregate supply, but cause a change in the quantity supplied as represented by a movement along the AS curve. The rationale behind this lack of shift in aggregate supply is that aggregate demand tends to react faster to changes in economic conditions than aggregate supply. 

As companies increase production due to increased demand, the cost to produce each additional output increases, as represented by the change from P1 to P2. The rationale behind this change is that companies would need to pay workers more money (e.g. overtime) and/or invest in additional equipment to keep up with demand, thereby increasing the cost of production. Just like cost-push inflation, demand-pull inflation can occur as companies, to maintain profit levels, pass on the higher cost of production to consumers’ prices.

   

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What should we look out for as evidence for cost-push and demand-pull inflation?

Cost-push inflation

1. The rate at which wages and salaries are rising

2. Data on producer prices and input costs such as the prices of raw materials

3. Trends in international commodity prices

4. The effects of changes in indirect taxes on prices

Demand-pull inflation

1. How fast is aggregate demand growing

2. Estimated size of the output gap

3. Profitability of businesses in different sectors of the economy

4. Growth of the money supply and credit / consumer borrowing

5. Trends in the values of assets such as property prices

6. Indicators of consumer and business confidence

7. Whether a firm’s prices are rising faster than their costs (tells you what is happening to profit margins)

Difference between the Cost-push inflation and Demand-pull inflation

Inflation is the persistent rise in general price level. Demand pull inflation is one where there is an increase in price level due to the increase in the aggregate demand.

On the other hand the cost push inflation is one where price level increases due to the increase in the price of inputs like increase in wages and raw materials. the increase in price of inputs decreases the short run aggregate supply which increases the price level.

thus if there is a shift in the supply curve backwards we say that inflation is cost push and when there is a rightward shift in the demand curve we say that its demand pull inflation.

Conclusion

Inflation is not simply a matter of rising prices. There are endemic and perhaps diverse reasons at the root of inflation. Cost-push inflation is a result of decreased aggregate supply as well as increased costs of production, itself a result of different factors. The increase in aggregate supply causing demand-pull inflation can be the result of many factors, including increases in government spending and depreciation of the local exchange rate. If an economy identifies what

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type of inflation is occurring (cost-push or demand-pull), then the economy may be better able to rectify (if necessary) rising prices and the loss of purchasing power.

References:

1. http://www.investopedia.com/terms/m/macroeconomic-factor.asp#ixzz1kdL0KnhZ

2. http://www.nber.org/papers/w4565.pdf

3. http://wiki.answers.com/Q/What_are_macroeconomic_factors#ixzz1kdR6pjYQ

4. http://en.wikipedia.org/wiki

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