China-USA Business Review (ISSN 1537-1514) Vol.12, No.2, 2013

China-USA

Business Review

Volume 12, Number 2, February 2013 (Serial Number 116)

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China-USA Business Review

Volume 12, Number 2, February 2013 (Serial Number 116)

Contents Economics

Financial Stability Warning Model for Beijing 99

Tu Yonghong, Zhao Xueqing, Tan Xiao

A Comparison of the Effects of 1929 Great Depression With the Effects of 2008

Global Financial Crisis: Policies Pursued in the Developed, Less Developed

and Newly Industrializing Countries 114

Özlen Hiç-BİROL

The Mathematic Modeling of Process Economization of Natural Resources 122

Simona Hašková, Pavel Kolář

The Relationship Between Economic Value Added and Earnings Per Share: An Empirical Analysis of the Turkish Cement Industry 130

Murat Azaltun, Irem Batibay, Ilker Calayoglu

Management

An Efficient Analytic Solution to a Supply Chain Management Problem 137

Sung-woo Cho, Soo-yong Shin, Myong-sop Pak

Challenges and Problems of Knowledge Management in Enterprises in Poland 149

Ryszard Borowiecki, Barbara Siuta-Tokarska

Halal Food Certification: Case of Malaysian SME Entrepreneurs 163

Mohani Abdul, Hashanah Ismail, Mazlina Mustapha

Loyalty Programs Rewards Based on Tourism Services: A Study of Their Influence on Behavioral Loyalty 174

Mª Teresa Villacé-Molinero, Eva Reinares-Lara, José Manuel Ponzoa-Casado

Religion as an Influential Factor in Corporate Governance Structures 185

Paul Diaconu, Dan Dumitrescu

Social Media Network—A Seminal Paradigm for Interactive Marketing 195

Kumarashvari Subramaniam, T.R. Gopalakrishnan Nair

Examining the Attitudes Towards Mobile Advertising Messages: A Field Research on Turkish Consumers 204

Fatih Geçti, Niyazi Gümüş

China-USA Business Review, ISSN 1537-1514 February 2013, Vol. 12, No. 2, 99-113

Financial Stability Warning Model for Beijing

Tu Yonghong, Zhao Xueqing

Renmin University of China, Beijing, China

Tan Xiao

China Investment Corporation, Beijing, China

The globalization of economic improves the capital and risk allocation efficiency of the financial industry, it hides

the high financial risks as well, the financial crisis turns normalizing and its linkage, infectivity and destructive

effect are becoming stronger. The stable financial development means a lot because Beijing is the political and

financial management center of China. Constructing the financial stability alarm target system is a way of

“prevention rather than cure”. Identify the risk resources through regular observation of the alarm indexes and then

targeted countermeasures can be set to decline in the probability of the financial crisis, which guarantee the

economy continue to develop stably. The paper starts with the analysis on the transmission mechanism of financial

crisis based on Beijing current economic development conditions and dissects its potential financial risks. Moreover,

construction on Beijing financial stability alarm target model is raised, which is an attempt to fill the theoretical

void of local financial regulation. Last but not least, this paper raises some relative suggestions: (1) strengthen

financial supervision and system construction to create a good financial environment; (2) develop the capital market

and the real estate market steadily, change the climate of speculation; and (3) display the function of financial

management, enhance cooperation with surrounding areas.

Keywords: financial crisis, financial stability, financial stability warning model, stability assessment, local financial

regulation, binomial tree models

Introduction

The economic globalization improves the capital and risk allocation efficiency of the financial industry, it

hides the high financial risks as well, the financial crisis turns normalizing and its linkage, infectivity and

destructive effect are becoming stronger. Since China joined WTO in 2001, external financial and economic

relations have been strengthened, and the financial risk has increased as well. Beijing’s stable financial

development plays a crucial role because it is the political and financial management center of the nation.

During the “12th Five-Year Plan” period, Beijing government proposed to consolidate its position as a national

center for financial regulation, strengthen its advantages in gathering headquarters and specialties of financial

institutions, provide supporting services for headquarters, introduce those world-class emerging financial

institutions, cultivate new functions such as off-shore finance, securities direct investment, trust and leasing,

Tu Yonghong, Professor, School of Finance, China Financial Policy Research Center, Renmin University of China. Zhao Xueqing, Ph.D., School of Finance, Renmin University of China. Tan Xiao, Fixed Income and Absolute Return Investment Department, China Investment Corporation. Correspondence concerning this article should be addressed to Tu Yonghong, School of Finance, Renmin University of China,

Beijing, China. E-mail: [email protected].

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FINANCIAL STABILITY WARNING MODEL FOR BEIJING

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enhance its function of bond issuance and settlement center and liquidation center, and finally establish the city

as a financial center with international influence. As all of these goals are based on the stability of the financial

industry, the system of financial stability alarm target is needed.

Constructing the financial stability alarm target system is a way of “prevention rather than cure”. Identify

the risk resources through regular observing the alarm indexes and then targeted countermeasures can be set to

decline in the probability of the financial crisis, which guarantee the economy continue to develop stably. This

paper starts with the analysis of the transmission mechanism of financial crisis based on the current economic

development conditions in Beijing and dissects its potential financial risks. Moreover, construction on Beijing

financial stability alarm target model is raised, which is an attempt to fill the theoretical void of local financial

regulation. Last but not least, this paper raises some relative suggestions.

Transmission Mechanism of Financial Crisis in Beijing

Since the outbreak of global financial crisis in 2008, the theoretical study of the financial crisis has been

paid full attention. Financial security is of great importance to a city, let alone the whole country. As the capital

of the nation, the financial security of Beijing is particularly crucial to the stable financial and economic

development nationwide. Based on Beijing’s unique resource endowments and economic structure, we are

trying to build a comprehensive and multi-channel framework of financial risk transmission in this part, to

analyze the risk factors in Beijing’s financial and economic development, and offer policy suggestions to

improve financial crisis management.

Crisis transmission is defined when a crisis breaks out, it transmits from one country to another because of

the ties between the two in both real economy and financial sectors (Fratzscher, 2002). Many scholars have

researched on the transmission mechanism of financial crisis from different perspectives. Reuven and Andrew

(1998) thought that the main transmission channel is international trade; Kaminsky, Lizondo, and Reinhart

(1999) focused their study on credit and borrowers; Calvo and Mendoza (1997) analyzed the herding behavior

in financial market; Escaith and Gonguet (2009) found the transmission mechanism of financial crisis to global

production networks.

According to the theory of international balance of payment, risks transmit through two channels—trade

and capital, between countries with economic ties. As the traditional channel, trade could be divided into

direct-bilateral and indirect-multilateral. However, the capital channel is becoming more important due to the

strengthening of financial globalization and international financial ties. The cross-border asset allocation and

speculative arbitrage exacerbate the contagion and spread of crisis. In addition, the risk transmission even has

huge impacts on those countries without ties in real economy, through investors’ psychological expectation.

Trade Channel of Financial Crisis Transmission

Financial crisis transmits through trade spillover effect. The financial crisis in one country is often

accompanied by a sharp depreciation of its currency, thus leading to deficit increase, foreign reserves shrinkage,

and fundamental deterioration in its trade counterparties, then competitive currency devaluation among

countries, and finally a financial turmoil. Financial crisis not only directly affects trade, but also increases trade

risks by changing the terms of trade between countries, as well as the external environment of imports and

exports.


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Crisis transmission is defined when a crisis breaks out, it transmits from one country to another because of

the ties between the two in both real economy and financial sectors (Fratzscher, 2002). According to the theory

of international balance of payment, risks transmit through two channels—trade and capital, between countries

with economic ties. As the traditional channel, trade could be divided into direct-bilateral and

indirect-multilateral. However, the capital channel is becoming more important due to the strengthening of

financial globalization and international financial ties. The cross-border asset allocation and speculative

arbitrage exacerbate the contagion and spread of crisis. In addition, the risk transmission even has huge impacts

on those countries without ties in real economy, through investors’ psychological expectation.

In terms of foreign trade, China is following the Asian economic model, but Beijing has its own unique

characteristics. First of all, Beijing has a much larger trade scale than the country’s average level, and a higher

degree of internationalization, thus is more vulnerable to international environment. Trade dependence is a key

indicator for measuring the degree of internationalization and external trade ties of a country or region. In

2000-2010, the total size of Beijing’s imports and exports is more than 100% of GDP by average during the

same period (see Figure 1), and even up to the highest 155.19%, much higher than the national level of 66%.

Secondly, Beijing is a consumption-oriented city with its import greatly exceeding export, thus its trade deficit

continues to expand. Its import is more than three times export in 2000-2010 by average (see Figure 2). The

financial crisis has a huge impact on Beijing’s trade, particularly on import due to its high degree of

internationalization. As the financial crisis broke out and spread, Beijing’s import and export volume sharply

dropped in the second half of 2008, and reached the lowest levels in January and February of 2009 respectively,

USD 815,276,000 and 349,735,000. The volume volatility of import is greater than that of export, and thus

obviously more affected as well. However, thanks to the consumption and investment-oriented structure, as

well as the efforts of “maintain growth, expand demand” in all levels of governments, the financial crisis did

not seriously affect Beijing through trade channels.

31.34%26.28%24.20%27.91%28.22%

36.28%37.27%37.78%35.93%

27.18%11.37%

98.01%88.68%

76.52%85.32%

101.53%111.24%

117.92%111.26%

133.84%93.55%

50.42%

0% 50% 100% 150% 200%

20002001200220032004200520062007200820092010

Degree of dependence on exports Degree of dependence on imports

Figure 1. Trade dependence of Beijing in 2000-2010. GDP is converted from RMB to USD by annual

cumulative average exchange rate from SAFE. Sources: Beijing Bureau of Statistics.


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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

imports exports

Figure 2. The imports and exports of Beijing in 2000-2010 (10 thousands of dollars). Source: Beijing Bureau of Statistics.

Capital and Market Expectation Channel of Financial Crisis Transmission

In the context of sound development of financial globalization, financial crisis forced international

speculative and investment capital to outflow to safe assets. Due to the large scale of foreign capital outflow,

investment in economies with high foreign dependence started to decline, whose currency depreciated, inflation

rose, and finally those economies dipped into recession (ZHU & Wang, 2009). The wave of financial

liberalization dating back to 1980s removed obstacles for capital flows. As China economy gradually opened

up, capital flows became more frequent, and played huge important role in its economic and social

development. As the political and economic center of China, Beijing is attractive to international capital. Large

inflow into Beijing hides lots of risks while stimulating the economic development in the mean time. As of

2010, the number of foreign-investment enterprises amounted to 9,292, although the amount of foreign capital

in the sources of funds showed a downward trend (see Table 1), but foreign capital still had significant effect in

certain areas, such as stocks and real estate markets. In 2008, foreign capital utilization in real estate increased

by 97.4%, with foreign direct investment growing by 131.1%. After the financial crisis, investors suffered huge

capital loss in crisis countries, and liquidity shrank sharply, thus they had to sell assets to gain liquidity,

resulting in a liquidity shock. Masson (1998) proposed the market expectation as a channel to transmit crisis.

Capital flows could easily lead to panic and erode investment confidence, especially when the “hot money” was

combined with market expectations during the crisis. The foreign capital outflow in the crisis caused the market

to fall, which in turn strengthened expectation, further reduced investors’ income, and affected their real

purchasing power and investment ability. Thus, the crisis transmitted from abroad to domestic. It can be seen

from Figure 4 that, 2008 is an important turning point of real estate market prices in Beijing, before which the

prices raised much. It could be mainly attributed to the outflow of foreign capital after crisis and the decline in

market expectation.

In addition, international capital flows has opened up a path for the international liquidity transmission to

domestic. After the financial crisis, the money demand decreased faster than did the money supply. And, due to

the leading role of global easing monetary policy, international liquidity was not inadequate but excessive. The

international liquidity flew into China, and further joined in domestic liquidity, thus, to a certain extent,

exacerbated economic volatility, and added to factors of instability.

30,000,000

25,000,000

20,000,000

15,000,000

10,000,000

5,000,000

0


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Table 1

The Breakdown of Sources of Investment in Beijing in 2000-2010 (%)

Year National budget Domestic loans Foreign capital Self-financed and others

2000 7.44 25.97 3.58 63.01

2001 7.61 23.90 1.98 66.51

2002 5.23 26.20 2.00 66.57

2003 2.93 28.24 1.97 66.86

2004 3.19 21.67 3.25 71.89

2005 2.83 23.19 1.56 72.43

2006 2.57 27.35 1.55 68.54

2007 1.65 24.44 1.34 72.58

2008 2.01 26.89 1.54 69.56

2009 1.36 34.92 0.45 63.27

2010 1.19 26.64 0.53 71.64

Note. Source: Beijing Bureau of Statistics—Statistical Yearbook.

Potential Problems of Financial Security in Beijing

Turbulent International Financial Environment

With the strengthening of economic globalization, frequent outbreaks of financial crisis and cross-border

transmission have increased the uncertainty of international economic and financial development. After the

financial crisis in 2008, in order to stimulate economic growth and increase employment, United States

launched two rounds of quantitative easing policy, leading to credit rating downgrades, more international

excessive liquidity, and the transmission of crisis. As the Euro-zone sovereign debt crisis worsened, the

international economic and financial upheaval intensified, and the economic friction expanded. At present,

China is at an important stage of the domestic economic restructuring and the gradual financial opening up.

Such a complex and changeable international situation poses enormous pressures on China’s economic and

financial security, and increases risk factors. As the capital, Beijing can never be an exception.

Vulnerability of Industrial Structure

At present, Beijing has basically formed an industry structure with the tertiary industry as dominant, in

which finance and real estate occupy important positions. The added value in finance and real estate was

287.01 billion yuan in 2010, a 7.65% growth year over year, and accounted for 27.1% of the tertiary industry,

and 20.3% of the city’s GDP, which proves that finance have become a main driver for profit and economic

growth. TU (2011) used impact index model after excluding seasonal effects and the ARMA model to

investigate the impact of financial crisis on Beijing’s industry structure, and found that the finance and real

estate sectors were most vulnerable to financial crisis. The industry structure is fragile, and will be badly hit

once another financial crisis occurs.

Obvious Inflation Pressure

Inflation could make price signals malfunction, lead to credit expansion in the short-term, reduce the effect

of monetary policy, and arouse financial market volatility, all of which are not conducive to economic stability

and growth. In addition, inflation could easily trigger social unrest and instability. Since 2011, prices in Beijing

have kept increasing, such as CPI. As of November 2011, CPI reached 105.7 (see Figure 3). Now, Beijing has

obvious inflation pressure, which has become a threat to local financial, economic and even social stability.


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Figure 3. CPI in Beijing from 2010 to 2011. Source: Beijing Bureau of Statistics—Monthly data in 2010 and 2011.

RMB Appreciation and Price Bubble in Real Estate Market

Exchange rate is a measure for a country’s external value. A reasonable exchange rate level and a sound

exchange rate system are strong guarantees for this county’s financial security. For a region’s economic

fundamentals, exchange rate fluctuations would seriously affect its terms of trade, thereby, affecting imports

and exports. From 2005 to 2010, RMB has cumulatively appreciated 23.97% against USD, and 14% against the

Euro. Since the subprime mortgage crisis, the international economic downturn occurred, and the trade

protectionism returned. Developed countries like United States, Europe, and Japan, and developing countries

like Brazil and Russia all took measures to force RMB to appreciate. The sharp appreciation of RMB and this

sort of expectation, have not only deteriorated of Beijing’s terms of trade, resulting in the shrinkage of foreign

exchange assets, but also made Beijing the target of international hot money.

95

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2005 2006 2007 2008 2009 2010

Housing sale index

Figure 4. Housing sale index of Beijing in 2005-2010. Source: Beijing Bureau of Statistics—Year data in 2005-2010.

A large amount of international hot money flew into China, continued to push up asset prices, and

increased risks in stock and real estate markets, in which the real estate bubble in Beijing was particularly

serious. Since 2005, real estate prices in Beijing have increased more than 50% (see Figure 4). Among all the

reasons, real demand helped, but the increase was largely attributed to the speculation of domestic and foreign

capital, which seriously affected the stable development of real estate and financial markets. Although the


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introduction of “National Four measures”, “National Eleven measures”, “New National Eight measures”,

especially the “Beijing Twelve measures”, have contained further surge of real estate prices in Beijing to a

certain extent, but have not fundamentally solved the bubble of asset prices. Commercial banks have had lots of

risks from real estate loans. Therefore, the downturn in real estate market could result in larger credit risk and

liquidity risk. In addition, the large outflow will be a major threat to Beijing’s financial security.

Scarce Money Supply to SMEs

Serious information asymmetry between SMEs and banks is the key reason for money supply scarcity. As

regional financial institutions could tap more local information, they are the main sources to meet SMEs’

financing needs. (Cull, Lance, Naomi, & Jean-Laurent, 2006). In addition, regional financial guarantee system

is an important way to solve the financing bottleneck of SMEs (Columbaa, Gambacortab, & Mistrulli, 2010;

GU, 2011). As a result, local governments and financial system should play a more important role in solving

the financing difficulties of SMEs.

Given the resource endowments of capital, talents, technology et cetera, Beijing has comparative

advantages in industries of high technology and cultural creativity, which also are highly value-added and

stable. However, it is SMEs that take the dominance in industries of high technology and cultural creativity.

Therefore, it is particularly important for Beijing to address the problem of financing difficulties for SMEs. As

of the end of 2010, the outstanding loans to SMEs in Beijing (excluding bills financing) were 728.21 billion

yuan, a 25.5% growth year over year. Despite the rapid growth, there is still a big gap for financing SMEs in

Beijing, and commercial banks still have discrimination against SMEs, with a high threshold to provide

guarantee. The 100%-guarantee mechanism in financial guarantee institutions, and a flat rate, will not only

increase banks’ moral hazard and customers’ adverse selection, but also miss the goal of better serving local

SMEs. As formal financial institutions could not meet the financing needs of SMEs, the majority of SMEs have

to turn to non-formal channels to obtain funds, that is, private finance. The generation and active development

of the private finance are positive to solve SMEs’ financing difficulties, but the lack of laws and regulations for

private finance should be solved.

The Multi-layer Capital Market Has not Been Established Yet

In recent years, most of international financial crisis originated from capital market, thus the stability of

capital market is directly related to the financial security of one country or even a region. With the gradual

opening up of financial sector in Beijing, its vulnerability will be highlighted in capital market. The current

stock market is filled with problems such as strong speculative atmosphere, sharp price volatility, and low

efficiency of financing et cetera. Meanwhile, the bond market is seriously lagged behind. In 2010, the trading

turnover of security market in Beijing amounted to 8,757,538 million yuan, in which stocks took 7,984,307

million yuan, accounting for 91.2%; funds had a quick growth, and took 171,494 million yuan; bonds took

338,428 million, only 3.9% of the stock market (see Table 2). Thus, there is a serious imbalance between stock

and bond markets.

Rapid Financial Innovation Can Easily Lead to New Financial Risks

The financial sector in Beijing has maintained a rapid rate growth and innovation, based on its advantages

in economics, policy, talents, and technology: (1) The market of financial factors continues to expand. The total

turnover of Beijing’s factor markets was approximately 1.3 trillion yuan in the first three quarters of 2011; (2)

The system of “1 + 3 + N” equity investment was initially constructed, and managed funds of 1.06501 trillion


106

yuan to support venture capital companies; (3) As of the end of 2011 quarter three, there were 132

financial-guarantee companies, and peak amount of small loan companies to apply for establishment, which

demonstrated the active participation of private capital; and (4) Actively explore pilot plans for the integration

of science and technology, cultural creativity, and finance, promote the development of OTC market, carry out

innovative tests for credit loans, intellectual-property-as-collateral loans, credit insurance and trade finance, and

equity-as-collateral loans et cetera. These financial innovations are conducive to promoting economic growth

and improving industrial structure in Beijing. However, on the other hand, it should be noted that the lag of

improvement in policy, regulations, regulatory and in-house technology, and risk monitoring may lead to new

financial risks.

Table 2

Turnover in Beijing Security Market (Unit: billion yuan) Year Total turnover Stocks Funds Bonds Warrants Others 2007 9,797.866 7,748.783 153.496 206.009 975.674 713.904 2008 6,277.356 4,623.127 138.937 405.252 958.751 151.289 2009 9,214.802 7,833.950 225.354 179.132 882.382 93.984 2010 8,757.538 7,984.307 171.494 338.428 228.776 34.533

Note. Source: Beijing Bureau of Statistics—Statistical Yearbook 2007-2010.

Financial Stability Warning Model for Beijing

Frankel and Rose (1996), Sachs, Tomell, and Velasco (1996), Kaminsky, Lizondo, and Reinhart (1998)

are early researchers of crisis warning model. According to international recognition, there are mainly three

precaution index models for financial stability. They are FR porobit model, STV cross-sectional regression

model, and KLR signal analysis. These models perform well in predicting, but they are not very suitable for

Beijing. Firstly, using these models requires large sums of data, which are not available for Beijing. Secondly,

these models generally use currency depreciation rate as the standard definition of crisis to do prediction. But

Beijing has neither the power to make monetary policy nor the ability to adjust the exchange rate. Besides,

exchange rate risk is not the biggest challenge of financial stability in Beijing. Finally, the function of these

models is limited to the warning of crisis. They cannot dynamically show Beijing’s potential financial risks, as

well as different stabilization levels of financial and economic development in Beijing. Due to the above

problems, we come up with a clear precaution model—binomial precaution system model.

Binomial precaution system model uses binomial method to predict the interaction between the binary

outcomes of each variable. Complex interactions are prevalent in precaution index for financial stability. Also,

there may be a nonlinear relationship between the indicators and the crisis probability. The model can work

well in the complex interaction of indicators and can divide the samples into observations in crisis and

non-crisis.

Index and Critical Value Selection

There are many traditional warning indicators of financial crisis. This model considers normative,

dynamic timeliness, comparability and the importance of the impact of Beijing’s financial and economic

stability. The stability of the financial sector is defined as the sustainable growth of the scale, price stability,

and a good realization of financial sector’s functions.

We use the system dynamic analysis method to choose the critical value. Taking the financial industry


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output value change rate as the dependent variable, we build the model as follows based on the transmission

mechanism of the financial crisis:

lnF = αlnG + βlnP + γR + δlnC + ζU + ηlnS + θR*+…+ ε (1)

In model (1), lnF is the financial industry output change rate of Beijing; lnG is GDP growth rate of Beijing;

lnP is CPI growth rate of Beijing; R indicates the Shanghai Interbank Offered Rate (3-month); lnC is

commercial bank’s loan growth rate of Beijing; U is the unemployment rate of Beijing; lnS is Beijing stock

trading volume growth rate; R* indicates the U.S. Treasury bill rate (10 years); and ε is the error term.

Due to the limitation of past data, we use Delphi method to decide the value of α、β、γ、δ、ζ、η、θ. When

an independent variable’s value changes as x, it leads to a substantial decline of the variable lnF and the

collapse of the financial industry. Then x is the critical value of the financial crisis for this independent variable.

On the basis of analysis of the transmission mechanism of financial crisis and the potential financial risk

factors in Beijing, we select three levels of indicators: external input, macroeconomic, and financial sector.

External input. Ten-year U.S. Treasury bill rate is not only the benchmark rate in international financial

market, but also an important signal to reflect external shocks in China’s financial market. The 10-year rate

reflects the liquidity of international financial market and basic economic outlook. Therefore, the change rate of

10-year U.S. Treasury bond interest rate can be used as external-shock indicator. When its change rate reaches

more than 10%, it shows that the international financial market is instable and economic uncertainty may

deepen.

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Figure 5. Ten-year U.S. Treasury bill rate trend. Source: U.S. Treasury website.

Macroeconomic Stability Indicators

(1) GDP growth rate. The gross domestic product (GDP) is the value of all final goods and services which

are produced in a given period (one year) and in a specific country or region. It is a core indicator to fully

reflect the economy development in a nation. GDP growth rate is the percentage increase or decrease of GDP

compared to the previous year. GDP has always been the most important goal to pursue in China’s economy.

China’s real GDP growth rate should not be lower than 8%, or the basic employment cannot be guaranteed.

Beijing is the leading city of China’s economic growth. Its GDP growth rate’s cordon should be higher than the

national average level. Based on historical analysis, we set the threshold at 10%.

(2) CPI. Inflation has always been a critical problem in China’s economic stability and development. The


108

inflation rate is dividing the supply of currency in circulation by the demand for currency in circulation. Due to

the lack of inflation data for Beijing, we use the consumer price index to measure the liquidity situation there.

Consumer price index is a measure of the relative change of the price level of consumer goods and services

over time. CPI can reflect the change of price households pay to purchase consumer goods and services. It is

often used as the indicator to reflect inflation (or deflation). Based on the experience of Asian countries and the

reality of China, the consumer price index cordon can be 5%-10%. We set the critical value at 10%.

(3) Real estate price. Real estate price index reflects the relatively change and trend of real estate price in a

certain period. It includes land transaction price index, house sales price index, rental price index, and property

management price index. House sales price index reflects the relatively change and trend of real estate sales

price. In this paper, we choose the house sales price index as the real estate price indicator. On April 20, 2010,

CBRC held the second economic and financial situation briefing. President Liu required major and medium

banks to carry out real estate loan pressure test on a quarterly basis. The results showed that a 30%-40% real

estate price fall could be tolerated for the banks, and the critical value is 40%.

(4) Unemployment rate. The unemployment rate can be calculated by dividing the unemployed workers by

total labor force. If the rate gets too high, the expense of social security and cost to insure political stability will

increase, thereby endangering the economic development. There is no uniform threshold defined for the

unemployment rate worldwide. According to National Bureau of Statistics of China, from 1980 to 2008 the

national unemployment rate is 3.1% on average. Li Yining, as well as many scholars, believes that the

threshold of unemployment rate in China should be 4%, according to past experience.

Financial Sector Stability Index

(1) Commercial bank loan growth rate. Commercial banks have always been dominant in China’s

financial system. Therefore they play a crucial role in the stability of financial markets. A sign which shows

that commercial banks are healthy is the steady and moderate growth rate of the size of loans. From 1979 to

2009, along with the rapid growth of China’s economy, Beijing’s RMB loans grow at a fast speed. The average

annual growth rate reaches 22%. According to the historical experience of economic development, when the

credit growth rate reaches 20% or 21%, economic growth and price levels will remain relatively stable. Thus,

we set the threshold etc. as 21%.

(2) Shanghai Interbank Offered Rate (3-month). Shibor (Shanghai Interbank Offered Rate) is calculated,

announced, and named on the technological platform of the National Interbank Funding Center in Shanghai. It

is a simple, no-guarantee, wholesale interest rate calculated by arithmetically averaging all the interbank RMB

lending rates offered by the price quotation group of banks with a high credit rating. The financial markets use

the three-month Shibor as the benchmark rate. This rate reflects the liquidity in financial markets for the present

year and can be guidance for the market. According to the historical data from 2006 to 2010, 2.5%-3.5% is a

stable range for Shibor (3M). Shibor (3M) can well reflect the stability of financial markets (see Figure 6).

(3) Stock financing amount growth rate. As we can see from Table 1, Beijing’s investment mainly comes

from regional financing and other financing. So the capital market and direct financing play major roles in

economic and social stability in Beijing. In this paper, we choose the growth rate of equity financing amount as

warning indicator to reflect the stability of capital markets. If the amount of equity financing increases, the

economic outlook will be positive. While it decreases, the economy may begin a downward trend. In addition,

if the equity financing amount growth rate is too high, for example, more than 100%, it shows the overheating


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of economy. Stock market may have bubbles.

(4) Stock market trading volume growth rate. The stock market is an important part of the financial

markets. It not only reflects and adjusts the movement of capital, but also has an important impact on the

running of the whole economy. Stock market trading volume reflects the condition of the market. In time of

financial and economic stability, stock trading volume should have a steady yearly growth. If it decreases, the

stock market may be in depression. But if the trading volume grows rate reaches more than 100%, it shows the

overheating of stock market and bubbles existing there.

Figure 6. 2006-2010 Shibor (3-month) trend. Source: Shanghai Interbank Offered Rate Website.

The Binary Trees Assessment of Warning Model About the Capital’s Financial Stability of China

According to the analysis of the conduction mechanism of the capital’s financial crisis, external shocks

have both a rapid, direct effect through the market expectations and an indirect effect through the real economy

on the financial markets. So, there is two conduction paths: (1) One is that when the interest rate of the United

States 10 years treasury bonds fluctuates fiercely—the variation surpasses 10%, external shocks will affect

China, even Beijing’s financial markets immediately through the market expectations, leading the domestic

Shibor change and influencing both the indirect financing market and direct financing market; and (2) The

other one is through the real economy to affect the financial markets. If the GDP growth rate is less than 10%,

the economy is going down and the unemployment rate will increase sharply, once the real estate price

collapses, there will be a substantial rise in the defect rate of banks, which causes a banking crisis easily. Even

though the unemployment rate does not exceed the warning line, the economy is expected to have a pessimistic

prospect, the scale of banking loans will decrease with the Shibor (3M) reducing significantly. While the GDP

growth rate and that of CPI are all over 10%, the economy will be in an overheating situation with a surprising

rise in the asset prices and a bubble in the stock market. If the Shibor (3M) is less than 3.5%, the scale of loans

will increase appropriately, equity financing will be normal, and then the financial and economic environment

is going to present a good and stable momentum.

Considering the above conduction paths, we build the binary trees warning model about the capital’s

financial stability (see Figure 7), where AAA, AA, A, BBB, BB, B, CCC, CC, C and DDD, DD, D, E, F

represent respectively the rating of the financial stability in an indirect way, while A*, B*, C*, D*, E* and F*


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are for that in a direct way.

Because of the missing of historical statistics and the fact that the early Chinese financial openness is not

too high, when there is a lack of the interest rate of the United States 10 years treasury bonds, as well as the

Shibor (3M), only considering using the indirect way of the real economy to make a history evaluation, we are

discovering a comparison between the historical results and the assessment of the past five years (see Table 3).

Table 3

The Historical Assessment of Beijing’s Financial Stability Time 1979 1980 1981 1982 1983 1984 1985 1986 1987

Rating A AAA DDD AAA A AAA B-CC AAA AAA

Time 1988 1989 1990 1991 1992 1993 1994 1995 1996

Rating B-CC B-CC DDD B-CC A B-CC CCC-CC B CCC-CC

Time 1997 1998 1999 2000 2001 2002 2003 2004 2005

Rating A-BB A-BB AAA A-BBB AAA A-BBB A-BBB AAA AAA

Time The assessment The practice

2006 C*—moderately stable. The external shocks are large; stock market tends to be hot.

Banking and insurance markets are running smoothly, price in the stock market is rising with an active trading.

2007 AA—moderately stable. The economy is hot, with an excess domestic liquidity, so as the stock market.

The economy has developed in a double-digit speed for nineyears, the trade surplus continues to expand, there is an excess liquidity, due to the wealth effect of the rising stock market and real estate, the commodities prices keep climbing.

2008

A*—stable. The external shocks are large, the overheat of stock market and economy is restricted, the financial markets is fundamentally steady.

An international financial crisis happens. The direct impact on the financial channels is limited. As a result of the pessimism, the Shanghai and Shenzhen stock markets crash, with market bubbles’ burst.

2009 D*—less stable. The external shocks are large and the interest rate market is fluctuating, but it does not show a liquidity squeeze in the market.

In the 2nd quarter of 2009, the capital’s economy has reversed, the financial markets runs steady. However, inflation is supposed to be apparent gradually, the prices of international commodities are going to rebound.

2010 AA—basically stable. The economic growth is steady and the loans increase reasonably.

The monetary policy is moderately loose, the total amount of the credit loans is appropriate, structure is in optimization. With the prices of domestic labor and raw material rising, inflation expectation continues to be strong.

In the light of the binary trees warning model about the capital’s financial stability, as well as the historical

assessment results, it’s concluded that:

(1) Beijing and China’s financial stability are both depend on the macroeconomic stability.

Macroeconomic stability is an important prerequisite for financial stability.

(2) Inflation threatens the safety of finance and economy of Beijing, even the society. This city’s CPI was

more than 10%—the warning line, in 1988 and 1989, at that time, the economic and social stability was poor,

the high price played an essential role in the serious social instability and the city’s political storm.

(3) From 1993 to 1996, the economy in Beijing improved rapidly, the average of the GDP growth was

26.13%. But on the surface of the high-speed growth, there was a critical structural problem. The average of the

current CPI growth rate was 18.2%, which was risky. Then in 1997, the Asian financial crisis broke out, the

bubbles were burst and the economy recovered in 1999 when reaching to the AAA rating.

(4) With the development of this city’s economy, the capital market gradually became the key for this

area’s financial stability. Between 2006 and 2007, our economy was overall overheating, this city’s equity

financing growth rate achieved 36,333.23% in the year of 2006, which promoted the stock market bubbles,

affecting the financial and economic stability.

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112

(5) From the historical data and the note level in 2008, 2009, and 2010, we can announce that this financial

crisis has a limited influence on Beijing’s financial and economic stability.

Conclusions

(1) Strengthen financial supervision and system construction, create a good financial environment.

Service industry is the largest industry in Beijing, in which financial sector is the leading one. The

financial industry accounted for an average of 12.8% of Beijing’s GDP since 2001 and played an important role

for the economic and social development of Beijing. It is not only necessary for current economic development

of Beijing to pay more attention to financial industry, but also necessary for long-term strategic interests of

Beijing. In recent years, Beijing’s economy grows rapidly and steadily. Foreign trade, international economic

and technological cooperation have got good developing tendency, high-tech and cultural industries have

become the development emphases. According to The Overall Urban Planning of Beijing (2004-2020), Beijing

identifies the goal for urban development as “national capital, the world city, a famous cultural city and a

livable city”, completely realizing modernization during the period from 2009 to 2020 and establishing a

modern metropolis with distinct characteristics, and meanwhile, consolidating the center position of national

financial management and building a financial center having international influence during the Twelfth

Five-year Plan period. To realize all the aims, a mighty financial industry which can match with them is

essential and that is why devoting major efforts to developing finance is of great importance for Beijing.

Beijing has the feature of headquarters economy and headquarters finance. It is the location of the headquarters

of commercial financial institutions and the national financial regulation and self-regulating norms center in our

country. It is also the center of national fund settlement. So its financial security problems would influence the

whole country and strengthen financial supervision has become a priority of Beijing.

Although local financial regulatory authorities lack permissions, it is significant in the daily management

of the monitoring. The essence of this financial crisis is the excessive deviation between asset prices and the

real economy as well as the absence of regulation. Any tiny fluctuations in the integrated global financial

markets may form a significant impact through the corporations’ balance sheets and investors’ expectation.

Preventive measures are better than remedying the situation. Therefore, the daily market monitoring and

management is more important. Local financial regulatory authorities have a better understand of the local

financial and economic reality, and could be able to build a more comprehensive supervision system by

combining their own development situation.

(2) Develop the capital market and the real estate market steadily, change the climate of speculation.

Innovation is the driving force of economic development of Beijing, and a perfect capital market can

provide innovation with strong financial support. It is an urgent task for Beijing to improve multi-level capital

market system and the investment and financing structure, and to optimize the capital market functions. At

present, the real estate price of Beijing is rising, the real estate market is experiencing excessive prosperity and

there is serious atmosphere of speculation. Supervision of the real estate market should be strengthened in the

future and investors should be helped to establish the correct investment philosophy and consequently reduce

the speculation in the real estate market. With the further deepening of China’s financial openness, Beijing

needs to pay close attention to the flow of hot money at the moment of opening capital account to strengthen

the supervision of international hot money, reduce the impact of hot money on the stock market and real estate

market, in order to avoid further expansion of the capital price bubbles. It is also necessary to promote asset

securitization, expand the bond market, and improve its levels, products, and term structure, in order to


113

revitalize the stock of credit assets, absorb foreign excess liquidity widely and improve the ability of financial

market to allocate resources. Constructing an asset “pool” on the basis of asset-backed bonds has important

strategic value. It manages arbitrage funds positively rather than defense hot money negatively; it is a long-term

strategy to ensure the stable operation of the financial system rather than a temporary measure to prevent

financial risks.

(3) Display the function of financial management, enhance cooperation with surrounding areas.

As the country’s economic, political, and cultural center, Beijing is also a regional financial center, the

core city of the Beijing-Tianjin-Hebei economic circle and even the Bohai Coastal region with the advantages

of economic, political, geographical, and technical talent. It assembles a wealth of financial resources, bears the

function of financial management and has the advantages of information for decision-making and headquarters

economy. The financial security of Beijing is closely related to the economic and financial situation of the

surrounding areas. Therefore, to maintain the financial stability of Beijing, not only the impact from foreign

countries needs to be paid attention, the potential instability from the surrounding areas should be watched on

closely. Beijing should strengthen the communication and cooperation with surrounding areas, give full play to

respective advantages and make up deficiencies, in order to achieve the common development of the regional

economy.

References Calvo, G. A., & Mendoza, G. E. (1997). Rational herd behavior and the globalization of securities markets. Working Papers No.

97-26, Duke University, Department of Economics. Columbaa, F., Gambacortab, L., & Mistrulli, P. E. (2010). Mutual guarantee institutions and small business finance. Journal of

Financial Stability, 6, 45-54. Cull, R., Lance, E. D., Naomi, R. L., & Jean-Laurent, R. (2006). Historical financing of small- and medium-size enterprises.

Journal of Banking & Finance, 30, 3017-3042. Escaith, H., & Gonguet, F. (2009). International trade and real transmission channels of financial shocks in globalized production

networks. WTO Working Papers ERSD-2009-06. Frankel, J. A., & Rose, A. K. (1996). Currency crashes in emerging markets: An empirical treatment. Journal of International

Economics, 41(3-4), 351-366. Fratzscher, M. (2002). On currency crisis and contagion. Working Paper, No. 139, European Central Bank. GU, H. F. (2011). Study on supervision channels to China small-medium enterprises credit guarantee system risk operation.

Journal of Regional Financial Research, 7, 41-45. Kaminsky, G. L., & Reinhart, C. M. (1999). The twin crises: The causes of banking and balance-of-payments problems. The

American Economic Review, 89(3), 473-500. Kaminsky, G., Lizondo, S., & Reinhart, C. M. (1998). Leading indicators of currency crises. IMF Staff Papers, 45, 1-48. Masson, P. C. (1998). Monsoonal effects, spillovers and jumps between multiple equilibriums. International Monetary Fund

Working Paper, No. 142. Reuven, G., & Andrew, K. R. (1998). Contagion and trade: Why are currency crises regional? NBER Working Paper, No. W6808. Sachs, J., Tornell, A., & Velasco, A. (1996). The Mexican peso crisis: Sudden death or death foretold? C.V. Starr Center for

Applied Economics, New York University, Working Paper No. 96-20. TU, Y. H. (2011). The impact of the international financial crisis on the industrial structure of Beijing. Frontline, April. TU, Y. H., & ZHANG, Q. (2010). Accelerate asset securitization, establish safe “pond” for hot money. Theoratical Horizon, 12,

27-29. ZHU, M., & WANG, J. Q. (2009). Conduction of the financial crisis to the economic downturn: Foundation, channels and

confidence. China Finance, 4, 14-16.


A Comparison of the Effects of 1929 Great Depression With the

Effects of 2008 Global Financial Crisis: Policies Pursued in the

Developed, Less Developed and Newly Industrializing Countries

Özlen Hiç-BİROL

İstanbul University, İstanbul, Turkey

A comparison of the Great Depression of 1929-1939 with the present global financial crisis and global recession

that broke out in the last quarter of 2008 will provide useful insights about economic developments in the world

and changes and progress in the understanding of economics and implementation of economic policies. There is no

doubt that the Great Depression was the deepest depression compared with the previous business cycles and

depressions and, thankfully it was never paralleled. The 2008 economic crisis, on the other hand, was the worst

encountered excepting the former mentioned. At the time of the 1929 Great Depression, however, economic theory,

hence economic policy implementation was not too advanced to draw out effective anti-depression policies. In fact,

most policies implemented by the USA and European countries actually deepened and lengthened the depression.

In contrast, the 2008 economic crisis took place in a highly globalized world and when countries were at a much

higher economic and technological level compared with 1929 Great Depression. Economic theory had also

progressed sufficiently to guide countries to implement policies that prevent the recession and at least that prevent it

to grow further into a deep depression. Within a highly globalized world economy, the financial crisis and recession

fast spread throughout the world, the developed, the less developed, and newly industrializing countries as well as

the emerging markets. But all countries were quick to implement effective measures against it in a milieu of

cooperation. Thus, as the crisis was globalized, the response to the crisis was also globalized. A short review of the

Great Depression followed again by a short account of the present economic crisis will bring to light the above

points more clearly. The first part of the article will cover a review of the 1929-1939 Great Depression and the

developments since the Great Depression up till the present times. The second part will cover the 2008 Financial

Crisis and its effects on the developed countries (DCs), namely, USA, Europe, and Japan, the effects on the less

developed countries (LDCs), newly industrializing countries (NICs) and Balkan, Russia, India and China (BRICs)

will be followed before dealing with the after-effects of the crisis and reaching the conclusions.

Keywords: Great Depression, global financial crisis, economic policies, policy measures during crisis

Understanding the Great Depression 1929-1939

The 1929 Great Depression had started in the banking sector of the USA, following the 1914-1918 World

War I and a short-lived economic revival in the 1920s. Herbert Hoover of Republican Party, the US president at

Özlen Hiç-BİROL, Assistant Professor, Economics in English Department, İstanbul University. Correspondence concerning this article should be addressed to Özlen Hiç-BİROL, İstanbul University, Economics Faculty,

Economics in English Department, Beyazıd, İstanbul-Turkey. E-mail: [email protected].

DAVID PUBLISHING

D

A COMPARISON OF THE EFFECTS OF 1929 GREAT DEPRESSION

115

the time responded by wrong economic measures. Firstly, he restricted imports in order to achieve foreign trade

balance and thus prevent the flight of gold. This was, in fact, a beggar-thy-neighbor policy hurting all the

countries, including the USA. Secondly, he abstained from intervening the economy. He did not expand

government expenditures to fight the depression. Neither did he take effective measures to solve the banking

crisis nor to ameliorate the plight of workers and farmers. The current economic theory and macro system at the

time was that of the Classical school and Classical economists believed that full employment would be

achieved automatically in the competitive markets; hence, no government intervention to the economy was

required. But the Classical macro system was unable to explain convincingly the business cycles and the

depression met throughout since the industrial revolution. As a result of this hands-off policy, hundreds of

banks in the USA went bankrupt; unemployment reached very high levels, one fourth of farmers lost their

lands.

Thus in the 1932 elections, Franklin D. Roosevelt of Democrat Party won the presidency and he

immediately implemented a program called the “New Deal”. The major aim of this program was to ameliorate

the plight of the farmers and the workers. By 1935 Roosevelt reformed the social security system of the

workers and introduced unemployment insurance. Otherwise, however, he kept the level of government

expenditures restricted. Though he was three times elected as president, consecutively because of the social

measures he tried to implement the depression in the USA lingered for quite some time till the World War II

because of the lack of aggregate demand and because the government expenditures were not raised out of fear

of budget deficits and inflation. Thus, low private consumption and investment expenditures were not

compensated by higher public expenditures.

The world was implementing the gold monetary system at the time of the depression. During World War I

the gold system had to be abandoned because of difficulties of meeting international debt payments in gold. But

because of budget deficits, the paper money regime that had to be implemented during the war years went hand

in hand with inflation. Therefore, after World War I all countries had returned to the gold monetary system.

European countries too fell victim to the Great Depression simultaneously with the USA, the problems

again starting with payment difficulties of the financial sector. Similar to the USA, European governments also

made the same two policy mistakes. Firstly, they restricted imports, trying to attain foreign trade balance. But,

when a country restricts its imports, it means exports of all other countries are decreased, hence the growth rate

falls, leading to less demand for exports from other countries, that is, countries that restrict their imports.

Therefore, it is, in fact, a beggar-they-neighbor policy as mentioned above, depressing the growth and income

of all countries, hence deepening the depression. The effects of import restrictions were such that by 1932 the

total volume of world trade had fallen down to only half of its 1928 level. Secondly, again similar to the USA,

the European governments also refrained from expanding government expenditures to fight the fall in income

levels. This further deepened the depression and increased unemployment levels.

In 1936, observing that the classical economic system did not hold and could not solve the problem of

recessions and depressions, Keynes published his famous path breaking book (The General Theory of

Employment, Interest and Money). Keynesian macroeconomic system emphasized that, contrary to the

Classical system, full employment is not achieved automatically; hence government intervention at the macro

level is required to bring about full employment. During the times of depression, according to the Keynesian

system, fiscal policy (of increasing government expenditures or lowering taxes) is much more effective than

monetary policy (of expanding money supply and lowering the interest rates). During and after the World War II


116

most countries chose not to return to the gold system, but remained with the paper money regime because it

was a more convenient monetary system to implement monetary policy. The USA, in contrast, having a

relatively large volume of gold, remained at the gold system for a longer time, but eventually abandoned it in

the early 1970s. The US dollar, however, remained as the world’s most widely used reserve currency.

The Great Depression had also triggered serious political upheavals. In Germany, the economic and

political turmoil of the depression plus heavy World War I indemnity payments demanded from Germany

finally brought Adolf Hitler and National Socialists to power in 1933, leading to World War II 1939-1945. In

Italy, Fascist Benito Mussolini had already come to power in 1922; he sided with Germany and Hitler in World

War II.

All developed countries (DCs) implemented Keynesian macroeconomic policies since World War II and

prospered steadily, with business cycles depression and inflations averted, up until the oil price rises by OPEC

in early 1970s which gave rise to stagnation and inflation (stagflation).

Developments Since the Great Depression Up Till Present

Following World War II (1939-1945) immediate steps had been taken not to fall back to international trade

restrictions that had been implemented after the World War I and during the Great Depression. Accordingly,

with the 1944 Bretton Woods agreement IBRD (WB) and IMF were established and GATT (General

Agreement on Tariffs and Trade) was reached in 1947. They aimed to secure and maintain liberalized

international trade, to lend short term credit to countries facing trade deficits and to lend long term investment

credit first to Europe for re-construction, and then to the developing countries to aid their development. By

1970s most of all the less developed countries (LDCs) and newly industrializing countries (NICs) facing

recurring foreign trade crises, hence lowering of growth rates accompanied by high inflation reverted from

closed economy, import-substitute industrialization model and fixed foreign exchange regime to open economy

model and market economy with flexible exchange rate regime, aided in this direction by the advices of IMF

and WB as well as their free and deliberate choice. Both international trade (exports and imports) as well as

Direct Private Investments (DPIs) increased steadily all throughout, including not only between the developed

countries but also from the DCs to the LDCs and to some extent also between the LDCs. International

migration (both legal and illegal), remittances of international migrants to home country as well as tourism also

increased steadily. After USSR was dismantled most of the Eastern European and Balkan countries that gained

full independence also opted for the market economy and relations with the West, including membership to

NATO as well as to the EU. At the same time, since the 1990s particularly short term financial flows (lending

credit, buying government or private bond or shares) from the DCs to the LDCs and NICs also increased

substantially, thus leading to a globalized world. Globalization raised the growth levels of all countries, up until

2007. The growth rates of LDCs and NICs rose even faster than those of DCs. In particular, Brazil, Russia,

India, and China (BRIC) registered remarkably high growth rates and economic transformation and these

countries began to be called “emerging markets”. China, who is interesting to underline, had abandoned

production by state enterprises, had entered World Trade Organization (WTO), and had become a major

recipient of DPIs coming mostly from the USA, Europe, and Japan. Thus, the global financial crisis and global

recession (in short, global economic crisis) hit the world in September 2008 when the world had become highly

globalized and incomes had risen to high levels, accompanied by decreased numbers of people below the

poverty line for the world in general.


117

The 2008 Financial Crisis and Its Effects on the Developed Countries

Recession in the USA

The 2008 financial crisis again first broke out in the USA, as had been the case for the Great Depression.

There were several factors why the financial crisis broke out. Firstly, the financial sector had been largely

deregulated since the Reagan era in the USA, similarly with UK since the Thatcher era. Secondly, consumers

incessantly demanded higher level mortgage credits from banks and mortgage institutions, based on the

assumption that house prices would continue to rise in future as had been the case in the past years. Thirdly,

banks were too eager to grant such mortgage credits in order to increase their profits (not writing them off as

bad or even risky “debts”, i.e., “credits” from the point of view of banks. Thus, salaries and premiums of CEOs

of banks and financial institutions concerned were raised along with reported increases in profits, so did the

value of shares of the shareholders and dividends they received. But with the slowing down and then falling

house prices, both the debtors to the bank who had received mortgage credits as well as the banks suffered.

Fourthly, financial sector is a particular sector which requires an optimum dose of regulation and control and

should not be deregulated. But both the government (the Secretary of the Treasury) and also the chairman of

the FED at the time (Alan Greenspan) failed to see the future risks involved, hence the financial sector was kept

largely deregulated during the George Bush era until the crisis broke out.

First it was supposed that banks suffered an “illiquidity” problem, but it was soon realized that it was a

much deeper and wider “insolvency” problem when many large banks and institutions dealing with mortgage

credits faced bankruptcy and had to apply for government help. Mortgage institutions, banks as well as “hedge

funds” (institutions investing the money of savers to profitable valuable papers) which held valuable papers tied

to mortgage debts all had suffered.

This time, however, unlike the experience of the Great Depression, the government (the Treasury)

immediately acted to rescue the insolvent banks and institutions. In some emergency cases, the Treasury put in

money to partly nationalize the ailing institutions. For other cases the Treasury established a special fund to buy

off these mortgage “debts” (i.e., credits of the banks) whose value had become worthless. The fund was called

Troubled Assets Relief Program (TARP). These “assets” were called “toxic assets” because their presence

affected the overall liquidity and solvency of the bank in question. The bank was then allowed either to go on

independently or else was encouraged to be sold to another but healthy bank. At the same time, the FED (Ben

Bernanke as chairman) decreased the interest rate (as far as down to 0.5%, i.e., to about zero) while it increased

its facilities for encouraging interbank credits. The funds appropriated by the FED far exceeded $1 trillion.

These measures by the FED were aimed to encourage private investments as well as private consumption at

low interest rates, and also to expand the credit availability of banks. Measures to save the financial sector were

effective in the sense that it prevented a total collapse of the financial sector; insolvencies and bankruptcies

were largely prevented. But these monetary measures were not enough to stimulate the economy and take it out

of recession. To fight the recession, the fall in the level of private investments and consumption, therefore, the

US government put into effect a special program of increased public investments (in infra-structure, clean

energy, etc. for the case of USA). After Obama became president, he disallowed bank nationalizations, but

preferred to lend credits to banks in trouble within a newly set-up and enlarged fund. But he also forced them to

undergo special tests (called stress tests) for their financial strength to withstand certain assumed negative

developments in the economy. Of the $700 bn. TARP, the previous fund, the remaining $350 bn. was


118

transferred to the new fund of $1 trillion, which was later raised to $2 trillion, and participation of private firms

specialized in purchases of bad assets was secured. Obama continued, however, with the public investment

program, adding to its health care improvements. In fact, long ago, in 1936 Keynes had warned that to prevent

recessions and depressions, effectiveness of monetary policy would be limited while fiscal measures (raising

government expenditures) would definitely bear out results. Thus, the economy could not be turned around

immediately to move up, but at least a serious depression was averted, the financial crisis and the recession

were, in fact, ameliorated. By late 2009 real estate prices finally stopped falling down, bank insolvencies and

illiquidity problems were largely subsided. Hence problems started to soften by 2010 but full recovery was not

attained up till present. It is true that the programs designed to help the ailing financial sector and to increase

public investments raised the level of government debt and budget deficits to record levels, all to be paid in

future. But had the programs not been put into effect, the cost to the economy both for the present and for the

future would have been much higher in terms of growth, income, and tax revenue levels while we would also

be faced with a very large increase in unemployment.

Next to the financial sector and the house construction sector, all sectors were negatively affected, but the

automotive sector suffered most from the recession and hence was a special sector for government aid in the

USA, as well as in all other countries. In the USA, GM, and Chrysler, in particular, suffered most. Therefore,

the government lent them credit in a limited way, but since both had also faced structural problems, the

government asked GM to prepare a program of reform, including lowering of personnel salaries and workers’

wages. For Chrysler, the government urged similar restructuring and sale of a substantial part of its shares to

Italian Fiat. GM, faced with $173 bn. debt finally had to apply to the Treasury for bankruptcy protection and

had to be 60% nationalized as the first step. Opel, a GM subsidiary in Germany was sold to Magna, a large

Canadian auto parts firm at the head of a consortium. It was finally decided, on the other hand, to sell 20% of

the shares of Chrysler to Fiat.

In sum, however, although a serious depression was averted the measures taken led to large budget deficits

as well as large balance of payments deficits and very high volumes of external debt for the case of USA. These

developments continue to create economic problems presently.

Recession in Europe and Japan

Both the financial crisis and the recession soon spread to the developed European countries and Japan.

Firstly, European and Japanese banks held assets of US banks and financial institutions which had become

worthless, hence suffered illiquidity and insolvency, leading to a financial crisis in these countries. The

European governments also intervened immediately, some banks were partly nationalized in some countries,

some were sold to other banks, and some received government credit to bail them out. Secondly, exports of

these countries to the USA decreased, thus further triggering the recession. Financial difficulties of exporting

firms, in turn, squeezed the banks even further. With falling and negative growth rates, similar to the USA,

private investments and private consumption also decreased. The European and Japanese governments,

likewise, again immediately intervened and put in force special government expenditure program to ameliorate

the recession. Again the Central Banks of European countries and Japan as well as the European Investment

Bank (EIB) lowered interest rates to encourage private investments and private consumption as well as to

strengthen the banks and aid them to continue giving out credits. The automotive sector in the developed

countries also suffered most from the recession and had to be aided by the governments. Generally, these


119

governments chose to aid their automotive sectors by offering to pay a certain sum to the scrapped old vehicles

to the buyers of new cars with up-to-date emission standards. In the case of France, the French government

further lent credit to French automakers while Sarkozy prevented any sales of companies to be taken over by

non-French firms, even by firms from the EU countries.

Generally, European countries implement deeper welfare measures, including social security system,

health care, unemployment insurance etc.. These measures taken as a whole tended to depress the growth rates

of European countries compared with the USA and UK, during the recession this time they helped by

preventing incomes and hence private consumption from falling more precipitously. Only the French

government implemented relatively intensive interventions and controls during the crisis, but it was temporary

though in general the French economic regime is more interventionist compared with, say Germany, and

naturally the USA and Japan. One thing, however, became certain, financial sectors were kept regulated with

care taken not to fall into over-regulation. The government sector was also somewhat enlarged because some of

the measures such as improvements in health care, etc. remained permanently. It would take time to

denationalize the banks that had to be speedily nationalized partly when the financial crisis broke out.

The 2008 Financial Crisis and Its Effects on the LDCs, NICs, and BRICs

The global recession of 2008 also spread to the LDCs and NICs as well as the emerging markets. Firstly,

most of these countries were exporting to the USA and Europe and along with the recession in the latter

countries, their exports declined considerably. Secondly, they relied on DPIs and financial flows coming from

the developed countries for stimulating faster growth. But due to the financial crisis and recession in the

developed countries these flows also declined, similarly even remittances of workers. China could implement

an anti-recessionary public investment program financed by the foreign exchange reserves that she had

accumulated. Brazil also suffered the least because of wise and pragmatic economic policies she had pursued

since Lula de Sylva came to power. India was also the least affected. But countries like Russia and Turkey

which had depended on ever increasing external borrowing to finance a faster growth rate, suffered more

because of the shrinking foreign exchange inflow, including not only exports but also short-term credits as well

as DPIs. Ukraine was also another country seriously affected by the present economic crisis. Thus, in future,

countries like China, Japan, and Germany have to rely less on an export-oriented growth strategy but also

encourage domestic private consumption, while Russia will have to rely less on external debt financing of

growth and development but keep relying on DPI flows. Countries like USA, UK, on the other hand, will have

to increase their savings in order to keep their private consumptions as well as imports not to rise above

sustainable levels. China, in addition, should raise the value of the yuan and refrain from artificial export

promotion and over-accumulation of foreign exchange reserves.

A Short Overview of the After-Effects of the 2008 Economic Crisis

For the case of the USA, the more serious problems arising out of economic measures to avoid the 2008

economic crisis were increased external debt, increased trade and current account deficit as well as increased

budget deficit. The Senate and the House of Representatives had to raise the level of external debt legally

allowed in order to avoid a catastrophe. Otherwise, the US economy continues to register some growth.

On the other hand many European countries, in particular, those in the Euro zone have, at present, that is,

by 2011 and 2012 displayed serious economic difficulties, such as high external debt, inability to pay this debt


120

as well as some weak points or banks in their financial sector. These countries included Greece, Ireland, Spain,

Portugal, and Italy, these problems also even in France. Despite help from the European Union, European

Central Bank and IMF, these problems continue to threaten the stability of the Euro zone. But these present

economic problems are only loosely related to the after-effects of the economic measures implemented during

2008 economic crisis.

At this point, we should have to mention Turkey as a special case. Although Turkey was one of the

countries worst hit by the 2008 global economic crisis, she made a very swift recovery. Hence she enjoys a

very high growth rate and continued flow of DPIs. On account of economic problems faced in Europe, the

Turkish government deliberately sought to increase exports to other countries, which it did successfully. But

increased trade and current account deficit and increased external debt remain a potential future threat. If the

Euro zone and EU countries go into a continued recession, Turkish economy would definitely be negatively

affected.

Conclusions

As the above explanations reveal, the magnitude of the 2008 global economic crisis was very high and due

to globalization the crisis had immediately spread throughout the whole world. But, in contrast to the wrong

policy implementations during the Great Depression, this time the right economic policies, on the whole, were

implemented by nearly all countries. Hence the response to the crisis by the governments and the Central Banks

were also global, that is, in harmony and in cooperation, broadly speaking. Therefore, though the crisis was the

worst experienced since the Great Depression, the recession was not allowed to develop into a depression.

Measures taken to prevent the 2008 crisis, however, gave rise to problems of external debt, budget deficits as

well as trade deficits presently, that is, by 2011 and 2012. This is certainly the case with the USA, while many

countries in the Euro zone and China as well as Turkey, on the other hand, are in a much better position

compared with other countries.

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İstanbul: İstanbul University. Hiç, M. (2008). A survey of Turkey’s economy and politics. Create-Space, Amazon Co.. Hiç, M. (2010). Major current economic and political problems facing Eurasian countries. Proceedings from the International

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Lal, D. (1983). The poverty of development economics. London: Institute of Economic Affairs Hobart 16. Lall, S. (1981). Developing countries and international economy. Basingstoke: Macmillan. Lewis, W. A. (1954). Economic development with unlimited supplies of labour. Manchester School of Economic and Social

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The Mathematic Modeling of Process Economization

of Natural Resources

Simona Hašková, Pavel Kolář University of Economics in Prague, Faculty of Management in Jindřichův Hradec, Czech Republic

The economic view of resources distinguishes between the term of a “natural resource” and an “economic

resource”. The “natural” resource becomes economically interesting only if it fulfills the following two conditions:

(1) there are technologies that enable the obtaining (drilling) and utilization of natural resources; and (2) there are

prices and conditions that enable a meaningful usage of the resources. The availability of condition two is being

checked by the projects’ financial analyses of the exploration and drilling. The main task is to find out what kind of

methods is available for use in the oil deposit exploration and what strategy of follow-up mining to choose so that

the expected net present value (E[NPV]) of the whole process is the highest one. If the expected NPV is positive,

the natural resource localized in the deposit justifies the economic resource and is therefore usable in practice. The

problem is solved by means of the sequential decision tree of the project, from which on the basis of the detailed

analyses of its relevant substructures (“case based reasoning” approach) the model of dependence of the expected

NPV on price of the drilling rights is derived. The interpretation is accompanied by a specific case study of the

exploration and mining analyses of an oilfield.

Keywords: natural resource, economic resource, expected net present value, option of a project termination, option

of drilling termination, oil well exploration method, seismographic exploration method

Natural Versus Economic Resources In 2009 the consortium of energy companies at the head of the American company Anadarko Petroleum

confirmed a giant oil strike along the African coast. The oil area stretches from the Sierra Leone to Ghana. The

relatively optimistic outlook was based on results of the exploration well Velus near the Sierra Leone shore,

which is about 1,100 kilometers away from Ghana’s predicted oil field.1

What the above mentioned news reports have in common is the information about the discovery of a

natural resource. However, drilling the crude oil starts only if the field is interesting from an economic point of

view. The first of the two assumptions of the “economic attractiveness” (the existence of technologies that

enable drilling and utilization of the natural resource) mentioned in the abstract is evidently fulfilled in this case.

At present the companies are working

on several projects within which they want to start crude oil drilling. Recently there was news in the press about

the discovery of a natural gas field at the European coast (Ordons News, 2009).

Simona Hašková, Ing., Department of Business Management, Faculty of Management, University of Economic in Prague. Pavel Kolář, Ing. CSc., Department of Business Management, Faculty of Management, University of Economic in Prague. Correspondence concerning this article should be addressed to Simona Hašková, Faculty of Management, Jarošovská 1117, 377

01 Jindřichův Hradec, Czech Republic. E-mail: [email protected]. 1 Original resource: The report in the Lidové noviny, September 2009 (amended).

DAVID PUBLISHING

D

THE MATHEMATIC MODELING OF PROCESS ECONOMIZATION

123

Both of the resources have very attractive utilization (actually, they are essential for today’s society). The

potential threat of the global energy crises contributed significantly to the development of technologies

available from various sites. According to the opinions of experts there is hardly anything else to improve in

this regard.2

The contribution is based on the results of solving a large-scale case study entitled “The decision making

between the use of traditional oil-well exploration method and the seismographic exploration method of a

newly discovered oil field” (Hašková, 2010) solved in connection with the said finding of oil along the African

coast. The model of the decision making problem about the optimal method choice, which is solved within the

decision on the acceptance or rejection of the project, is the decision tree. All known information is reflected in

the structure and in the evaluation of the individual leaves and derived expectations.

That is why this assumption does not hinder the transformation of natural resources to economic

recourses very much (Hyne, 1984).

The situation is different in the case of the second assumption the “economic attractiveness” that concerns

the price adequacy and general unspecified “conditions”. Search for the natural resources fields for their

exploitation is now in the hands of multinational companies. Deposits occur mostly in places where nobody has

been looking so far, often in the countries of “the third world”. The governments of these states are increasingly

realizing the strategic significance of raw oil. The local government perception of the wealth that is stored in oil

resources reflects in their requirements applied when determining the conditions for permitting drilling. The

significant role played in these conditions is in particular the price and mode of payment assigned drilling rights.

The future of the oil field depends upon the agreement or disagreement on this issue and therefore, whether the

resource is used for the benefit of all. To achieve the ubiquitous agreement contributes not only knowledge of

how these factors translate into economic aspects of the project, but also the choice of survey methods and site

selection strategies of drilling. The aim of the paper is to illustrate the crucial aspects related to this problem.

The Decision Tree of the Problem

3

From the root node “R” of the decision tree in Figure 1 two branches appear. The oil-well exploration

branch leads upwards

The result of many

complex calculations and considerations is the completely specified decision tree in Figure 1, on which further

considerations is based.

4 and the seismographic exploration leads to the right side.5

2 In the case of oil we have in mind the presence of oil in the liquid state. This oil was a natural resource in the time of pharaohs as well, but drilling technologies neither existed nor was the usages of it known. The natural resource is today even oil in the form of insoluble saturated clay. This natural resource is much more abundant than conventional oil fields but the lack of the cheap oil drilling technologies for extracting oil from the clay makes it economically unattractive. 3 These are the drilling conditions including information about the exploration field methods being considered, techno economic parameters of available drilling rigs and other drilling equipment, information concerning the occurrence of oil in comparable locations, estimates of resource abundance, expectations about demand and prices, etc.. 4 The node Vi, i = 1, 2, 3 describes the situation of an exploratory well at a depth i measured in thousands of feet. The number of the horizontal edge that comes out of it gives the conditional probability that the well remains dry under the assumption that the well was dry even above 1,000 feet. The opposite case (the oil is hit at depth i in thousands of feet) describes the edge upward. The situational node to which the edge enters distinguishes its output edges between the appearances of small or large quantities of oil (large quantity is twice as probable). The highest decision-making nodes to which these edges direct introduce the option (the right to choose) to abandon oil drilling in case the oil production is unprofitable. Only the presence of oil at a depth of 1,000 feet means that the oil production cannot be unprofitable and therefore the option is not needed at the V1 node. On the contrary, low-lying decision-making nodes embedded in between the situational nodes Vi represent the options for abandonment of the project already in the exploration phase. The application of any of these options would occur at an oil-well exploration depth, where they hope to offset the marginal cost of further oil-well drilling by expected yield of extracted oil would fade.

5 The node S0 shows the possible outcomes of the seismographic exploration: We can expect oil at a depth of 1,000 feet with a


124

Figure 1. The simplified model of a decision tree problem.

As Figure 1 shows, it is not counted with oil drilling from the depths greater than 3,000 feet. The numbers

probability of 70% (the situation S1). With 10% probability there is no oil at a depth under 3,000 feet (which results in a loss of seismographic exploration costs, unlike the oil-well exploration method where, in the same case, the loss of oil-well exploration costs would increase the price of already purchased drilling rights). With the same probability (10%) the oil can be expected at depths of 2,000 or 3,000 feet. The situations S2 and S3 are analogies to the situations at V2 and V3. However, unlike the situation at V1, the options have to be included in the output edges of the situation S1, the high price of drilling rights can cause a loss in oil production.

drilling

0.3

dry

oil well

2,000 dry

2/3

1/3

0.5

dry

0.5

oil well 3,000

stop stop

V2 V3

S0

S1

S2

S3

drilling drilling drilling drilling

1/3 1/3

1/3 2/3

2/3 2/3

drilling drilling

1/3

–X

drilling 2/3

1/3 2/3

drilling drilling

1,000 0.7

2,000

0.1

3,000 0.1 no oil

0.1

R Seismographic exploration

1,000 Oil well

V1

0.7

1/3 2/3

1.185–TP 11.83–TP

–2.48–TP 6.48–TP –8.05–TP –1.9–TP

–1.67–TP –2.08–TP

–2.08–TP –2.5–TP

–2.5 –TP

–X–TP+2.855 –X–TP+13.5

–X–TP–0.4

–X–TP+8.56

–X

–X –X

–X–TP–5.55 –X–TP+0.6


125

in the leaves of the tree indicate the NPV in millions USD (in case of the exploratory drilling its cost is already

accounted to them), from which the unknown TP values (prices of the drilling rights) are deducted. In the right

branch there is also “X” deducted, which in the model represents costs of the seismographic exploration (these

are not included in NPV figures).

From Varian’ (1992) point of view the situational nodes can be regarded as the elementary lotteries or

compound lotteries (in case of the S0 node). This economic approach in the form of NPV was studied in detail

(Hašková & Kolář, 2010). The decision tree then can be viewed as a model of a certain strategic game: every

application of option cuts off the part of the tree and every combination of application of options forms a

strategy process. The optimal strategy is the one that offers the highest resulting expected NPV. The aim of the

game is to find this strategy. Let us see Figure 1 for how to play the game.

The Effect of the Drilling Rights Price on the Exploration Method Choice and the Drilling Strategy

This part will explore the impact of a parameter TP (price of the drilling rights) on the formation of an

optimal game strategy. Every consideration of exploration methods will be analyzed separately, the optimal

strategies and unbiased prognoses of NPV at the situational nodes of the tree are derived backward from the

end to the beginning (that is from the outermost leaves to the root).

The Drilling Strategy After the Oil-Well Exploration The method of oil-well exploration requires purchasing the drilling rights before starting the oil-drilling

(that is when we are not sure if we will ever come across the oil and therefore if there will be any oil to drill).

The failure here means the loss of the total oil-well costs and cost of drilling rights. In Figure 2, we can see

upper branch (sub-tree) of the decision tree from Figure 1. Crossing out the edges indicate the possibilities that

were not selected by the application or non-application of the options. Values shown in italics at the situational

nodes are the unbiased prognoses of NPV in the corresponding situation.

Figure 2. The tree-cut option “the oil-well exploration”.

The optimal strategy for exploratory drilling and possible follow-up drilling can be easily read from Figure

2 (at a depth of 1,000 feet to drill regardless of the abundance of resources, at a depth of 2,000 feet to drill only

when there is a “lot” of oil and not to drill to a depth of 3,000 feet). The dependence of the unbiased prognosis

of NPV (E[NPV]1) on TP of this strategy is given by E[NPV]1 = 5.74 – TP, which was re-derived at the V1 root

1.185-TP

2⁄3 1⁄3

V1

11.83-TP

0.7

2⁄3

8.28-TP

0.3

dry V2

2,000

oil well

-1.67-TP

-0.18-TP

2⁄3

2⁄3

dry V3

oil well

2,000 3,000

-2.5 -TP

3.63-TP

1⁄3

1⁄3 2⁄3

-2.08-TP driling

-2.48-TP 6.48-TP

driling

1⁄3 2⁄3

-2.1-TP

0.5

0.5

dry

-2.5-TP

-8.05-TP -1.9-TP

driling driling

-2.08-TP

5.74-TP -2.3-TP

stop stop


126

of the sub tree. This strategy is independent of TP to the value TP = 5.74. The exploration oil-well method will

not be used at TP > 5.74.

The Drilling Strategy After the Seismographic Exploration Unlike the oil-well exploration, it is possible to purchase the drilling rights after the completion of the

seismographic exploration that is when it is known that there is oil to be produced and it is decided on starting

the oil extraction. The failure here means the loss of X value (the seismographic exploratory costs). The

decision on the use of the seismographic exploration method is based on the sub tree with the S0 root (right

branch) of the decision tree in Figure 1. From the evaluated leaves of this sub tree it is obvious that as in case of

oil-well exploration, low abundance of resource means that oil will never be drilled at a depth greater than

1,000 feet. Whether oil will be drilled from a low abundant resource at a depth of 1,000 feet or highly abundant

resource from other depths depends solely on the TP price. Within the decision-making about the oil production

the seismographic exploration costs of X are the sunk costs, therefore it does not affect the application or

non-application of options. Around the prices TP ∈ {0.6; 2.855; 8.56 a 13.5 million USD} it leads to changes

in the application of these options, which alters drilling strategies. Therefore it is necessary to examine the

strategies separately at five successive intervals 0 ≤ TP < 0.6; 0.6 ≤ TP < 2.855; 2.855 ≤ TP < 8.56; 8.56 ≤ TP < 13.5, and TP ≥ 13.5. The examination result of the interval 0 ≤ TP < 0.6 can be seen in Figure 3.

Figure 3. The tree-cut option “the seismographic exploration” at 0 ≤ TP < 0.6.

It can be seen that the optimal strategy in this case differs from the oil drilling strategy in Figure 2 only in

drilling

S0

S1

S2

S3

1/3 2/3

drilling drilling

1/3

–X

drilling 2/3

1/3 2/3

drilling drilling

1,000 0.7

2,000

0.1

3,000 0.1 no oil

0.1

–X–TP+2.855 –X–TP+13.5

–X–TP–0.4

–X–TP+8.56

–X

–X –X

–X–TP–5.55 –X–TP+0.6

–X–2TP/3+0.4

–X–2TP/3+5.71

–X–TP+9.95

–X–0.83TP+7.576


127

drilling the abundant oil resource even from the depth of 3,000 feet. The predicted NPV of this strategy (the

root S0) takes on the value E[NPV]0 = –X – 0.83 · TP + 7.576.

The transition to the neighboring higher interval 0.6 ≤ TP < 2.855 means that the oil drilling at the depth of 3,000 feet would be added to already marked loss oil drillings in Figure 3. In the structure of the sub tree it

would come to a change of cutting the edge in the right decision node placed under the situational node S3

(application of the option “not to drill”). As a result the drilling strategy would fully coincide with the drilling

strategy after the oil-well exploration (see Figure 2). It would also come to a change of the evaluation of the node

S3 to −X, which would alter the prognosis of NPV at the root S0 to E[NPV]0 = –X – 0.77 · TP + 7.536.

The described consequences of the transition to the neighboring higher interval values of TP can be

generalized and applied to other transitions:

By the transition from the interval 0.6 ≤ TP < 2.855 to the interval 2.855 ≤ TP < 8.56 comes to an application

of the option “not to drill” also to the oil drilling from the poor oil resource at a depth of 1,000 feet (the decision

node at the top left). This strategy change alters the evaluation of the node S1 to –X – 2 · TP/3 + 9 and the NPV

prognoses at the root S0 to E[NPV]0 = –X – 0.53 · TP + 6.871;

Compared with the previous case by the transition from the interval 2.855 ≤ TP < 8.56 to the interval 8.56 ≤ TP < 13.5 comes to an application of the option “not to drill“ also at the oil drilling from the rich oil resource in

a depth of 2,000 feet (the decision root placed under the node S2). This strategy change alters the evaluation of the

node S2 to –X and the NPV prognoses at the root S0 to E[NPV]0 = –X – 0.47 · TP + 6.3;

The transition to the interval TP ≥ 13.5 enforces an application of the option that was the only one non-applied in the previous case (the decision node at the top right), which blocks any possibility of oil drilling.

All situational nodes (including S0) then take on the value of –X and the seismographic exploration will not be

realized. It does not come to the transformation of a natural resource to an economical resource.

The results of the above analyses are incorporated in a simple geometric model (see Figure 4), for which

multiple use can be found in practice.

The Model Dependence of the Predicted NPV on the Price of Drilling Rights (TP) By connecting the partial sequences of the dependency of the unbiased NPV prognoses, which are obtained

in the previous section, over the individual intervals of TP values, we get the course of this dependence over the

entire range of TP values. This dependency in case of X = 0 (neglecting the seismographic exploration costs) is

illustrated by the solid bold line in Figure 4. By taking the seismographic exploration costs of X into account the

line is moved in a parallel way about –X value vertically. An example of such a line is a broken dotted line,

plotted also in Figure 4, moved about 2.141 downwards. It illustrates the course of dependence for the value X =

2.141 million dollars.

Apart from the two mentioned lines there is a dashed line plotted for the oil-well exploration in Figure 4.

Comparing both of the courses we can see that on the entire range of TP values the course of dependence

decreases more slowly in case of the seismographic exploration than in case of oil-well exploration. However,

within the seismographic exploration we see that with the growth of TP values the decrease of NPV values slows

down. Therefore, when the both courses intersect somewhere (in our example it occurs when the price TP = 1.5

million USD) it means: to the left of the intersection the oil-well exploration method would be more

advantageous and to the right of the intersection the seismographic exploration method would be better. The

important information is the zero points of courses indicating the limit boundaries of usability of both examined


128

methods. We can see that the price TP = 5.74 million USD is the limit of usability of oil-well exploration,

whereas the limit of usability of the seismographic exploration in the amount of X = 2.141 million USD lies

somewhere near 8.6 million USD.

Figure 4. The graphic representation of the model.

It should be emphasized that the model (as well as the decision tree, from which it was derived) is based on

the knowledge of the situation before the oil field exploration. It is therefore a useful tool for only the first step in

deciding on the entire project, when it comes to a decision whether or not to be concerned with the oil-field

exploration or to reject the project. The project is rejected if the price of mining rights is on the right side of the

usability limit boundaries of both methods. Otherwise the project will be accepted and the model decides on the

use of the oil-field exploration method.

The fact that the project was accepted and the oil-field exploration started would not mean that the natural

resource became the economic resource. This would happen only if the oil drilling started. A decision on the oil

production is based on the exploration results. Suppose that at the price of TP = 3 the seismographic exploration

finds little abundant resource at a depth of 1,000 feet (the tree branch protruding from the node S1 to the left). In

this case the oil production is loss making and the natural resource remains unused. None of the interested parties

(owner of the resource or people interested in oil drilling) gain anything of it, on the contrary, both lose. This

may be the motivation for the negotiation on the TP price reduction, which in this case prevents the

transformation of the natural resource to the economic resource. If it comes to a price reduction by 0.5 million.

USD on the basis of the negotiation, oil will be produced. A natural resource becomes an economic resource and

both parties get richer.

However, in the same situation it may become that the seismographic exploration does not express clearly

to the richness of the resource (the possibility of an abundant resource is still in play) and the owner of a resource

0 0.6 1.5 2.855 5.74 8.56 13.5

TP

NPV

5.74

7.576

2.141

–0.83TP+7.576

–0.77TP+7.536

–0.53TP+6.871

–0.47TP+6.3

5.74–TP


129

will not tend to reduce the TP price because of his pursuit of a fair profit distribution. Then other information can

help to clarify the matter. However, this may not be available for free. By now the problem of setting an

appropriate price of information comes into play. It is based on an argument that says that the price of

information should not outweigh the benefit, which the information provides. In this context the work by

Hašková (2011) deals with the pricing of information based on Shannon’s conception of uncertainty.

Conclusions As it is shown in case of the seismographic exploration the low cost of mining rights made the oil an

economic resource at a depth of 3,000 feet and increases in its price made it gradually economically unattractive

in depths of 2,000 or even 1,000 feet. We have seen how the analyses of relevant substructures of the decision

tree allowed constructing useful tools to detect and eliminate the causes and factors that prevent a meaningful

application of natural resources. We have indicated the possibilities how can the resulting information contribute

to an agreement on the TP price and thereby to remove barriers that hinder from the use of natural resources.

Therefore the analyses can be considered as a useful tool that can help to discover new “economic resources”.

References Brealey, R. A., & Myers, S. C. (2011). Fundamentals of corporate finance (7th ed.). United States of America: Mcgraw-hill

Education. Frank, R. H. (2009). The return of the economic naturalist. London: Virgin Books.

Hašková, S. (2010). The fundamentals of theory and praxis of managerial calculations (Dissertation, University of Economics in Prague, FM VŠE, Czech Republic). Retrieved from https://www.vse.cz/vskp/21678_Z

Hašková, S. (2011). The wealth maximization criterion & the utility maximization criterion. Sborník příspěvků z vědecké konference doktorandů, studentů magisterského studia a mladých vědeckých pracovníků. Vysoká škola ekonomická v Praze:

Nakladatelství Oeconomica—Jindřichův Hradec. Hašková, S., & Kolář, P. (2010). A contribution to a mathematic modeling of the behavior of private and institutionalized

investors as observed in practice. Proceedings of the 28th International Conference on Mathematical Methods in Economics. JU České Budějovice.

Hyne, N. J. (1984). Geology for petroleum exploration, drilling and production. Tulsa, O.K.: PennWell Books. Ordons News. (2009). Repsol makes two new oil discoveries offshore Spain. Retrieved from

http://www.ordons.com/europe/western-europe/806-repsol-makes-two-new-oil-discoveries-offshore-spain.html Varian, H. R. (1992). Microeconomic analysis (3rd ed.). United States of America: W.W.Norton & Company, Inc..

http://www.ordons.com/europe/western-europe/806-repsol-makes-two-new-oil-discoveries-offshore-spain.html�


The Relationship Between Economic Value Added and Earnings

Per Share: An Empirical Analysis of the Turkish Cement

Industry

Murat Azaltun, Irem Batibay, Ilker Calayoglu

Okan University, Istanbul, Turkey

EVA is an acronym for economic value added, is a measure of corporate performance that differs from most others

by including a charge against profit for the cost of all the capital a company employs. EVA is much more than just

a measure of performance. It is the framework for a complete financial management and incentive compensation

system that can guide every decision a company makes. It combines factors, such as economy, accounting, and

market information in its assessment. The main objective of this study is to introduce the concept of Economic

Value Added (EVA) and compare with the method of Earnings Per Share (EPS). This study aims to determine the

effect of the Economic Value Added and Fundamental Analysis of the company’s earnings per share in the cement

industry sector. Especially, the study is examined the economic crisis period 2000-2001 and 2007-2008 and their

reflection to the financial statements of the cement companies. The methodology used in this research is a

web-based data collection is the company’s financial statements and the company’s earnings per share amount

which is then processed and analyzed using Microsoft Excel. Having obtained the results of analysis using

Microsoft Excel, then the data are performed using the SPSS 17 statistical test to determine the effect of the

Economic Value Added and Fundamental Analysis of the company’s earnings per share. This study employs

pooled time-series, cross sectional data of listed 15 cement companies in the Istanbul Stock Exchange (IMKB) over

the period 1999-2010 to examine whether EVA or Earnings Per Share (EPS) is associated more strongly with

companies performance. Findings indicated that the proponents of EVA provided evidence to establish this method

as a superior performance measurement and incentive compensation system and claimed that it is really better to

use EVA, than Earnings per Share Method.

Keywords: performance measures, EPS, EVA, Turkish cement industry, Economic Value Added (EVA), Earnings

Per Share (EPS)

Murat Azaltun, Assistant Professor, Department of Accounting and Financial Management, School of Applied Sciences, Okan

University. Irem Batibay, Ph.D. candidate, Department of Accounting and Financial Management, School of Applied Sciences, Okan

University. Ilker Calayoglu, Ph.D. candidate, Department of Accounting and Financial Management, School of Applied Sciences, Okan

University. Correspondence concerning this article should be addressed to Irem Batibay, Okan University, School of Applied Sciences,

Department of Accounting and Financial Management, Campus Box 34959, Tuzla, Istanbul, Turkey. E-mail: [email protected].

DAVID PUBLISHING

D

AN EMPIRICAL ANALYSIS OF THE TURKISH CEMENT INDUSTRY

131

Introduction Maximizing shareholders value has become the new corporate paradigm in recent years. Shareholder’s

wealth is measured in terms of returns they receive on their investment. It can either be in forms of dividends or

in the form of capital appreciation or both. Capital appreciation depends on the changes in the market value of

the stocks.

The market value of stocks depends upon number of factors ranging from company specific to market

specific. Financial information is used by various stakeholders to assess firm’s current performance and to

forecast the future as well.

EVA has following principles:

(1) EVA helps in reducing agency conflict and improve decision making (Lovata & Costigan, 2002);

(2) EVA is more strongly associated with stock return than other measures (Maditinos & Sevic, 2006);

(3) EVA improves stock performance (Ferguson, Rentzler, & Yu, 2005);

(4) EVA adds more informational content in explaining stock returns (Erasmus, 2008).

As Drucker puts in his 1995 Harvard Business Review article:

EVA is based on something it has been known for a long time: What it has been called profits, the money left to

service equity, is usually not profit at all. Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it

devours in resources… Until then it does not create wealth; it destroys it. (Drucker, 1995, p. 54)

Many corporate managers have forgotten this basic principle because they have been conditioned to focus

on conventional accounting profits, which include a deduction for interest payments on debt but have no

provision at all for the cost of equity capital, worse still, most line managers focus on operating profits, which

do not even have a charge for debt. True profits do not begin until the cost of capital, like all other costs, has

been covered.

EVA is a measure of those true profits. Arithmetically, it is after-tax operating profits minus the

appropriate capital charge for both debt and equity. What remains are the amount by which profits in any given

period exceed of fall short of the cost of all capital used to produce those profits. This is a number that

economist refers to as residual income, which means exactly what it implies: it is the residue left over after all

costs have been covered. Economists also refer to this as economic profit or economic rent. Accountant calls it

EVA, for economic value added. It is simple, though the actual calculation of EVA is somewhat more

complicated. It first requires a number of decisions about how to properly measure operating profits, how to

measure capital, and how to determine the cost of capital (Ehrbar, 1998).

The Concept of EVA A concept critical in evaluating the performance of any business is economic value added. In generic

terms, value added refers to the additional or incremental value created by an activity or a business venture.

Economic value added is a refinement of this concept—it measures the economic rather than accounting profit

created by a business after the cost of all resources including both debt and equity capital have been taken into

account. Economic value added is a financial measure of what economists sometimes refer to as economic

profit or economic rent. The difference between economic profit and accounting profit is essentially the cost of

equity capital—an accountant does not subtract a cost of equity capital in the computation of profit, so in fact


132

an accountants measure of income or profit is in essence the residual return to that equity capital since all other

costs have been deducted from the revenue stream. In contrast, an economist charges for all resources in his

computation of profit—including an opportunity cost for the equity capital invested in the business—so an

economist’s definition and computation of the profit is net above the cost of all resources (Boehlje, 2000).

The Relationship Between Positive and Negative EVA With Accounting Performance Companies with positive EVA’s will lead to better organisation and have strong market positions. This

study believes that companies that have positive EVA value or value creator companies have a strong

accounting returns and better market positions. In addition, they might also have higher profits and good

accounting indicators, since a positive EVA is indicative that companies have high excess profit after deducting

cost of investments. This again will be indicating that, the company is well organised in reaping higher returns

exceeding investor’s expectations. Returns on investment made by this type of company will also be higher

than returns expected by the investors.

The Relationship Between Positive and Negative EVA With Stock Return Positive EVA means the company is experiencing an excess of net operating profit after tax (NOPAT)

after deducting the charge for capital (both debt and equity) which is obtained by multiplying the percentage of

weighted average cost of capital (WACC). It means the company had excess real profit that the company

gained after deducting cost of investment by investors from net profit.

It is the norm nowadays for companies to only declare profit that, while not taking into account of the cost

of capital or investment. In contrast, for value destroyer companies (negative EVA) the net profit is not enough

to cover the cost of investment by investors. The negative EVA means that a company is running in losses,

after deducting the cost of capital.

Turvey studied the relationship of the highs and lows of EVA against market return (Tuvey, Van Duren, &

Sparling, 2000). Their results were consistent with other researchers that, positive EVA will correlate with

higher market return.

Literature Review There are some studies that do and some that do not support the claim that EVA provides better stock

returns. Biddle analyzed a sample of firms over the period 1984-1993 by comparing the stock market adjusted

returns against EVA, Residual Income, and Operating Cash Flow (Biddle, Bowen, & Wallace, 1997). The

results do not support that EVA dominates traditional performance measures in its association with the stock

market returns. Ismail conducted a study on EVA and its association with stock returns viz-a-viz accounting

earnings and stock returns and found that net operating profit after taxes and net income outperform EVA in

explaining stock returns. Further, this study states that accruals and operating cash flows have significant

incremental information content than EVA (Ismail, 2006).

P. P. Peterson and D. R. Peterson (1996) analyzed traditional and value-added measures of performance

and their relationship with stock returns. Their findings state that traditional measures are not empirically less

related to stock returns than return on value added measures. Kyriazis and Anastassis in their study of Greek

firms concluded that relative information content tests reveal that net and operating income appear to be more

valuable than EVA (Anastassis & Kyriazis, 2007). EVA components add only marginal information content as


133

compared with accounting profit (Sharma, 2010).

Proponents of EVA claim that EVA is highly correlated with stock returns. Lefkowitz analyzed the US

companies and a result of the study supported Stern-Stewart hypothesis, i.e., EVA is better correlated with

stock returns as compared with traditional performance measures (Lefkowitz, 1999). They found that EVA is a

reasonably reliable guide to understand the firm’s value. Lehn and Makhija investigated the degree of

correlation between different performance measures and stock market returns (Lehn & Makhija, 1997). The

results indicate that EVA is the highest correlated measure with stock returns.

Research Data and Methodology EVA is defined as the amount of net operating profit after tax (NOPAT) minus the charge for capital (both

debt and equity) obtained by multiplying the percentage of weighted average cost of capital (WACC). EVA is

an estimate of the amount by which earnings exceed or fall short of the rate of return shareholders and lenders

could get by investing in other securities of comparable risk and includes a charge against profit for the cost of

all the capital a company employs.

EVA calculation steps:

(1) Calculate Net Operating Profit After Tax (NOPAT);

(2) Identify company’s Capital (C);

(3) Determine a reasonable Capital Cost Rate (CCR);

(4) Calculate company’s Economic Value Added (EVA).

EVA = Net operating profit after taxes − Cost of capital

Calculating Net Operating Profit After Taxes (NOPAT), NOPAT is easy to calculate. From the income

statement we take the operating income and subtract taxes.

NOPAT = Operating Income – Taxes

Calculating Cost of Capital:

Cost of Capital = TC × WACC

where, TC = Total Capital, and WACC = Weighted Average Cost of Capital.

EVA = NOPAT – WACC × TC

Exploratory designs and correlational method have been chosen for this study, since the purpose of the

study is to explore the relationship of EVA as company performance method and Earnings per Share Method.

The analysis will use time series and cross section analysis simultaneously. The findings on each performance

tool and earnings per share is analysed at this level.

The sample of the companies comprises the public listed cement companies in Istanbul Stock Exchange

over the period 1999 to 2010. Based on these criteria, for period 1999 to 2010, 15 companies are involved.

Cement industry is chosen for this research, because cement industry is a basic industry which plays an

important role in the process of economic development of the country. It is an essential material for building

infrastructure like dams, bridges, hospitals, and plants. Consequently, the cement industry has a manifold

accelerating effect on activities in many sectors of the economy. Thus the extent of forward and backward

linkages of cement industry highlights its prominence in fitter industry growth. This industry is also significant

from the point of view of direct and indirect employment it generates, revenue contribution by way of taxes and

duties to government and catering to basic standard of living, namely, housing.

Cement industry has been accorded a significant place in the scheme of priorities for facilitating


134

investment process in the industrial development. It is produced both in public and private sectors. Certain

guidelines were adopted for the private sector in order to augment production without encouraging the

concentration of economic power.

In this research 15 cement companies, which exist in IMKB are used. These companies are shown in

Table 1.

Table 1

Name of the Listed Cement Industry Companies in Istanbul Stock Exchange Name of the companies ADANA ÇİMENTO SANAYİİ T.A.Ş. AFYON ÇİMENTO SSANAYİİ T.A.Ş. AKÇANSA ÇİMENTO SANAYİ VE TİCARET A.Ş. ASLAN ÇİMENTO A.Ş. BATIÇİM BATI ANADOLU ÇİMENTO SANAYİİ A.Ş. BATISÖKE SÖKE ÇİMENTO SANAYİİ T.A.Ş. BOLU ÇİMENTO SANAYİİ A.Ş. BURSA ÇİMENTO FABRİKASI A.Ş. ÇİMENTAŞ İZMİR ÇİMENTO FABRİKASI T.A.Ş. ÇİMSA ÇİMENTO SANAYİ VE TİCARET A.Ş. GÖLTAŞ GÖLLER BÖLGESİ ÇİMENTO SAN. VE TİC.A.Ş. KONYA ÇİMENTO SANAYİİ A.Ş. MARDİN ÇİMENTO SANAYİİ VE TİCARET A.Ş. NUH ÇİMENTO SANAYİİ A.Ş. ÜNYE ÇİMENTO SANAYİ VE TİCARET A.Ş.

The balance sheet and income statement of all companies are achieved from IMKB (Istanbul Stock

Exchange Market) and KAP (Kamuyu Aydınlatma Platformu—Public Disclosure Platform).

Table 2 shows the calculations of CCR, NOPAT, and EVA of the Adana Cement Company. The

calculations are made with the company’s balance sheet and income statement reports for the years between

1999 and 2010. Some assumptions are made for calculating EVA. Government bond interest rates have been

assumed as an alternative cost of capital. The bold figures in Table 2 show that Adana Cement Company had

negative EVA on the years 1999, 2000, and 2001. It means that on those years the company was losing value

on its capital-consuming activities

Table 2

CCR, NOPAT, and EVA of the Adana Cement Company

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

CCR 0.075002 0.0911985 0.1597802 0.1612683 0.1617494 0.156620 0.0098072 0.0120197 0.0232866 0.029810 0.0309954 0.0265390

NOPAT 32,605,213 49,617,679 49,678,092 126,253,944 133,234,965 83,705,239 36,609,726 42,504,742 14,232,860 9,484,165 10,993,540 14,689,471

EVA -20,986,302 -6,775,683 -35,471,290 20,297,141 41,190,617 3,159,343 33,135,417 38,944,305 10,271,684 5,014,603 8,076,458 12,014,119

Table 3 shows the calculated EVA of the companies. As it is seen most of the variables are negative,

which means that the companies have lost value by investing in capital-consuming activities (Çakıcı, 2008). As it

is seen after the economic crisis in 2000-2001 and 2007-2008, most of the companies begin to have more

negative EVA.

Table 4 shows the Earnings per Share of the companies during the years. As it is seen during and after the

economic crisis in 2000-2001 and 2007-2008, most of the companies begin to have less EPS. The bold figures in

Table 4 show EPS values below zero mean that the company is losing money.

Tab

le 3

C

alcu

late

d EV

A of

the

Cem

ent I

ndus

try L

isted

Com

pani

es

Com

pani

es

1999

20

00

2001

20

02

2003

20

04

2005

20

06

2007

20

08

2009

20

10

Ada

na Ç

imen

to

12,0

14,1

19.9

9 8,

076,

458.

11

5,01

4,60

3.72

10

,271

,684

.98

38,9

44,3

05.8

4 33

,135

,417

.67

3,15

9,34

3.02

41

,190

,617

.92

20,2

97,1

41.2

4 -3

5,47

1,29

0.02

-6

,775

,683

.91

-20,

986,

302.

11

Afy

on Ç

imen

to

-132

,434

.81

-553

,475

.08

-1,0

40,4

11.9

5 83

6,90

8.68

-9

,527

,068

.45

-3,0

41,0

68.9

3 4,

469,

599.

04

5,17

5,51

6.07

-1

9,99

9,09

9.41

-9

,263

,093

.16

-7,5

91,7

76.3

3 -5

,504

,159

.95

Akç

ansa

Çim

ento

-2

5,40

4,98

7.81

-4

6,44

0,59

4.71

-4

9,31

1,84

6.76

-7

2,58

8,65

3.51

-2

35,6

14,8

23.5

1 -1

66,1

62,0

17.2

9 -7

,558

,773

.01

15,4

22,2

29.7

4 -1

2,92

5,29

2.77

4,

645,

597.

52

-16,

005,

388.

75

-27,

000,

346.

65

Asl

an Ç

imen

to

-3,7

43,3

66.1

3 -1

0,88

2,89

6.99

-1

5,03

7,14

5.36

-1

0,99

5,83

6.45

-7

3,95

5,85

7.64

-4

7,43

8,77

2.97

-2

,046

,317

.18

9,97

0,55

0.52

6,

295,

808.

35

-19,

070,

712.

47

-52,

854,

423.

46

-18,

536,

619.

05

Bat

ıçim

Çim

ento

-7

,888

,370

.62

-14,

030,

933.

78

-10,

328,

847.

41

-21,

663,

336.

78

-120

,093

,584

.42

-82,

947,

215.

80

-33,

986,

065.

46

45,0

08.1

2 -2

0,58

2,17

6.37

-6

8,43

8,42

8.36

-3

5,34

6,72

0.67

-2

7,97

2,83

7.02

Bat

ısök

e Ç

imen

to

-10,

923,

532.

58

-19,

600,

481.

69

-23,

786,

346.

02

-25,

199,

981.

04

-71,

477,

407.

28

-51,

736,

066.

05

-8,5

21,9

47.9

9 2,

074,

997.

71

-15,

810,

654.

16

-28,

622,

690.

30

-16,

396,

302.

81

-15,

433,

868.

33

Bol

u Ç

imen

to

-6,5

70,8

71.9

5 -1

6,48

5,65

0.05

-1

7,59

5,13

1.91

-2

1,73

5,82

8.26

-4

5,38

1,88

6.26

-3

3,16

2,35

0.81

9,

435,

399.

97

35,3

10,6

15.4

9 -7

76,7

74.3

9 -1

,540

,657

.90

-10,

793,

675.

17

-6,2

30,3

86.2

1

Bur

sa Ç

imen

to

-3,8

39,3

01.9

4 -8

,409

,244

.45

-8,6

36,9

90.2

7 -1

1,09

2,63

9.51

-5

8,15

5,86

1.61

-2

7,05

6,09

9.46

15

,560

,321

.70

31,4

15,7

13.9

0 11

,057

,776

.95

-16,

613,

815.

00

-33,

519,

657.

42

-26,

530,

217.

76

Çim

enta

ş Cim

ento

-1

2,63

0,95

6.86

-1

6,58

9,62

7.91

-2

4,61

3,74

7.88

-1

7,01

0,39

7.75

-9

4,73

8.08

-6

9,08

1.39

-4

8,23

5.78

-6

4,35

6.96

-7

1,42

4.18

-9

8,40

0.77

-2

2,27

4.40

-5

7,75

5.84

Çim

sa Ç

imen

to

-2,1

47,9

20.7

7 -2

3,81

0,00

3.10

-3

3,44

0,79

0.52

-4

6,56

2,65

2.45

-1

86,8

51,5

80.0

2 -1

37,3

99,5

50.8

1 12

,137

,932

.70

80,9

82,3

82.9

7 46

,438

,831

.35

-14,

874,

633.

79

53,4

55,5

70.4

8 87

,304

,689

.94

Göl

taş Ç

imen

to

1,75

1,44

7.67

-8

76,2

12.8

0 -1

3,55

2,11

2.99

-8

,671

,307

.26

-79,

376,

087.

77

-32,

663,

029.

27

-3,7

92,6

04.2

3 -1

4,52

9,54

3.85

-6

0,85

6,07

7.83

-4

5,70

9,64

0.51

-2

7,70

3,77

2.15

-3

2,32

3,95

0.97

Kon

ya Ç

imen

to

-1,2

82,5

26.1

6 -5

,313

,893

.16

-13,

293,

536.

43

-11,

580,

856.

86

-73,

513,

715.

98

-49,

028,

977.

02

5,97

1,23

5.82

15

,530

,137

.31

-10,

124,

827.

65

-40,

332,

424.

87

-24,

646,

070.

95

-7,9

94,6

88.1

3

Mar

din

Çim

ento

-1

,024

,743

.70

-3,6

71,7

10.5

4 -3

,454

,068

.98

-7,1

45,1

44.5

1 -2

7,23

1,61

3.02

-1

2,34

9,92

6.40

34

,048

,599

.28

51,5

56,0

68.4

5 37

,078

,230

.81

20,1

14,5

47.0

0 46

,396

,508

.14

43,9

84,7

03.5

5

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-8

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,356

.64

-25,

553,

963.

37

-29,

304,

181.

51

-31,

409,

261.

58

-231

,405

,496

.62

-101

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,521

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13,2

59.7

3 26

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,106

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46,9

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438,

917.

63

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882,

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25

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-5,0

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6,53

4.72

-1

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6,05

5.86

-7

4,14

2,67

3.27

-7

6,29

6,23

3.88

-5

3,65

8,15

7.98

31

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,307

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58

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90.7

9

Tab

le 4

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ings

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re o

f the

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ndus

try L

isted

Com

pani

es

19

99

2000

20

01

2002

20

03

2004

20

05

2006

20

07

2008

20

09

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A

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1.30

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1.47

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66

0.48

0.

63

0.85

3

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to

0.05

0.

04

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21

0.12

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97

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06

0.96

0.

30

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00

0.37

7

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0.

29

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0.

16

0.18

0.

02

0.04

0.

59

0.77

0.

97

0.54

0.

39

0.31

0.

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0 0.

35

1.22

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72

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21

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64

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46

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59

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78

0.26

0.

14

0.21

0.

413

Bat

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0.27

0.

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0.37

0.

51

0.40

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0.36

0.

62

0.01

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34

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06

0.26

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0.27

0.

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0.51

0.

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0.25

0.

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0.30

0.

55

0.38

0.

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0.35

0.

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0.96

0.

55

0.40

0.

62

1.07

0.

81

0.69

0.

43

0.05

0.

11

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2

Çim

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0.

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0.18

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85

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61

0.24

0.

289

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0.64

0.

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1.66

0.

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0.

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0.09

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6


136

Results Proponents of EVA provided evidence to establish this method as a superior performance measurement

and incentive compensation system and claimed that it is really better to use EVA than traditional accounting

performance measures such as Earnings Per Share (EPS).

EVA’s during years have a positive correlation between each other. EPS of companies are also positively

correlated according to years. But when analyzing the correlation between EVA and EPS, it is obvious that

there is not appropriate relationship.

The results of this study show that earnings per share method are not a confidential method for calculating

company’s performance. The reason is that the manipulative and speculative information can affect the stock

prices. And according to this influence companies earning per share can have different amounts than it should be.

EPS ratios change too quickly and too much to be of any real use for financial analysis.

The collected data of this study are examined from the balance sheets and income statements of the

companies in the sector one by one. It has been explained before how the EVA calculation should be. But it is

necessary to recall that the starting point for the calculation is the companies’ operating profit and loss accounts.

The research has showed that most companies have profit on their financial statements while they have a negative

EVA. This means that most of the companies in this industry make profit from operations other than their main

activities. This can be another research topic to study.

References Anastassis, C., & Kyriazis, D. (2007). The validity of the economic value added approach: An empirical application. European

Financial Management, 13(1). 71-100. Biddle, G. C., Bowen, M. R., & Wallace, J. S. (1997). Does EVA beat earnings?—Evidence on associations with stock returns

and firm values. Journal of Accounting and Economics, 24(3), 301-336. Boehlje, M. (2000). Economic value added, strategic business planning for commercial producers, center for food and

Agricultural Business, Purdue University. Retrieved from http://www.agecon.purdue.edu/extension/sbpcp/resources/creatingvalue.pdf

Çakıcı, C. (2008). Ekonomik Katma Değer Yaklaşımı (p. 16). İstanbul: Beta Yayınları. Drucker, P. (1995). The information executives truly need. Harvard Business Review, 73(1), 54-63. Ehrbar, A. (1998). EVA the real key to creating wealth. New York: John Wiley & Son’s. Erasmus, P. D. (2008). The relative and incremental information content of the value based financial performance measure cash

value added (CVA). Management Dynamics, 17(1), 2-15. Ferguson, R., Rentzler, J., & Yu, S. (2005). Does economic value added (EVA) improve stock performance or profitability?

Journal of Applied Finance, 15(2), 101-113. Ismail, A. (2006). Is EVA associated with stock return than accounting earnings? The UK evidence. International Journal of

Managerial Finance, 2(4), 343-353. Lefkowitz, S. D. (1999). The correlation between EVA and MVA of companies (MBA dissertation, California State University). Lehn, K., & Makhija, A. K. (1997). EVA, accounting profits, and CEO turnover: An empirical examination. Journal of Applied

Corporate Finance, 10(2), 90-96. Lovata, L. M., & Costigan, M. L. (2002). Empirical analysis of adopters of economic value added. Management Accounting

Research, 13, 215-228. Maditinos, I. D., Sevic, Z., & Theriou, N. (2006). The introduction of economic value added (EVA) in the corporate world.

Proceedings from The International Conference: Innovation, Entrepreneurship and Competitiveness in Balkan and Black Sea Countries. Kavala, Greece.

Peterson, P. P., & Peterson, D. R. (1996). Company performance and measures of value added. Charlottesville, V.A.: The Research Foundation of the Institute of Chartered Financial Analysts.

Sharma, K. A. (2010). Economic value added (EVA)—Literature review and relevant issues. International Journal of Economics and Finance, 2(2), 200-220.

Tuvey, C. L., Van Duren, E., & Sparling, D. (2000). The relationship between economic value added and the stock market performance of agribusiness firms. Agribusiness, 16(4), 399-416.

http://www.agecon.purdue.edu/extension/sbpcp/resources/creatingvalue.pdf�


An Efficient Analytic Solution to a Supply Chain

Management Problem

Sung-woo Cho

Kunsan National University, Gunsan, South Korea

Soo-yong Shin, Myong-sop Pak

Sungkyunkwan University, Seoul, South Korea

As the market trends shift from a seller’s to a buyer’s market, today’s business face highly competitive nature of

business environment and this in turn has created tremendous pressure for global company operations. To compete

and survive, it has become inevitable for enterprises to apply supply chain management which offers effective

management systems. As competition becomes more burdens and brings problems to enterprises they have started

to focus on system integration to increase their business benefits. This paper looks at methods such as Enterprise

Resource Planning (ERP), Enterprise Application Integration (EAI), and Component-Based Development (CBD)

including SAP software in order to study the advantages and disadvantages of each method offers. These methods

allow enterprises to integrate their systems and supply chains and moreover, help to investigate values for today’s

organizations. The paper then selects one specific business enterprise in order to review their current supply chain

management systems and to find out what the problems they are facing are. Based on the findings, it proposes and

suggests solutions for the chosen enterprise which may help to reduce the inefficiency they have under the current

system. Relevant literature review will be conducted in carrying out the chosen research topic.

Keywords: supply chain management, Enterprise Resourcing Planning (ERP), Enterprise Application Integration

(EAI), Component-Based Development (CBD), problem solution

Introduction

Enterprises in the supply chain can optimize supply chain management by sharing high quality

information in a timely manner. Companies all over the world have adopted and developed enterprise systems

for easy information flow. Despite the development of various tools and techniques, however, it is often

A shift from a seller’s market to a buyer’s market has severe business consequences, both locally and

internationally. Persistent overcapacity in the buyer’s market results in intensely competitive pricing. To

overcome these challenging situations, a number of enterprises have explored the concept of supply chain

management (SCM) and applied it to their organizations, because a well-organized and integrated supply chain

is one of the key requirements for a successful business (Lee, Kwon, & Severance, 2007).

Sung-woo Cho, Assistant Professor, Ph.D., Logistics, Kunsan National University. Soo-yong Shin, Senior Researcher, Institute of International Trade, Sungkyunkwan University. Myong-sop Pak, Professor, Ph.D., Business Graduate School, Sungkyunkwan University. Correspondence concerning this article should be Soo-yong Shin, Sungkyunkwan University, Institute of International Trade,

53, 3-ga, Myeongnyun-Dong, Jongno-Gu, Seoul, 110-745, South Korea. E-mail: [email protected].

DAVID PUBLISHING

D

AN EFFICIENT ANALYTIC SOLUTION TO A SUPPLY CHAIN MANAGEMENT PROBLEM

138

difficult to analyze the current system and develop new methods to integrate enterprise systems.

The principal objective in this study was to gain a precise understanding of the business context and

problems of a specific case, and provide an efficient solution. The paper is structured as follows. In the next

section, it provides the business background for the specific case and review the relevant literature. Then, it

identifies suitable approaches to develop a supply chain management solution for the specific case. In the

concluding section, it discusses implementation issues and the potential advantages and limitations of the

proposed system.

Business Background and Literature Review Business Background

A medium-sized company is a supplier of aerosol cans of various sizes and with different contents. The

firm purchases a diverse range of parts from a variety of material suppliers and then fills cans with

customer-specified ingredients. The aerosol cans are composed of a tube, valve housing and cup, stem, actuator,

and straw (optional component).

In general, it takes six weeks from the time an order is received when the products are supplied to the

client. This means that the entire process has a six-week lead-time. After confirming the order, the firm checks

its own stocks and then, if they have available stock, the company can start to produce the required product in

fixed batch sizes. If the can components are not in stock, the company places an order with suppliers.

The ordered spare parts arrive at the factory on a daily basis. The purchasing manager checks and records

item quantities. The production manager decides what the daily production schedule is based on the available

stock. The total amount of each component used is recorded on a weekly basis.

The system described above is not efficient and sometimes provides inaccurate information, because data

are updated only on a weekly basis. Therefore, the company would like to improve its current system to reduce

stocks, reform order processing, more accurately predict the production schedule, and build formal

communication channels.

Literature Review Enterprise Resource Planning (ERP). Various definitions of ERP exist. Lee, Siau, and Hong (2003)

defined ERP as follows:

ERP is an enterprise-wide software solution designed to streamline the data flow between different functions in an organization. ERP is an industry term for the broad set of activities supported by multi-module application software that

assists a manufacturer or other business in managing the important parts of the business, including product planning, parts purchasing, maintaining inventories, interacting with suppliers, providing customer service, and tracking orders. (p. 56)

Wallace and Kremzar (2001) defined ERP as follows:

An enterprise-wide set of management tools that balances demand and supply, containing the ability to link customers and suppliers into a complete supply chain, employing proven business processes for decision making, and providing high degree of cross-functional integration among sales, marketing, manufacturing, operations, logistics, purchasing, finance,

new product development, and human resources, thereby enabling people to run their business with high levels of customer service and productivity, and simultaneously lower costs and inventories; and providing the foundation for

effective e-commerce. (p. 5)

One important function of an ERP system is that management practices in an organization, for example

supply chain management and finance, are systemized. These changes promote “greater managerial control,


139

speedy decision-making, and huge reduction of business operational cost” (Su & Yang, 2010). Su and Yang

developed a classification system of ERP benefits based on a review of the publications of Irani and Love

(2001), Harris (1996), Mabert et al. (2000), Stratman and Rothe (2002), Vemuri and Shailendra (2006), and

Shang and Seddon (2000). This classification system is based primarily on the paper of Shang and Seddon

(2000) and comprises five constructs and 32 subcategories (see Appendix Table A1).

If a company incorporates an ERP system completely into its organization, does the enterprise benefit

from these changes? This question can be answered from the perspective of operational issues. A company has

to allocate a large part of its budget to operating different departments after adopting an ERP system (Goodhue,

Wybo, & Kirsch, 1992; Soh, Kien, & Tay-Yap, 2000). However, even if the ERP system is set up successfully,

some departments still need to prepare operating expenses (Gattiker & Goodhue, 2004). To operate effectively,

Park and Kusiak (2010) stated that “four types of ERP operational issues should be considered: propagation

costs, continuous training, data quality, and internal control”. An advanced support system for ERP is essential

to deal with these factors.

Enterprise Application Integration (EAI). A new method of system integration called “Enterprise

Application Integration (EAI)” was reported in the mid-1990s (Lee et al., 2003). This method has opened up a

new field of research and there is much current research in this field.

Lee et al. (2003) defined the basic concept of EAI as follows:

EAI is mainly in its externality of enterprise integration with lower costs and less programming using existing application. EAI is a business computing term for plans, methods, and tools aimed at modernizing, consolidating, and

coordinating the overall computer functionality in an enterprise. (p. 57)

Generally, companies have their own accumulated data, legacy systems, applications, and programs. Many

companies prefer to improve their current system by adding new applications and technologies rather than

implementing a new system, because of the expense and long time period associated with budgeting for,

applying, and implementing a completely new system. In addition, it is essential to convert data-codes and used

the converted data in the proposed system. However, there is unique middleware in the EAI. The function of

this middleware is to connect different applications and support development of a new system. Moreover, if a

company uses an EAI, it does not need to perform programming. Figure 1 shows the differences between the

EAI concept and the traditional method.

Figure 1. A comparison of the EAI approach and the traditional approach.

Web Applications

Applications Servers

Interapplication Middleware

Legacy Applications

Database Systems

(EAI Integration)

Web Applications

Web Applications

Legacy Applications

Legacy Applications

(Traditional Integration)


140

According to Themistocleous et al. (2004), many EAI suppliers have developed their own EAI packages

to maximize system integration. However, when system developers apply EAI packages to systems, they have

to be extremely careful, because EAI vendors sometimes develop packages with the object of providing

specific fields. A number of EAI packages to integrate ERP systems are currently available. Nevertheless, EAI

packages cannot cover all ERP systems. Puschmann and Alt (2001) strongly recommended that more than one

EAI package should be used for new systems, regardless of the costs. However, these costs are still “…much

less compared to the cost of the point-to-point solutions” (Themistocleous & Irani, 2001).

Component-Based Development (CBD). The development of supporting program is critical for

enterprises to integrate applications. Several researchers have focused on developing efficient integration

software. “Component-based development is a software development approach in which all aspects and phases

of the development life-cycle, including requirements analysis, design, construction, testing, development, and

project management, are based on components” (Zhao & Siau, 2002).

CBD is a very useful tool when companies want to integrate their systems. CBD has the advantages of

hardware compatibility, adaptability, standardization, and quick application via the Internet, e.g., e-commerce

and e-business.

CBD evolved from the object-oriented methodology that encapsulates internal details of objects, and allows external applications to know and use the objects’ interfaces. Over time, it proved difficult for objects developed with different

languages, platforms, and running environments to work together (interoperability), and it was found that this difficulty impedes software reuse. (Zhao & Siau, 2002, p. 207)

Suitable Approaches and Information Flows Analysis of Suitable Approaches

Both technical integration and organizational performance are critical requisites for a successful system.

The whole process is complicated and requires large amounts of money and time. Furthermore, system

management is challenging. However, the benefits of an integration system can outweigh the costs. Numerous

methods, tools, packages, and hardware to integrate systems have been developed. The main approaches

investigated in this study were ERP and EAI.

ERP systems have numerous benefits. It can be challenging for medium-sized companies to incorporate

different organizational units such as business units, application units, and technology units. Nevertheless,

many SMEs wish to establish their own ERP systems despite the financial and time burdens. Some of the key

benefits for the given case are listed below:

Inventory. The company can reduce stocks and easily control stocks;

Order processing. The company can reduce ordering mistakes;

Production scheduling. The company can reduce and effectively manage planning and manufacturing

cycle times;

Quick response. The company is able to respond promptly to market dynamics;

Information sharing. The company can share information within the organization and with its partners.

SMEs must consider several critical issues before implementing ERP such as human resources, costs,

barriers, business processes, and maintenance. Once the project is initiated, going back is really difficult. These

days, enterprises tend to initiate ERP integration tasks with a certain level of manual control.

Two different ERP implementation approaches can be taken. The first approach enterprises can take is to


141

adopt a basic ERP template, for example, comprehensive, vanilla, or middle-road. In this case, companies need

to reform their business processes to match ERP functionality. The merit of this approach is that there is no

difficulty in upgrading. The second way is to customize the ERP system for the business processes of the

company. This approach has the disadvantages of slow implementation, high cost, and a complex upgrade

process (Kale, Banwait, & Laroiya, 2008).

In contrast, the EAI approach is

Pull-oriented in that existing applications and business process are used to map and integrate separate functionalities of an enterprise into a form that is more acceptable to members of the organization. The EAI approach is also designed as a

top-down method, due to its business-mapping procedure. (Lee et al., 2003, p. 59)

The differences between the ERP and EAI approaches are shown in Figure 2.

Figure 2. Comparison of the ERP and EAI approaches.

Both ERP and EAI methods are expensive and time-consuming, but the ERP system takes longer to

institute than the EAI system. While EAI facilitates the incorporation of enterprise systems above an expected

level, ERP drives the launch of standardized business processes. Therefore, ERP is a more centralized business

approach whereas EAI generally forces a decentralized business approach. Even though a mapping process is

required for EAI, which takes some time, there is no need to redesign the business process ahead of ERP

implementation. “Depending on the industry and specific functions, EAI could reduce the expense of

integration from 10% to 60% of the price of the ERP software” (Lee et al., 2003). The technical and behavioral

characteristics of ERP and EAI are listed in Table 1.

Table 1

ERP and EAI Characteristics (Source: Lee et al., 2003) ERP EAI

Technical

Degree of BPR

Integration method Implementation period

High/Medium

Process integration Long

Medium/Low

Process mapping Medium

Behavioral

Degree of resistance

Business process Internationalization period

High

Centralized Long

Low

Decentralized Short

(a) ERP Approach: Push-oriented

Bottom-up

(b) ERP Approach: Pull-oriented

Top-down

Standard Business Process Organization Business Process

Internalization Externalization

Externalization Internalization


142

Information flow in an extended enterprise includes the supply chain partners (the process is illustrated in

Figure 3). If a certain department has some problems, a “bull-whip effect” can be transmitted through the entire

supply chain. In addition, when customer demand changes unexpectedly, it is difficult to control inventory, the

production schedule, and logistics.

Information Flows in an Extended Enterprise

Figure 3. Information flows in an extended enterprise.

The Suitability of SAP as an ERP Many SMEs are still under the impression that SAP software was developed to support large-sized

enterprises. Over 71,000 SMEs, however, have chosen SAP software which provides efficient and customized

solutions for SMEs and is affordable. SAP software for SMEs is simple to adopt and use and is scalable (easy

to upgrade and connect with partners).

SAP software for SMEs has been developed for a variety of industries, including the automotive, chemical,

consumer product, mill product, and wholesale distribution industries, among many others. For the case

considered in this study, the principal purpose of SAP software implementation is to reduce stocks, improve

order， and purchase processing, share information with partners, and establish efficient formal communication

channels.

Retailer

Purchasing

Manufacturer (Assembler)

Logistics Purchasing

Accounting Production

Checking Stocks

Delivery (Daily)

Warehouse

Chemical Supplier

Logistics

Suppliers

tube, valve housing and cup stem, actuator, straw (optional)

Logistics

Date

External Communication

Internal Communication

Data

Data Offer Acceptance

Order (Specific due date)


143

SAP software covers business and technology areas because in these areas, it is critical to manage the

supply chain effectively and to optimize it. Specialists agree on the following essentials:1

Balance material and capacity using a pull strategy with extended supply chain networks;

Collaborate with your suppliers and partners in real time to fulfill customer orders more quickly and

reliably;

Use sales forecast and supply chain visibility to guide operations;

Standardize your internal processes and controls to minimize exceptions and one-offs;

Streamline and automate business processes and routine operational tasks.

SMEs can manage each process in their supply chain such as procurement, production, marketing,

logistics, and customer service. There are two main types of software solutions for SMEs: business

management software solutions (SAP Business One, SAP Business ByDesign, and SAP Business All-in-One)

and business intelligence solutions (Crystal Report Offerings, Xcelsius, and SAP Business Objects Edge

Solutions). Table 2 shows each characteristic of management software solutions.

Table 2

Business Management Solutions SAP business one SAP business by design SAP business all-in-one

What it is A single, integrated solution to manage your business

The best of SAP, delivered on demand

A comprehensive, integrated industry solution to power your business end to end

Best for Small businesses that have outgrown their packaged accounting-only solutions

Companies that need business software but do not want to support a large IT backbone

Midsize companies with industry needs that want a scalable foundation

Employees Up to 100 100-500 100-2,500

Industry Primarily used in wholesale, retail, professional services, and light manufacturing

Primarily used in manufacturing, professional services, and distribution

Used in all major industries

Key functionality

General business management functionality and 550+ add-on solutions, many of them industry-specific

General business management functionality

General business management functionality and 700+ industry-specific solutions

Deployment On premises On demand On premises

Implementation 6-8 weeks 4-8 weeks 8-16 weeks

How to buy Traditional licensing Monthly subscription Traditional licensing

Proposed System According to the research, in order to ensure the success of the business in the given case, the company’s

current systems need to be integrated into an efficient system, and the business processes and information flows

need to be optimized. To achieve these goals, it is recommended that the company adopt an ERP system with

SAP for SMEs and then introduce an EAI system after evaluating the stability of the ERP system, because the

company provides over 3,000 different products. The company can incorporate its legacy system with new

applications and business partners using an EAI approach if the firm plans to expand its business areas in the

future.

1 Retrieved from http://www.sap.com/sme/whysap/foryourneeds/supplychain.epx.


144

Adoption of an ERP System With SAP The two approaches used to implement an ERP system were introduced in section 3. First, enterprises can

adopt basic ERP templates: comprehensive, vanilla, or middle-road. If this approach is used, it is essential to

redesign the business process to match ERP functionality. The advantage of this approach is that system

extension is simple. A second approach is to adopt a customized ERP system. Using this approach, system

errors are easy to detect and the company can recover rapidly from a serious error. However, this approach is

slow to implement, expensive, and the upgrade process is complex. Therefore, the first approach is more

reasonable for SMEs.

SAP business management solutions for SMEs were introduced in section 3. The choice of SAP Business

One, SAP Business ByDesign, or SAP Business All-in-One software depends on the business circumstances of

the organization. SAP Business ByDesign is the best solution for the given case considering the characteristics

of the company.

EAI Implementation Approaches There are four different EAI implementation levels. Once a level is chosen, it is critical to decide among

five different EAI topologies. These topologies are described and summarized in Table 3.

Table 3

EAI Software Topologies Topology Description

Hub From source to a central hub (also known as a “star” topology)

Bus Source puts messages on a bus (also known as a “bulletin board” topology)

Point-to-point Applications communicate with one another

Pipeline FIFO (first in first out) information flows

Network Best use for asynchronous activity and independent transactions Note. Source: Lee et al., 2003.

“Determining the appropriate topology is critical to enable organizations to manage maintenance costs and

integration performance” (Lee et al., 2003). For the given case, it is recommended a bus topology for internal

integration and a hub and spoke topology for external integration. Advantages of the hub and spoke topology

are its simple design, implementation, and simplicity of system extension. However, if there are problems in

hub system, it is impossible to share information with external systems. Therefore, it is important to connect the

hub using high performance PCs.

The next step is to evaluate different EAI systems, such as BEA systems, CrossWorlds, IBM, and so on.

Table 4 shows the characteristics of different EAI systems. Deciding “which system” and “how many systems”

is not simple or straightforward. For example, the multinational corporation, the Robert Bosch Group, selected

three systems: IBM, Level 8 Systems, and Mercator. It is believed that CrossWorlds United Applications

Architecture is the best system for the given case.

Component-based development (CBD) can promote company integration (Zhao & Siau, 2002): “This

would enable an enterprise to have agility and flexibility as well as standardization and compatibility through

the Internet (allowing for efficient e-commerce, e-business, and m-commerce, for example)”. Application of

CBD in the given case after setting up the EAI system is likely to be challenging. Architecture for this case is

provided in Appendix Figure B1.


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Table 4

Five Different Types of EAI Systems

System Development and runtime service

Connectivity services Services interface and transformation services

Process management services

BEA systems eLink

Toolkit application Tight and loosely coupling

Custom-built application integration

Intra-organisational integration

CrossWorlds United Application Architecture

Integration application Tight coupling Standard application integration

Intra- and inter- organizational integration

IBM MQSeries Integrator

Toolkit application Loose coupling Custom-built application integration


Level 8 Systems Enterprise integration template

Toolkit application Tight and loose coupling Standard application integration


Mercator Software Mercator

Toolkit application Loose coupling Custom-built application integration and SAP R/3

Intra- and inter- organizational integration

Conclusions A well-organized and integrated supply chain is one of the key factors that determines whether a business

is successful or not. To achieve an integrated supply chain, a number of enterprises have attempted to integrate

internal as well as external systems. However, integration of various systems is expensive and time-consuming

complete, especially for small and medium enterprises (SMEs).

The current system of the company considered in this study is not efficient and sometimes provides

inaccurate information because aggregate data are updated on a weekly basis only. To improve the system, this

study reviewed the concepts of ERP, EAI, and CBD. In addition, the paper reviewed information flow in an

extended enterprise in Section three, and author considered the suitability of SAP as an ERP system based on

SAP business management solutions.

It is recommended to select SAP Business ByDesign based on consideration of the various characteristics

of the system. To integrate internal systems, a bus topology and to incorporate external systems, a hub and

spoke topology have been selected. Moreover, CrossWorlds United Applications Architecture was chosen as

the best software for building an EAI system. Finally, this study considered the application of CBD after setting

up an EAI system. The proposed solutions have some limitations. Several enterprises have adopted more than

one software solution during implantation of EAI in their systems, because a single software solution may not

always respond to different integration scenarios.

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systems. MIS Quarterly, 16, 293-311. Harris, S. (1996). Human communication and information system. Oxford: NCC Blackwell. Irani, Z., & Love, P. E. D. (2001). The propagation of technology management taxonomies for evaluating investments in

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supplier, internal integration, and customer. Supply Chain Management: An International Journal, 12, 444-452.


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Production and Inventory Management Journal, 41, 52-58. Park, K., & Kusiak, A. (2005). Enterprise resource planning (ERP) operations support system for maintaining process integration.

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Enterprise Information Management, 17, 105-116. Shang, S., & Seddon, P. B. (2000). A comprehensive framework for classifying the benefits of ERP systems. In H. Chung (Ed.),

Proceedings of the Sixth Americas Conference on Information Systems, Association for Information Systems, 1005-1014. Soh, C., Kien, S. S., & Tay-Yap, J. (2000). Cultural fits and misfits: Is ERP a universal solution? Comm. ACM, 43, 47-51.

Stratman, J. K., & Roth, A. V. (2002). Enterprise resource planning (ERP) competence constructs: Two- stage multi-item scale development and validation. Decision Sciences, 33, 601-628.

Su, Y. F., & Yang, C. (2010). Why are enterprise resource planning systems indispensable to supply chain management? European Journal of Operational Research, 203, 16-24.

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planning). New York: Wiley. Zhao, L., & Siau, K. (2002). Component-based development using UML. Communications of the Association for Information

Systems, 9, 207-222.

Appendix

Table A1

The Constructs of SCM Competencies and ERP Benefits Construct Items and definitions Operational process SOP 1 SOP 2 SOP 3 SOP 4 SOP 5 SOP 6

Firm has the competency to support requirements, and supplier integration links externally performed work with internal work processes in a seamless manner Relevancy Responsiveness Cross-functional unification Standardization Operational fusion Supplier management

Planning and control process SPCP 1 SPCP 2 SPCP 3 SPCP 4 SPCP 5 SPCP 6

Planning and control process integration refers to information systems that support the wide variety of operational configurations needed to serve diverse market segments, and the capability to develop measurement systems that facilitate segmental strategies and process Information management Internal communication Connectivity Collaborative forecasting and planning Functional assessment Activity-based and total cost methodology

Behavioural process SBP 1 SBP 2 SBP 3 SBP 4 SBP 5

Firm has the competency to build lasting distinctiveness with customers of choice: also refers to the ability to develop and maintain a shared mental framework with customers and suppliers regarding inter-enterprise dependency and principles of collaboration Role specificity Guidelines Information sharing Gain/risk sharing Strategic alignment

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(Table A1 continued)

Construct Items and definitions Operational benefits EOP 1 EOP 2 EOP 3 EOP 4 EOP 5 EOP 6

The benefits of an ERP system that result from automating cross-functional processes, using data to better plan and manage production, manpower, inventory and physical resources, and the monitoring and control of the financial performance of products, customers, business lines, and geographic areas Cost reduction Cycle time reduction Productivity improvement Quality improvement Customer service improvement Error reduction

Managerial benefits EMNG 1 EMNG 2 EMNG 3 EMNG 4 EMNG 5 EMNG 6

Managerial benefits are expected to improve the day-to-day business process (long-term impact), and are reflected in long-tem benefits such as improved customer responsiveness, improved customer satisfaction, on-time delivery, and improved decision making Resource management Decision making and planning Performance improvement Partnership with customer and vendor Scheduling Quality management

Strategic benefits ESTG 1 ESTG 2 ESTG 3 ESTG 4 ESTG 5 ESTG 6

Focuses on the benefits that arise from the system’s ability to support business growth, reduce the cost of maintaining legacy systems, and capture the benefits derived from facilitating business learning, empowering staff, and increasing employee morale and satisfaction Worldwide expansion Business alliance Business innovations Cost leadership Product differentiation External linkages

IT infrastructure benefits EIT 1 EIT 2 EIT 3 EIT 4 EIT 5 EIT 6

Involves building business flexibility, reducing IT costs, and increasing IT infrastructure capacity Flexibility IT cost reduction Enabling e-commerce Information management Improve IT architecture Single interface

Organizational benefits EOG 1 EOG 2 EOG 3 EOG 4 EOG 5 EOG 6

Relating to the support of organizational changes, business learning, empowerment, and the building of common visions Changing work patterns Organizational learning Empowerment Common vision Employee morale Behaviour


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Figure B1. Architecture of the aerosol can manufacturer.

Hub & Spoke

Topology

(with customers and suppliers)


Challenges and Problems of Knowledge Management in

Enterprises in Poland

Ryszard Borowiecki, Barbara Siuta-Tokarska Cracow University of Economics, Cracow, Poland

The aim of the publication is to show practical implications concerning knowledge management in enterprises on

the grounds of the presented theoretical bases. The empirical part of the publication is to show relevant research

concerning enterprises functioning in Poland, both in the small and medium-sized enterprises and the large

enterprises. The first, theoretical part of the article systemizes the basic notions concerning the subject of the

publication and referring to the question of knowledge and knowledge based management in an organization on the

basis of Polish and foreign literature. In the second part, theoretical frames presented before are referred to the

factual state, assessed on the basis of the research findings from the selected research centres. They concerned on

the problems and the level of progress of Polish enterprises in knowledge management. Here, the analytical and

synthetic approach was applied, followed by appropriate conclusions. The empirical part of the publication presents

the main areas constituting the source of problems in the knowledge management process in Polish enterprises, as

well as appropriate suggestions to counteract the low level of knowledge management in these entities. The paper

takes into consideration the findings of empirical research in the selected research centres. On their basis, the

condition of knowledge management in Polish enterprises was assessed. Moreover, appropriate conclusions and

suggested solutions are presented.

Keywords: knowledge management, knowledge based economy, enterprises in Poland, large enterprise sector

(LSE), small and medium-sized enterprise sector (SMEs)

Understanding and the Substance of Knowledge The Forms of Knowledge Classification

In the most general terms, knowledge is a result of the act of cognition, however, the relation between knowledge and cognition has a character of mutual influence. On the one hand, knowledge is a consequence of cognition, on the other hand, cognition is conditioned by knowledge to a great extent (WielkaEncyklopedia, 2005). Undoubtedly however, the subject of knowledge is a specific individual, although the society is also indicated (WielkaEncyklopedia, 2005) 1

Ryszard Borowiecki, Professor, Department of Economics and Enterprise Organization, Cracow University of Economics.

as a significant source of both the past and the contemporary knowledge. Some authors also point at the biological sources of knowledge acknowledging that a certain store of knowledge used by an individual has an innate character.

Barbara Siuta-Tokarska, Ph.D., Department of Economics and Enterprise Organization, Cracow University of Economics. Correspondence concerning this article should be addressed to Barbara Siuta-Tokarska, Department of Economics and

Enterprise Organization, Cracow University of Economics, Rakowicka 27, 31-510 Cracow, Poland. E-mail: [email protected]; [email protected]. 1 Knowledge gained socially is very often incoherent.

DAVID PUBLISHING

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CHALLENGES AND PROBLEMS OF KNOWLEDGE MANAGEMENT

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It is worth noticing that “the possessed knowledge influences the choice of the explored subject and the way it is explored, whereas cognition gives a new store of knowledge, even the minimum one, which modifies the knowledge gained so far” (WielkaEncyklopedia, 2005). Such a modification may have both a quantitative2 and a qualitative3

For the first time the notion of knowledge as “justified and true conviction” was introduced by Plato (Pawluczak, 2002). Then, Aristotle indicated specific kinds of knowledge (Kulczycki, 2012):

character.

knowledge which is universal and theoretical (Episteme); instrumental, contextual, and practical knowledge (Techne); normative knowledge based on experience, context, and common sense, defined as “practical wisdom”

(Phronesis). Within the theory of cognition, the combination of rationalism and empirism was suggested by Kant, who

in turn, pointed out that any knowledge results from experience, but at the same time he acknowledged that experience should be supported by logical reasoning. In comparison with reasoning, basically boiled down to drawing conclusions from the possessed knowledge, experience is more diverse. It is divided into sensual experience, internal experience, so-called introspection or intuitive cognition, recognized as another type of experience or the third source of knowledge (alongside reasoning and experience) (WielkaEncyklopedia, 2005).

One of the classification forms are questions the possessed knowledge should give answers to (WielkaEncyklopedia, 2005). knowledge on specific, individual facts of historical or geographical type (what happened?); knowledge on various techniques, recipes and operating procedures (how to do something?); knowledge on regularities ruling the world: natural, social or psychological ones (why does it happen?); knowledge of a psychological type, enabling to distinguish various types of existences and phenomena

(what is it?). It should be emphasized that to a great extent individual memory, which is unreliable and limited, is the

basis of the possessed knowledge. Therefore, it is supported by two other media, namely, the institutional media (e.g., specialists who may pass it to us) and the material media (e.g., books, computer memory), in case of which it is necessary to know the code in which knowledge has been recorded (language codes, maps, charts, drawings, metaphorical and analogous images are mainly used) (WielkaEncyklopedia, 2005).

Among the basic qualities which are desired for knowledge, the following should be indicated (Ziółkowski, 1989), usefulness dependent on the adopted axiology, ethos, lifestyle, etc., which is most frequently conditioned by the social environment, as well as its truthfulness, which in turn depends on the adopted criteria of truthfulness4

To what extent the used knowledge is conscious knowledge and to what extent an unconscious part of knowledge may become conscious?

. Among other qualities of contemporarily understood knowledge, the following are mentioned (Siuta-Tokarska, 2010): dominance, inexhaustibility, simultaneity, and non-linearity.

When analyzing the question of broadly-understood knowledge, we can indicate two fundamental problems related to it, expressed in the form of the questions (Scheler, 1990):

2 When the previous state of knowledge is completed with new components. 3 For example, when the previous knowledge turns out to be untrue or when the new elements of knowledge show that the structure of the previous knowledge is inadequate and it must be subject to structuring and ordering operations. 4 Scientific criteria are a special case. As regards them, with reference to knowledge, justification is aimed at and it is done by the reference to transmission procedures, others, or, for example, most often occurring in the social practice reference to the authority of a person, an institution or a work.


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To what extent individual knowledge is fully passed to others and to what extent it is possible to build a message from it which would fully pass the known knowledge to every person who knows the proper communication code?

Thus, nowadays, it is quite common to adopt a division of knowledge into two categories: codified (manifest, not hidden), that is organized, systematized, easy to measure, recorded knowledge which characterizes with a possibility to store and transfer in various ways, and not codified knowledge (silent, hidden, non-manifest), being a result of talent, experience, abilities, constituting a good of a special type, and because of that difficult to measure (Howitt, 1996). Generally, the literature of the subject indicates two basic dimensions of creating knowledge (Materska, 2006): the epistemological one, touching the sources of cognition (manifest/formal knowledge and hidden/silent knowledge) and the ontological one (relations between individual, group, organizational or inter-organizational knowledge).

When processing knowledge, we can indicate its four stages (Skyrme, 1999): during the first stage, data are distinguished, the data are the basic unit of information, the structuralized and interpreted set of information constitutes knowledge, and the ability to use, modify, and create knowledge is called wisdom.

On the present stage of social development, apart from the growing level of general knowledge, special attention is paid to knowledge related to the economic development, including knowledge which refers to the dynamically spreading technological progress. The progress is determined first of all by innovations based on new and constantly developed information and communication technologies, biotechnologies, the automation of production processes, the application of numerically controlled machines, etc.. The initiation and the proper use of the mentioned sources of technological progress in the economy of a given country decide about the innovativeness of this economy.

Attributes of Using Knowledge in Organizations The knowledge stored and used is an exceptional attribute in the functioning of an organization, and it is a

specific combination of ideas, institutions, the experience and the skills of people and their teams or groups. It is often reflected both in documents and in processes and procedures, practices and norms of the organization, and in the followed customs. It is particularly significant in organizations using the mass production of goods.

Knowledge gives an ability to solve problems on the basis of the possessed information, and the added value resulting from knowledge and knowledge management is “overcoming destructive impact of changeability and making out of it a chance for better work of the organization or customer service, or for the implementation of still another goal” (Materska, 2006). It also enables to predict, connect different facts, analyze and take decisions (Materska, 2006).

The commercialization of knowledge may undergo parallel in a codified form, namely, in the form of the sales of licences and patents and franchising, but also in the form of the expert knowledge, such as management contracts, consultations or counseling (Materska, 2006). It should be added that in the knowledge based economy, many organizations do not create knowledge, and their activities consist in its distribution and configuration (Fazlagić, 2003).

The theory of a knowledge based organization applies its division into: information or knowledge about facts, products and their properties, as well as know-how, that is procedural knowledge which is the ongoing description of the practices within the company, among others on how to organize the company, cash flow, how to establish functional divisions, etc. (“know-how is understanding of how to organize the company in


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accordance with the formal and informal divisions”) (Materska, 2006).

Definitions of Knowledge Management in Organizations Knowledge management in an organization is understood as a process aiming at possibly best, optimal use

of the resources of knowledge which is at the organization’s disposal to achieve the desired effectiveness of activities, especially in the volatile and highly complex conditions of the environment.

Out of numerous definitions of knowledge management, we can indicate the following of its characteristics (Dąbrowski, Koładkiewicz, & Staniewski, 2002): Knowledge management is a process owing to which organizations generate value from the intellectual

assets and the knowledge based assets possessed by it (Santosus & Surmacz, 2001); “Knowledge management is a process by means of which the organization generates wealth based on its

intellectual assets or knowledge based organizational assets” (Bukowitz & Williams, 1999); Knowledge management “is specific and systematic management of knowledge which is significant for

the organization, and related to it processes of creating, gathering, arranging, diffusion, applications and exploitation, implemented in the strive for achieving the organization’s goals” (Skyrme, 1999).

Although the problem of knowledge management is in the centre of attention of both contemporary theoreticians and practicians working for small and huge organizations, still it does not mean that the problem was not dealt with before or that it was dealt with too little.

Knowledge Management in Organization—Theoretical Grasp The Concepts of Knowledge Management in Organizations

The knowledge management has been generally known for thousands years, which is proven by, among others, records coming from about 4,000 years ago and found in Syria, being the testimony that “the man gathered and distributed knowledge, tried to pass it from generation to generation, enabling development to new generations based on the achievements of the predecessors”(Kozarkiewicz-Chlebowska, 2012). The effects in the development of knowledge may be proved by the library in Alexandria, phonetic alphabet, papyrus, the invention of print, book and nowadays the Internet. The works of authorities from the field of management raise a lot of interest in the problem of knowledge in organizations, including the publications by Drucker from 1980s who popularized the notions like: knowledge based economy, leadership with regard to knowledge or knowledge as the most important, unique resource. Toffler and Nasbitt’s works, published in the same period, played a similar role (Zarządzaniewiedza, 2000).

In consequence of analyzing the development of knowledge management concept in organizations, three basic approaches to this problems have been distinguished: the Japanese one, originating from the Japanese intellectual tradition and based on the division of knowledge (Nonaka & Takeuchi, 2000); the resource one, based on the concept of key competences and key skills (Leonard-Barton, 1995); and the process one, comprising the processes of knowledge creation, codification, and transfer (Davenport & Prusak, 1998).

The Japanese concept of knowledge management assumes that the conversion of knowledge occurs cyclically in the form of four processes, namely: Adaptation, consisting in permeating hidden knowledge into another hidden knowledge through learning

by imitation and exercises; Internalization via the conversion of available knowledge into hidden knowledge as a result of learning in

action;


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Externalization through changing silent knowledge into manifest knowledge by using analogy, hypotheses, or even metaphors; Connection, consisting in the replacement of manifest knowledge into another one of the same kind as a

result of ordering and the proper accumulation of various elements of available knowledge. In the resource concept of knowledge management, the existence of five elements is distinguished,

namely: Key skills including the knowledge and the skills of employees, and the management systems and

techniques, as well as mandatory standards and values; Solving problems collectively and searching for the best solutions with the simultaneous sharing

knowledge; Implementation and integration of new technologies and tools; Experimenting aiming at the search for better and innovative solutions; Importing knowledge.

The process concept includes its basic components, namely: Creating knowledge gained via its import from the environment, among others, as a result of taking over

companies, or their best employees and the emergence of knowledge by creating favourable internal conditions; Codification of knowledge and its proper processing for its better understanding; Transfer of knowledge by transmitting it or presenting it to the recipient, and the absorption of the

transmitted knowledge, that is its assimilation for further use. The process concept was developed by Probst, Raub, and Romhardt (2002), in which they distinguished

and analyzed six most important processes of knowledge management that are knowledge identification, knowledge acquisition, knowledge development, knowledge use, knowledge preservation, and knowledge distribution, which is presented in Figure 1.

Figure 1. The elements of knowledge management.

The developed process concept in knowledge management as presented in Figure 1 is one of the most

Knowledge Goals

Knowledge Measurement

Knowledge Identification

Knowledge Use

Knowledge Acquisition

Knowledge Preservation

Knowledge Development

Knowledge Distribution

Feedback


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useful concepts for practical use in organizations, which does not prejudice the usefulness of using other concepts. Moreover, every organization, depending on the conditions of its functioning, can or even should apply an individual approach in knowledge management, with the proper use of the distinguished concept components. Knowing them may facilitate organizing the knowledge management in one’s own organization.

Factors Stimulating Modern Knowledge Management in an Organization Regardless of the above, we should bear in mind the necessity of flexible attitude in the concept of

knowledge management in an organization in the practical grasp, adjusted to turbulent changes in the environment, also including the impact of the global economic crisis on enterprises. These fundamental changes in the environment require a change in the organizational form and structures, and the cooperation of organizations. In consequence, slimming and flattening of organizational structures take place, and at the same time there is an effort for organizational flexibility and the improvement in the adaptation ability to the competitive changes in global markets. It is believed that a flexible organization is the one whose structure and culture enables fast adaptation to the requirements of the competition and changing customer needs (Kochański, 2007).

At present, there is gradual withdrawal from the classic organizational structures based on the division of power and functions which are replaced by the structures based on projects, processes or cooperation networks (Kubicka, 2009). These types of the desired changes may undergo first of all in organizations based on knowledge management.

Similar claims are expressed by some economists (Sojka, 2007) presenting a view that in the digital era economy, enterprise competitiveness does not depend so much on their economic potential but rather on the ability to change fast and achieve the growing added value. Chances in this process are possessed mainly by organizations which are: based on knowledge; flexible and slim, among other things, able to invest fast, with low fixed costs; “intelligent”, having, among others, developed intellectual resources, investing in employees and research

and development; inter-cooperative, searching for cooperation instead of competition and executing numerous contracts with

clients and purchasers, as well as strategic alliances with competitors, among others in the form of cooperation in the legally legitimate form, e.g., in the form of so-called clusters of entrepreneurship.

Owing to the application of the knowledge management system in an organization, compared with the organization with the traditional management system, it is possible to achieve the following benefits, among others: improvement in communication, acceleration of the decision-making process, an increase in the organization innovativeness, shortening the time for solving difficult and key problems, broadening knowledge and employee competences, improving the effectiveness and the competitiveness of the organization operations on the market (Budziewicz-Guźlecka & Drab-Kurowska, 2006).

Knowledge Management in Enterprises in Poland—Empirical Research Knowledge-Based Assets

On the present stage of social and economic development of the world, special role falls on so-called Knowledge-Based Economy (KBE). The notion appeared as early as in 1990s (Fazlagić, 2003). According to Staniewski and Wawrzyniak (2003), the group of important actors building KBE includes: “the government


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and its departments, self-government authorities—regional and local ones, colleges and universities, as well as institutes and entrepreneurs”, but entrepreneurs are regarded the major actor building KBE.

It is extremely desirable for the Polish economy to make its way towards development in the direction of highly-developed countries, with reference to which we can talk about the real occurrence of KBM.

Due to the above, it seems justified to pay special attention to the development of Polish enterprises focused on knowledge management. In order to indicate and distinguish knowledge-based assets possible to be used in the knowledge management process in an enterprise, both on the tactic level and the strategic level. Figure 2 presents the knowledge management process according to Bukowitz and Williams (1999).

Figure 2. Knowledge management process according to Bukowitz and Williams (1999).

Problems Related to Knowledge Management in Large Enterprises Enterprises in Poland which implement the knowledge management process encounter numerous

problems and barriers which hinder their development. Figure 3 presents findings of the research conducted by Bernard Brunhes Polska (2004)5

5 Bernard Brunhes Polska Spółka z o.o. w Warszawie. The research was conducted in 2004. The aim of the research was to diagnose enterprises at an angle of knowledge management methods and tools. Most frequently, senior executives, among others in human resources, finance, marketing or IT, were the respondents.

, within the framework of which 20 enterprises were studied, operating in such economic sectors as: the electric power industry, telecommunications, banking, trade, and IT.

Resulting from the data presented in Figure 3, the most important barriers hindering the functioning of the knowledge management system in enterprises in Poland include: remuneration system disregarding employees’ efforts in gaining knowledge and sharing it, and insufficient motivation from the superiors to share knowledge, as well as the lack of time to pass one’s knowledge to other employees.

Cannot meet it?

Tactical Triggered by market-driven

opportunity or demand

Can meet it?

Lost opportunity

Use Get

Learn/contribute

Strategic Triggered by shifts in the

macro-environment

Assess

Build/Sustain

Divest

Knowledge-based Assets Knowledge repositories

Relationships Information technology Communication infastr.

Env. responsiveness Organizational intelligence

Failure External sources


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Figure 3. Barriers to knowledge management among the studied enterprises of electric power, telecommunication, banking and IT sectors in Poland (answers of some of the enterprises in which a given barrier occurs). Notes. Explanation: A—remuneration system which does not award employees for searching knowledge and sharing it, B—insufficient motivation from the superiors to share knowledge, C—lack of time to pass knowledge to others, D—lack of knowledge of employees on who possesses the information searched by them, E—the company structure promoting so-called silo effect (communication only within departments/sections), F—company culture not promoting the results of an individual and their knowledge on sharing experiences, G—limited funds for the implementation of new solutions, H—user-unfriendly IT system, I—the lack of employees’ knowledge that their experiences may be useful to others, J—“hedge leveling” culture (disfavouring outstanding individuals by other employees), K—the “not invented here” syndrome (unwillingness to use solutions created somewhere else), and L—insufficient training of employees on the IT system operation.

What also results from the above research is that the knowledge management concept is known to these enterprises, and the companies taking part in the research notice the need to organize intellectual capital, but only some enterprises turn it into specific actions. Regardless of the fact that the contemporary, modern economy enforces the necessity and the skill to manage knowledge, as many as 75% of enterprises consider this area of their functioning as badly organized (Tomczak, 2005). Another implication of the research carried out by Bernard Brunhes Polska is that among the major factors motivating the studied entrepreneurs to manage knowledge, the following may be indicated: the development of employees’ competences and the acceleration of operations, and only then an increase in the customer satisfaction and cost reduction.

Figure 4. Major factors motivating entrepreneurs to manage knowledge in the company (the answers from a part of enterprises which mentioned a specific goal).

What results from the research ordered by KPMG Polska6 in 20047

6 KPMG Sp. z o.o.—An audit, tax, and advisory company. 7 The research was ordered by KPMG and conducted by SMG/KRC Millward Brown Company on the representative sample of 121 large enterprises and organizations operating in Poland. The interviews were carried out by means of the CATI method—Computer-assisted telephone interviews. The respondents were presidents, CEOs, their deputies, and other executives, in consequence of which 80% of the respondents were members of management boards, responsible for making strategic decisions on the directions of development of the studied organization.

, out of the 121 biggest enterprises,

0

20

40

60

80

A B C D E F G H I J K L

75 7569

6350

44 4431

25

6 6 6

[%]

81

63

50

44

0 10 20 30 40 50 60 70 80 90

the development of employees’ competences

acceleration of operations

increase in the customer satisfaction

cost reduction

[%]


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employing at least 250 workers and making the revenues of over 40 million Euros per year, over 50% share of entities was marked in which the knowledge management process was not implemented and the need to implement it was not considered at all (28%). In a relatively smaller part of the enterprises it was implemented or the implementation was in progress.

Considering the fact that large active enterprises in Poland, on the one hand, constituting small percentage of the total number of economic entities (namely, 0.16% of 1,704,527 enterprises in 2004), and on the other hand deciding about 42.3% of the people employed in enterprises in Poland (Borowiecki & Siuta-Tokarska, 2008), and having considerable human, economic, and technical potential at their disposal, as well as a broad spectrum of capabilities to organize it properly and use it to introduce the knowledge management process, perform the implementation process within too limited scope and show too little interest in the implementation of knowledge management in the enterprise. Figure 5 presents detailed research findings on the course of the implementation process in large enterprises in Poland.

Figure 5. Large enterprises in Poland and the implementation of knowledge management (research ordered by KPMG, 2004).

Similarly to the presented Bernard Brunhes Polska research, also the research in large enterprises in Poland conducted on commission from KPMG Polska indicates specific problems related to knowledge management, out of which the lack of time to share knowledge was considered to be the most serious one (see Figure 6).

Figure 6. Problems related to knowledge management in large enterprises in Poland.

The researchers found that in 18% of the surveyed enterprises the annual losses of the organization

0 5 10 15 20 25 30 35

implementation of the knowledge management programme is in progress

we are considering whether there is a need to implement such a programme

we do not have such a programme/we did not consider its implementation

the knowledge management programme has been implemented

we discussed if there is a need to implement it and we decided not to implement it

31

28

26

15

0

[%]

0 10 20 30 40 50 60 70

lack of time to share knowledgetoo much information

unnecessary repetition of the same actionsfailure to use technologies for effective sharing of knowledge

failure to use ideas for improving the organization …failure to use market opportunities

others

6457

40

3533

216

[%]


158

connected with an ineffective use of knowledge and intangible assets with reference to revenues constitute up to 5%, whereas in 7% of the enterprises the declared range of losses was from 5%-10%. In the overwhelming majority of the surveyed entities (65%) it was difficult to assess what losses the enterprise makes on this account. We may assume that such an answer would be given by those enterprises in particular which do not implement the knowledge management process in their organization, and because of that they cannot determine consequences, that are losses related to an ineffective use of knowledge and intangible assets in their organization.

Moreover, the survey of large enterprises in Poland indicated that the implementation of knowledge management definitely took place by involving the members of the board and top executives (42% and 21% respectively) in it, and only in small percentage of entities by means of middle-level management employees and others (7% and 1% respectively). Comparing the results in this respect with international research—a different situation was observed in Poland in comparison with the situation revealed in highly-developed countries where a great majority of top executives postulated the implementation of the knowledge management system, and only then they were followed the members of the board. More detailed research into it could reveal the reasons for such a situation, with the simultaneous directing actions which are to lead to greater activation of top and middle-level management in large enterprises in Poland within this scope.

In order to determine the level of advancement in knowledge management in an organization, the Knowledge Management Journey Benchmark methodology may be used, within the framework of which the five-stage scale of knowledge management in an organization is used, from the stage of chaos to the stage of system integration, namely: The stage of chaos, in which the use of knowledge in practice is random and informal; The stage of awareness, characterizing with conducting pilot projects of knowledge management; The stage of focus in which there is a noticeable connection between procedures and tools used in

knowledge management and benefits gained from it; The stage of management in which the knowledge management procedures and tools are implemented in

the studied organization but certain technological and cultural problems still zero occur; The stage of system integration, in which knowledge management is an integral part of operating

processes, and the resources of knowledge constitute a certain value in the organization. As a result of the conducted research it was established that a great majority, 61% of the organizations in

Poland, are on the lowest level of knowledge management, namely, they are knowledge chaotic, and none of them qualified to so-called stage of system integration. The detailed data within this scope are presented in Figure 7.

What arises from the KPMG research repeated in 2008 is that in large enterprises in Poland “there has been a set-back in the development of this management concept”, which cannot instill optimism (as many as 70% Polish enterprises classify on the lowest level within the scope of using the resources of information and knowledge). According to Morawski, it may be the consequence of the lack of competences in the implementation of successive stages of knowledge management. In particular, it concerns the lack of “competencies to combine resources and skills resulting from information management, including the use of equipment, data base, programmes, networks, with the competencies of managing employees who create, acquire and use knowledge and information” (Wielicka, 2009). It is possible to agree with the opinion, all the more that as early as in 2008 (the period of the KPMG research) negative consequences of the global economic


159

crisis manifested themselves also in the Polish economy and the effects related to it occurred with reference to enterprises in the form of special pressure on operating activity related to solving ongoing financial problems. Due to that, the operations of some enterprises were rather connected with the strategy of survival rather than the extension and development, including an increase in the expenditure on information and knowledge management.

Figure 7. The findings of the research into the advancement of knowledge management in large organizations in Poland based on the five-stage scale of the assessment of the organizational development level.

Problems Concerning Knowledge Management in Small- and Medium-Size Enterprises Some research concerning knowledge management in enterprises in Poland was also carried out with

regard to the SME sector, which is micro, small and medium-sized enterprises employing from 0-249 employees in total, whose share in the total number of enterprises in Poland exceeds 99%.

In the research conducted by the Central Statistical Office, it was marked that among the main sources of information for creating innovation in SMEs the following are used: internal sources—25% of SMEs, clients—21%, fairs and expositions—12%, competitors—10%, enterprises from the same group, conferences, meetings, professional journals—7%, suppliers—5%, patent disclosure, research and development units, consulting company—2%, colleges and universities, academic institutions of the Polish Academy of Sciences, other Polish and foreign units—1% of SMEs (Raport o staniesektora, 2010). The presented research findings confirm the low level of SME interest in acquiring information and knowledge which serves innovative actions, which should be assessed negatively. The CSO research also shows that in the SME sector, there is a group of enterprises which are really innovative, but these are mainly medium-sized entities, constituting a small percentage of the total number of enterprises of this class (Wolański, 2007).

What results from the research conducted by Krajowa Izba Gospodarcza Elektroniki i Telekomunikacji (KIGEIT) (National Economic Chamber of Electronics and Telecommunications) within the framework of the KIGEIT project is that small and medium-sized enterprises in Poland generally do not take advantage of the advanced IT tools to increase the quality and effectiveness of management, although in the prevalent number (90%-93%) they are equipped with computers and have the internet access. In practice, the majority of them use e-mail for business purposes and almost half of them have their own websites. However, computers are mainly used as typewrites, and the Internet is used to communicate or as a browser (Skibicka, 2010). It means that possessing the ICT tools mentioned above by small and medium-sized enterprises does not determine their

61

14

24

1

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

knowledge centric 0%

knowledge management 1%

knowledge focused 24%

knowledge aware 14%

knowledge chaotic 61%


160

comprehensive use, and only the performance of their basic functions (Skibicka, 2010). What arises from the research conducted under the supervision of Professor Wielicki, California State

University, on the sample of 1,100 enterprises of the SME sector in Poland, Portugal, and Spain, and 700 enterprises from California is that the awareness of Polish enterprises concerning benefits resulting from the use of IT tools in knowledge management is much lower than among American or West European entrepreneurs. The differences are also noticeable with reference to perceiving barriers in using professional applications in small- and medium-sized enterprises in individual countries with the indication to a greater awareness of Western entrepreneurs (Skibicka, 2010). Moreover, the conducted research shows that within the scope of equipping with computers and the Internet access, as well as the course of processes related to customer service and sales, there are significant similarities in the operations of SMEs in the distinguished countries. On the other hand, visible differences are observed in business processes related to production, logistics, trainings, and human resources management—but SMEs in Poland are placed on the lowest level in comparison with SMEs in the indicated countries.

From the analysis of the presented research we can draw a conclusion that the owners of small and medium-sized enterprises in Poland:

Rarely use modern ICT tools in company management, which is the consequence of the lack of awareness, and due to that of the lack of such needs, as well as of the financial barrier - high-tech tools are expensive, their implementation is also expensive. (Skibicka, 2010)

Conclusions From the Research Into the Problem of Knowledge Management in Enterprises in Poland

In the context of the presented outline of the situation within the scope of using high-tech ICT tools and the level of advancement of knowledge management in the SME sector in Poland, it seems justified to consider the suggestion of an appropriate educational and training programme for entrepreneurs, e.g., by specialist centres or agencies (advisory and training centres for SMEs, the National System of Services for small and medium-sized enterprises, Polish Agency for Enterprise Development, or others) alongside the presentation of appropriate empirical examples. Moreover, the suggestion by Skibicka (2010) seems worth considering, which concerns the creation of knowledge standards for small and medium-sized enterprises, related to the development of templates of necessary documents which could be adjusted by every company as required, as well as suggesting repetitive organizational solutions for a given type of enterprises, which, in consequence, could contribute to the improvement of knowledge management in their organizations. With reference to large enterprises, but also the SME sector, it seems advisable to introduce marketing activities properly publicized in the media (e.g., advertising) and suitable TV programmes of training and educational character, which would propagate the introduction of the knowledge management system in these entities, aiming at an increase in their competitiveness and motivating to the growth of pro-innovative activities. It may be performed, among others, by using appropriate structural funds, particularly taking into consideration the fact that the growth of competitiveness and innovativeness is currently one of the fundamental activities within the framework of the Europe 2020 strategy.


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Halal Food Certification: Case of Malaysian SME Entrepreneurs

Mohani Abdul, Hashanah Ismail, Mazlina Mustapha

Universiti Putra Malaysia, Selangor, Malaysia

Small and medium enterprises (SMEs) are not only recognized as the backbone of a country’s economy,

but they also serve as a catalyst to promote a balanced and sustainable growth to the country’s gross national

product. In Malaysia, SMEs are an important segment of the economy and represents 99.2% of the total

business establishments in Malaysia. These establishments contribute to 31.4% to the country’s GDP, 56.4% to

employment and account for 19% of Malaysian exports (Thut & Chang, 2010). Of the total number of

enterprises in Malaysia, 12% are involved in the food and beverage industry, which accounts for about 9% of

the overall contribution of the manufacturing sector to Gross Domestic Product (GDP) and the processed food

and beverage were also exported to more than 80 countries (FMM-MATRADE Industry Directory, 2010).

This paper reports on 108 Malaysian SME entrepreneurs’ perceptions towards Halal Food Certification (HFC) in

Malaysia along four dimensions of market share and market competitiveness, government support and monitoring,

information dissemination and rigor of certification process using a structured questionnaires distributed during

MIHAS 2011. Based on their responses, the study finds that HFC is important to promote customers’ confidence,

trust, and satisfaction but they were of the opinion that the contents of information were insufficient. Respondents

ranked certification process as tedious and stringent hence needs to be improved. They were dissatisfied with the

information dissemination on halal hub. Hence the government needs to improve its support and monitoring system.

The study also indicates that respondents who have attended entrepreneurship courses, have ventured into

international markets, have obtained Halal Certification for their food products and attained at least a bachelor

degree level of education have significant different responses towards the HFCs.

Keywords: perceptions, small medium enterprises (SMEs), Halal Food Certification (HFC), market share and

market competitiveness, government support and monitoring, information dissemination, rigor of certification

process

Introduction

Food is a basic necessity for all mankind. As a Muslim country where Islam is the official religion, every

facet of a Muslim’s life in Malaysia is guided by the tenets of Islam including what food is appropriate for

consumption without jeopardizing a Muslim’s faith. Since food is produced by third parties unknown in

identity to consumers both Muslim and non-Muslim, there is a need for assurance to the former that food to be

selected and consumed meets the Islamic tenet of “Halal” or fit for consumption. Halal is a credence quality

Mohani Abdul, Ph.D., Faculty of Economics and Management, Universiti Putra Malaysia. Hashanah Ismail, Faculty of Economics and Management, Universiti Putra Malaysia. Mazlina Mustapha, Ph.D., Faculty of Economics and Management, Universiti Putra Malaysia. Correspondence concerning this article should be addressed to Mohani Abdul, Faculty of Economics and Management,

Universiti Putra Malaysia. E-mail: [email protected].

DAVID PUBLISHING

D

HALAL FOOD CERTIFICATION: CASE OF MALAYSIAN SME ENTREPRENEURS

164

attribute, i.e., a product characteristic that cannot be evaluated or ascertained by the individual consumer, even

upon or after consuming the goods (Darby & Karni, 1973; Grunert, 2005). However, there is neither a

worldwide authority on halal nor is there a consistent “Halal” trademark with over 15 halal logos in the world

market although harmonization efforts have begun (Minkus-Mckenna, 2007). Thus, Muslim populations are

making their presence felt socially and politically and are requesting for halal labeled food products (Riaz &

Chaudry, 2004).

The way of life for all Muslims regardless of where they live, are based on Islamic principles. For food,

Islam decodes that food must be fit for human consumption in accordance with “halal” requirements of Syariah.

However, how “halal” is assured requires the involvement of the country’s regulations and regulating bodies

under the jurisdiction of the country’s law. Since many of the food producers in Malaysia comprise of SMEs,

are such enterprises concerned about getting halal certification for their products? It is the objective of this

paper to examine SMEs’ perceptions of the halal certification process as anecdotal evidence from press reports

appear to indicate that many SMEs are reluctant to apply for certification because the process is costly, takes a

long time and imposes a burden to the business. Despite strict regulations by the Malaysian authorities on Halal

Labeling, incidences of false labeling could mar the credibility of the Halal Label adopted by the relevant

authority chiefly, JAKIM (Talib et al., 2010). As such this study will be able to help the policy makers and

regulators in reviewing their policy besides taking some corrective actions to meet the worldwide demand on

Halal food as required by the Muslim population. It also will be able to serve as a feedback to agencies tasked

with oversight of food quality especially in the Asian region besides contributing to the body of knowledge and

marketing strategy of SME entrepreneurs particularly who involved in food and beverage industry.

Overview According to the Pew Research Center’s Forum on Religion and Public Life (2009), the total number of

Muslim population worldwide is estimated to be 1.57 billion out of an estimated total world population of 6.8

billion. Thus the Muslim population is growing rapidly with nearly one in four people in the world practicing

Islam. Therefore, various marketing opportunities are available to meet the needs of Muslims worldwide

especially in the halal food industry with the potential halal sector to contribute to the economy of a country.

The Halal industry has seen considerable growth and development over the years fuelled by the escalation in

awareness of Halal products among consumers and product manufacturers (Global Leader, 2008). With the

global emphasis on food marketing, it is thus imperative that the food industry understands the requirements of

the Muslim consumers if it wants to tap the Muslim market which represents 24% of the world’s total

population in 2005 (one man out of four) and this figure will attain 33% in 2050 (One man out of three), and it

could reach 37% in 2100 (One man out of 2.7). The size of the halal food market for Malaysia was estimated

US$8.2 billion in 2009 and US$8.6 billion in 2010 (Chan, 2011).

Most of past researches concerning Halal food in Malaysia were mainly focused on consumers’ behavior

and not many have been done on the SMEs and Halal food certification. Some researches on the SMEs are like

Marzuki, Hall, and Ballantine (2011) reported that most of the restaurant managers have high expectations

toward halal certification as it signifies attributes such as trust, safety, and hygiene, thus Halal certification is

therefore perceived by restaurant managers as an important aspect in the food service industry. Abdul et al.

(2009) reported that based on their survey on 136 SME owners that there was a significant relationship between

religion of the SME owners and Halal certification, however, in contrary there was no significant association


165

between Halal certification and venturing internationally. They also reported that majority of their respondents

agreed that Malaysia has the potential to lead the Halal certification and has the potential to be a Halal hub.

However, the Government of Malaysia needs to improve on the monitoring mechanism on Halal certification to

improve its compliance. Thus this paper provides a more in-depth study on this topic, particularly it ranks the

respondents from various characteristics and their perceptions towards four categories of Halal Food

Certification (HFC): HFC 1 (respondents’ perceptions towards market share and market competitiveness); HFC

2 (their views on the government support and monitoring); HFC 3 (perceptions on information dissemination);

and HFC 4 (their level of agreement/disagreement on the stringency and tediousness of the certification

process).

Exploring the entrepreneurial actions towards enhancing their business will not be complete without

considering the attitudes of their customers, whom indirectly affect the entrepreneurial business strategy.

Attitudes toward a product are not only determined by the consumers’ motives and the consumption

experience, but also by their perceptions of the product (Alvensleben, 1997; Jamal, 2003; Talib et al., 2010).

Perception is most likely to be distorted. Subsequently, the perceived world and the real world do not

correspond with each other and attitudes regarding the perceived properties of the product are linked to selected

variables (Kotler & Armstrong, 1993). The more positive or negative is a consumer’s attitude towards a product,

the more drawn the consumer is to the positive (or negative) properties of the brand-leading to a stabilization of

the attitude towards the product (Kotler & Armstrong, 1993). Santos and Fernandes (2008) emphasized that

consumer trust is sensitive to perceptions of justice and the importance of trust of consumers in a company.

Without a detailed understanding of buyer behavior and the purchasing process, marketing strategies are based

on incomplete and often misleading data, hence the challenge is to generate the critical information on buying

behavior directly from consumers. In the international food market, Malaysian Halal product exports are less

than half of Thailand’s while exports to the Middle East make up only 0.5% of total volume (Toh, 2009).

Furthermore, unlike multinational corporations like the Nestle group, which has already carved a name for

itself in the halal industry, many people in the international halal market are still not familiar with Malaysian’s

local halal companies since many of them are small- and medium-enterprises and this could be seen as an

obstacle for them to penetrate the global market (Toh, 2009).

Given the obstacles surrounding the SMEs to venture into the international market, initiatives such as the

Government Guarantee Scheme was introduced to assist in upgrading the SME’s capabilities and capacities

enabling them to export and produce as well as penetrating the global Halal market (Daganghalal.com, 2009).

Besides, the Halal Industry Development Corporation (HDC) has implemented The Halal Anchor Company

Program to facilitate the SME development by identifying, grooming, and developing an elite group of

home-grown SMEs to penetrate the global Halal market and in the process serve as iconic role models and

inspiration to other SMEs in the Halal related industries (Halal Industry Development Corporation, 2009).

Market Competition According to mainstream economic theory, the notion of competition is associated with the absence of

market power to change in price or product quality (Kirzner, 2000). Hence a competitive market is one in

which no firm possesses market power. Thus competition is seen as the antithesis of monopoly. To understand

market competition and rivalry among the firms, ones need to be exposed or have knowledge on the

competitive business environment. Thus in an indirect way one can conclude that by attending entrepreneurship


166

course or exposed to a higher academic institution, based on the entrepreneurs’ past experiences like attending

strategic management and marketing literature courses (which fall under entrepreneurship program) could

possibly enable them to understand competition from a cognitive psychology, marketing and strategic

management perspective. Hence it served as a competitive advantage for these entrepreneurs when compared

with those who have not been exposed before. As suggested by Kemp et al. (2004), an important field of

competition in strategic management is concentrating on mapping the competitive environment. The marketing

and strategic management stream of literature on competition pays more attention to the process behind

competitive strategy and the decision making process of competitive action, most of the time at firm level of

analysis. Among business strategy and marketing scholars there is common ground that an important role is

played in competition by key decision makers who monitor rival organizations and formulate strategies to

achieve competitive success (e.g., Porter, 1980). According to Porac and Thomas (1990) it is because that this

key role played by decision makers in an organization’s response to rivalry, that “inquiry is necessary about the

social psychological factors influencing how decision makers frame competitive environments and understand

the nature of competitive perceptions” (p. 224). The same goes to the SMEs involved in Halal food. Based on

the information gathered and events observed, characteristics of the different firms in the firm’s environment,

the firm’s business definition and strategy and other variables, decision-makers form their competitive map.

Similarly, Kemp et al. (2004) argued that in cognitive psychology there is also a well-known

information-processing framework that consists of the following steps: (1) observing information or events; (2)

the interpretation thereof; and (3) the reaction according to this interpretation. This framework is also used in

strategic management and marketing to capture the perception of competition among the firms involved in

Halal food.

In relation to this study, the government’s role is to ensure that firms comply with the halal certification by

providing a proper monitoring mechanism because the government agency such as Jabatan Kemajuan Islam

Malaysia (JAKIM) or state Department of Religious Affairs have been entrusted with issuing halal certification.

Methodology A set of structured questionnaires were distributed among SMEs entrepreneurs who participated in the

Malaysian International Halal Showcase (MIHAS) 2011 from 26-28 February based in Penang and from 6-9

April 2011 based in Kuala Lumpur. MIHAS is an event organized annually by the Malaysian Government to

help SMEs throughout Malaysia to showcase their products and link with potential overseas partners. In the

process, SME Corp has identified businesses which are SMEs involved in the Food and Beverage businesses,

hence this event provides a ready made sample of Food and Beverage businesses in the SME Category in

Malaysia.

The questionnaire was divided into two sections. The first section deals with respondents’ demographic

data such as gender, age, marital status, academic background, entrepreneurship course, ventured

internationally, and certification for the product(s). The second section consists of 18 questions:

• Six questions eliciting their perceptions towards the market share and market competitiveness (denoted as

HFC 1);

• Five questions on their views on the government support and monitoring (denoted as HFC 2);

• Five questions eliciting their perceptions on information dissemination on halal hub (denoted as HFC 3);

• Two questions posed to elicit their levels of agreement/disagreement on the stringency and tediousness of


167

the certification process (denoted as HFC 4).

Respondents were asked to fill in the questionnaire indicating their level of agreement or disagreement in

the Second Section using a five point Likert Scale where 1 indicates strongly disagree and the other end 5

indicates strongly agree.

A mean score for each of the HFC was computed, which were later used to test for their significance

(two-tailed t-test) against the respondents’ characteristics. The characteristics used were as follows:

• Either has undertaken entrepreneurship course or otherwise;

• Has ventured internationally or otherwise;

• Has certification for product(s) or otherwise;

• Academic background—Has at least a degree or otherwise.

As this is an exploratory study, this study seeks to test the following propositions:

• Proposition 1—There is a significant relationship between those entrepreneurs who have attended

entrepreneurship course compared with those who did not attend;

• Proposition 2—There is a significant relationship between the SME entrepreneurs who have ventured

internationally compared with those who did not;

• Proposition 3—There is a significant relationship between the SME entrepreneurs who have halal certified

product(s) versus who did not have;

• Proposition 4—There is a significant relationship between the SME entrepreneurs who have at least a

bachelor or degree compared with those without degree.

Data were analyzed using an independent t-test using Statistical Package for Social Sciences (SPSS). This

statistical test was done to compare the mean of an independent variable under study in two sets of data and

search whether there exist any significantly different from these two mean values due to the treatment (under

dependent variables) and not any other factors at 0.1 and 0.05 significant levels. Two-tailed t-test was chosen

because of is non-directional test.

Results A total of 108 usable questionnaires were collected from the exhibitors at the MIHAS 2011 exhibition.

The Cronbach Alpha result gives 0.91 (see Table 1) and factor analysis, the Kaiser-Meyer-Olkin measure of

sampling adequacy gives 0.840, exceeding the recommended value of 0.6 (Ho, 2006) and the Bartlett’s test of

Sphericity (Bartlett, 1954) gives approximate value of Chi-Square of 1156.909 (df 153) and Significant value is

0.000. Hence the Cronbach and factor analysis results confirmed that the set of questionnaire is both valid and

reliable.

Table 1

Reliability Test No. of questions HFC Value of cronbach alpha

6 5

5 2

HFC 1 HFC 2

HFC 3 HFC 4

0.90 0.89 0.91

0.88 0.69


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Part 1—General Results Table 2 shows overall summary of the descriptive statistical analysis on the HFC. Generally all of the

questions on HFC are distributed normally as depicted in this table. Based on the five-point Likert Scale used,

the minimum for all HFCs rating was 1 and a maximum of 5.00 and this gives a range of 4. This table reflects

that most of respondents agreed that Halal Certification promotes satisfaction, confidence and trust with a mean

score of 4.27. They also agreed that Halal Certification is important to increase market share (mean score is

4.25) and market competitiveness (mean score is 4.19). However, there were some problems in the

dissemination of information on halal hub such as the contents of information were insufficient (mean score is

3.01), was not up to date (mean score is 3.05) and was not published in regularly accessed media (mean score is

3.16).

Table 2

General Descriptive Statistical Analysis Questions number Mean Median Std. Dev. Minimum Maximum Range Kurtosis Skewness 1. Awareness process involved (HFC 1)

3.95 4.00 1.122 1 5 4 0.611 - 1.160

2. Tediousness (HFC 4) 3.64 4.00 0.901 1 5 4 -0.157 -0.465 3. Stringentness (HFC 4) 3.91 4.00 0.952 1 5 4 0.445 -0.804 4. Increase market share (HFC 1)

4.25 4.00 0.968 1 5 4 3.185 -1.721

5. Increase market competitiveness (HFC 1)

4.19 4.00 0.919 1 5 4 2.699 -1.484

6. Customers very particular HFC (HFC 1)

3.94 4.00 1.026 1 5 4 0.937 -1.086

7. HFC promotes satisfaction, confident & trust (HFC 1)

4.27 4.00 0.953 1 5 4 3.448 -1.753

8. Potential to be halal hub (HFC 1)

4.08 4.00 0.855 1 5 4 2.889 -1.441

9. Regulatory framework is sufficient (HFC 2)

3.45 4.00 1.054 1 5 4 -0.347 -0.609

10. Proper monitoring mechanism (HFC 2)

3.36 4.00 1.148 1 5 4 -0.754 -0.446

11. Govt. proactive enforcing HFC (HFC 2)

3.36 4.00 1.156 1 5 4 -0.589 -0.561

12. Transportation system is effective (HFC 2)

3.29 4.00 1.120 1 5 4 -0.469 -0.591

13. Facilities for research centers (HFC 2)

3.32 4.00 1.101 1 5 4 -0.462 -0.505

14. Content of information is sufficient (HFC 3)

3.01 3.00 1.123 1 5 4 -0.974 -0.220

15. Content of information is up to date (HFC 3)

3.05 3.00 1.071 1 5 4 -0.781 -0.233

16. Content of information is published regularly (HFC 3)

3.16 3.00 1.069 1 5 4 -0.687 -0.227

17. Halal hub information is relevant (HFC 3)

3.51 4.00 0.891 1 5 4 0.843 -1.118

18. Sufficient websites on halal products (HFC 3)

3.29 4.00 0.977 1 5 4 -0.598 -0.546

Among these four HFCs, based on the average mean score (see Table 3), HFC 1 (market share and

competitiveness) scored the highest (average mean score is 4.113). This shows that most of respondents agreed

that Halal Certification enables them to increase their market share and market competitiveness. However, most

of them agreed that Halal Certification process was tedious and stringent (HFC 4 with average mean score of


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3.775—second top of the list). It seems that they were not satisfied with the current Malaysian government

support and monitoring (HFC 2), only being third in the list (average mean score is 3.356); and finally there

were problems with information dissemination on halal hub (HFC 3) being the last in the list (average mean

score is 3.204).

Table 3

Descriptive Statistics for Each of the HFC HFC No. Average mean Average Std. Dev. No. of items HFC 1 4.113 0.974 6 HFC 2 3.356 1.116 5 HFC 3 3.204 1.026 5 HFC 4 3.775 0.9265 2

Part 2—Specific Results Principle Components Analysis (PCA) revealed the presence of four components with Eigen values

exceeding 1 and Table 4 presents the total and cumulative variance for each of the HFC. HFC 1 contributes the

most as it accounts for the largest variance (40.9%) among the HFCs, followed by HFC 2 and so on.

Table 4

Principal Components Analysis Statistics

Component Initial eigenvalues

Total % of variance Cumulative % HFC 1 7.357 40.873 40.873 HFC 2 2.542 14.122 54.995 HFC 3 1.519 8.440 63.435 HFC 4 1.160 6.444 69.879

Tables 5 and 6 depict the results of the study. Table 6 shows that respondents who have undertaken

entrepreneurship course compared with those who have not taken the course produces significant results for all

the HFCs (HFC 1 to HFC 4) at least at 90% confidence level, thus it supports that there is a significant

relationship between entrepreneurs who have undertaken entrepreneurship course and HFC1 to HFC 4.

Table 5

Profile of Respondents No. Characteristics Total No. Percentage 1. Undertaken entrepreneurship course

Yes No

55 53

50.9 49.1

2.

Ventured internationally Yes No

42 66

38.9 62.1

3. Has halal certified product(s) Yes No

74 34

68.5 31.5

4. Academics background Degree holder Non-degree holder

55 53

50.9 49.1

As for academic background of respondents, it seems that there is a significant relationship between

academic background of respondents with HFC 1 and HFC 3 at 95% confidence level and with HFC 4 at 90%


170

confidence level. However, there is no significant relationship between academic backgrounds of respondents

with HFC 2.

Table 6

HFC Versus Entrepreneurs’ Characteristics HFC Description Mean Value HFC 1 Perceptions towards market share and market competitiveness

(1) Entrepreneurship course a. Yes b. No

(2) Ventured internationally a. Yes b. No

(3) Halal certificate for product(s) a. Yes b. No

(4) Academic background a. Degree level b. Non-degree level

4.2516 3.9788 4.1151 4.1051 4.2297 3.3578 4.2788 3.9403

0.078* 0.951 0.025** 0.028**

HFC 2 Views on the government support and monitoring (1) Entrepreneurship course

a. Yes b. No




3.1811 3.5273 3.1048 3.5108 3.3135 3.4529 3.9057 3.6455

0.052* 0.027** 0.471 0.465

HFC 3 Perceptions on information dissemination (1) Entrepreneurship course

a. Yes b. No




2.9698 3.4255 3.0381 3.3108 3.1622 3.2882 3.3745 3.0226

0.005** 0.105 0.474 0.030**

HFC 4 Level of agreement/disagreement on the stringentness & tediousness of the certification process (1) Entrepreneurship course

a. Yes b. No




3.6415 3.9000 3.5357 3.9231 3.6757 3.9853 3.6455 3.9057

0.094* 0.014** 0.062* 0.092*

Note. *Significant at 10% level; **Significant at 5% level.


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In relation to venturing internationally, there is a significant relationship between entrepreneurs who have

ventured internationally with HFC 2 and HFC 4 at 95% confidence level in contrary to HFC 1 and HFC 3 that

indicate no significant relationship.

Finally those SME entrepreneurs who managed to have their product(s) halal certified gave a significant

result for HFC 4 at 0.1 significant level. On the other hand, there is no significant relationship between the

SME entrepreneurs who managed to have their product(s) halal certified compared with those who did not have

in relation to HFC 1, HFC 2, and HFC 3.

Discussion Most of respondents agreed that Halal Certification able to promote satisfaction, confidence and trust

among consumers. Living in a multicultural society as in Malaysia with different religious background, hence

being a Muslim, one needs assurance that food to be selected and consumed meets the Islamic tenet of “Halal”

or fit for consumption because food was prepared by third party. Since Halal is a credence quality attribute,

thus it was merely based on trusted information, such as halal certified by JAKIM or by the state Department of

Religious Affairs could enhance their perceptions that the food taken is halal. Similarly, they also understand

that by having their products halal certified could boost their market share and market competitiveness.

However, their perceptions towards information dissemination on halal hub was low and need to be taken into

consideration by JAKIM and state Department of Religious Affairs in promoting halal hub amongst SMEs like

the sufficiency of its contents, up to date information and published regularly in accessed media.

Besides information dissemination, JAKIM also needs to improve on the certification process. They could

educate these SME entrepreneurs by giving proper trainings or seminars on halal certification process before

registering their products for certification so that they understand the process thoroughly. The Malaysian

government also needs to improve on its support and monitoring if it wants to be a champion in the halal food

product industry.

In relation to the propositions, perceptions of respondents who have undertaken entrepreneurship course

compared with those who have not taken the course show significance differences for all the HFCs (HFC 1 to

HFC 4). The entrepreneurship course that they have undertaken could possibly enabled them to foresee the

opportunities to increase their market share and competitiveness through Halal Certification (HFC 1). By

having their product(s) Halal Certified could instill customers’ confidence and trust and also presents one of

their strategies to be competitive in the market place as suggested by Kemp et al. (2004). Through their basic

knowledge in entrepreneurship that they have studied also could affect their expectation from the government

to provide more support and monitoring compared with those who have not studied entrepreneurship (HFC 2).

They also expect the information dissemination on Halal hub like the contents, different types of media

publication and the relevance still need to be improved compared with those who have not taken

entrepreneurship course before (HFC 3). However, entrepreneurs who have undertaken entrepreneurship course

before found that the certification process was not that stringent or tedious compared with their counterparts.

This could be due to their exposure in the course (HFC 4).

As for the academic background of respondents, it shows that HFC 1, HFC 3, and HFC 4 to be significant.

This could be explained that educated entrepreneurs were able to see the trend of customers’ needs and wants

compared with those non-educated entrepreneurs (HFC1). They also expect more from the information

dissemination compared with those uneducated ones (HFC 3). They also might find that the process of getting


172

Halal Certification was not that tedious and stringent compared with those who were not educated could be

possibly due to their knowledge and exposure in the university (HFC 4).

As for those who have ventured internationally compared with those who have not, there are significance

results for HFC 2 and HFC 4. Possibly this is due to their tendency to compare with the government of other

countries and foresee that the government of Malaysia could do more to support and monitor local

entrepreneurs compared with those who have not being exposed to international market. Similarly, they might

find that the process of Halal Certification was not stringent and tedious compared to their counterparts.

Those who have Certified Halal products gave significance results for HFC 1 and HFC 4. This could be

explained that they foresee by having Halal product Certification will enable them to boost their market share

hence expanding their businesses through customers’ confidence and trust (HFC 1). Since they have undergone

the Halal Certification process, they might find that the process of getting Halal Certification was not that

tedious and stringent compared with those who did not have Halal Certified products.

Conclusions This paper reports on the relationship between four characteristics of SMEs (involved in halal food) viz.

attended entrepreneurship course, managed to venture in the international market, able to have their product(s)

Halal Certified and their academic background in relation to their perceptions towards market share and market

competitiveness, their views on government support and monitoring, their perceptions on halal hub information

dissemination and their level of agreement on the stringency and tediousness of the Halal Certification process.

Results show that respondents who have undertaken entrepreneurship course compared with those who have

not taken the course produced significant results for all the HFCs tested. There are significant differences

between those with and without degree for HFC 1, HFC 3, and HFC 4. In relation to venturing internationally,

the results show that there are significant differences between those who managed to venture internationally

compared with those who did not with HFC 2 and HFC 4. Finally having halal certified product(s) is significant

only for HFC 4.

The study suggests that the government/policy makers need to take some corrective actions in order to

enhance Halal Food Certification process in Malaysia. Similarly it also needs to improve on the Halal hub

information dissemination if it wants to be a champion in this industry. Future studies should consider

entrepreneurs from other jurisdictions as to how they perceive the Halal Certification process in their country to

discern if cultural factors could affect such perceptions. Future studies can also consider problems experienced

by SMEs according to different food sectors.

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Loyalty Programs Rewards Based on Tourism Services: A Study

of Their Influence on Behavioral Loyalty

Mª Teresa Villacé-Molinero, Eva Reinares-Lara

Universidad Rey Juan Carlos, Madrid, Spain

José Manuel Ponzoa-Casado

Universidad Complutense, Madrid, Spain

The aim of this paper is to analyze the differences found in behavioral loyalty according to the typology of the

incentives of a loyalty program and also tests, if tourism rewards based on experiences and travels show the best

results in terms of buying behavior. The research had a longitudinal dimension. Data of the study were compiled

throughout seven years from the transactional data bases of a loyalty program and the analyzed retailer. The

variables used to measure behavioral loyalty were based on existing literature. A sample of 1,200 people was

selected, where 383 of them had redeemed. To contrast the proposed hypotheses, three types of tests were

implemented: T-test, Wilcoxon test to confirm the results obtained with the T, and for independent samples the test

Kruskal-Wallis was carried out. The results reflect that those members who choose incentives based on experiences

and travels show better values in the behavioral variables (volume of the basket, average annual expenditure, and

average numbers of visits to the store). Nevertheless, differences found between the types of rewards are not

statistically significant. Finally, the research highlights the degree of importance for tourism businesses of being

part of a multi-sponsor loyalty program, offering redemption of points in tourism services.

Keywords: loyalty programs, consumer behavior, rewards, behavioral loyalty, redemption, tourism

Introduction

Concern for customer churn has led to the proliferation of loyalty programs based on possession of cards

that allow the accumulation of points or to obtain discount coupons (Dekay, Toh, & Raven, 2009). In Spain,

according to Infoadex (2011), real investment in loyalty cards estimated in 2010 was 41.8 million Euros.

Despite its substantial size, this figure represents a decrease of 9.9% in relation to 2009 (46.4 million). After

five years’ of steady increases, the decrease may be associated with the general decline of investment in

advertising and marketing caused by the general crisis period which the country is going trough. However,

industries where loyalty programs are more widespread, are tourism services as airlines or hotels (Kim, Shi, &

Srinivasan, 2001). In fact, according to a study developed by Hosteltur and Deloitte (2012), 30% of travel

Mª Teresa Villacé-Molinero, Ph.D. in Advanced Marketing, Department of Business Administration, Universidad Rey Juan

Carlos. Eva Reinares-Lara, Ph.D. in Business Administration, Department of Business Administration, Universidad Rey Juan Carlos. Jose Manuel Ponzoa-Casado, Ph.D. in Market Research and Marketing, Department of Marketing and Market Research,

Universidad Complutense. Correspondence concerning this article should be addressed to Mª Teresa Villacé-Molinero, c/Camino del Molino s/n 28943

Fuenlabrada, Madrid, Spain. E-mail: [email protected].

DAVID PUBLISHING

D

A STUDY OF THEIR INFLUENCE ON BEHAVIORAL LOYALTY

175

agents considered “relevant” a loyalty program as a selection factor of the tourism product and it is particularly

influential in the choice of airlines (67%) and cruises (68%).

The literature reviewed reflects that there are few conclusive studies on the impact of loyalty programs on

customer loyalty (Villacé, Ponzoa, & Reinares, 2011). On the one hand, very favorable positions are found

confirming the influence of loyalty programs (García Gómez, Gutiérrez Arranz, & Gutiérrez Cillán, 2006;

Demoulin & Zidda, 2008, 2009; Lacey, 2009), while others also support more moderate points of view: loyalty

programs influence on behavioral loyalty but it is something temporal and reduced (B. Sharp, & A. Sharp, 1997;

Nunes & Drèze, 2006; Meyer-Waarden, 2008). At the more critical of the effectiveness of loyalty programs,

there are opinions that clearly question their ability to influence customer loyalty (O’Brian & Jones, 1995;

Wright & Sparks, 1999; Benavent, Crié, & Meyer-Waarden, 2000). Actually, the authors believe that these

programs are promotions, therefore they do not encourage customer loyalty.

One of the factors that influence the success of a loyalty program is the reward, i.e., the incentive or

benefit given to a client for his/her participation. However, there are limited researches that examine specific

aspects of managing rewards based on tourism (Kivetz & Simonson, 2002; Reinares & García de Madariaga,

2007).

At the international level, the most common types of rewards used in loyalty programs are: tourism,

tangible personal, tangible utility, and tangible pleasure, and the ones less developed: ecology, solidarity, and

social benefits (Ponzoa Casado, 2007).

In Spain, the awards related to the tourism sector have a high level of acceptance among users of loyalty

programs (Ponzoa & Reinares, 2010a). According to these authors, the percentage of redemption in tourism

services is 30.9% of total rewards redeemed in units (see Table 1). This participation is low, when is compared

with the most important category: tangible rewards (appliances, household accessories, DIY, cooking, etc.),

which have a lower unit cost and, therefore, greater access for holders who accumulate fewer points.

Table 1 Distribution of the Redemption According to Different Parameters and Types of Rewards in Multi-sponsor Loyalty Programs (2009) (%)

Type of reward Holders Rewards redeemed Points used Euros used Total reward value

Plane tickets 15.3 10.5 19.9 29.5 21.7

Other tourism services 24.5 20.4 43.5 65.1 47.7

Tangible rewards 42.1 42.2 19.4 1.9 16

Solidarity rewards 0.4 0.2 1.1 2.1 1.3

Discount coupons 1.1 1.2 0.6 0 0.5

Leisure and experiences 16.6 25.6 15.5 1.4 12.8

Note. Source: Ponzoa and Reinares (2010a).

However, taking into account the economic value of the reward, it is observed that 39.8% of the holders of

a loyalty program in Spain redeemed 69.4% of the value of prizes associated with tourist services (plane tickets

and other tourist services as hotels, car rental, etc.). On the other hand, 42.1% of the holders redeemed 16% of

tangible rewards (DVDs, etc.). Solidarity rewards and discount coupons were less chosen, 0.2% and 1.2%

respectively.

Given the importance of rewards in running loyalty programs and the large investment made by

companies in them, this research aims to deepen their studies. The principal objective is to analyze the


176

differences found in behavioral loyalty according to the typology of the incentives of the program. More

specifically, it aims to analyze how the incentives based on tourism services influence on the customer’s

behavior.

On the other hand, the research also aims to study the degree of importance for tourism businesses of

being part of a multi-sponsor loyalty program, offering redemption of points in tourism services. And finally, it

will be discussed the need for corporate sponsors of loyalty programs of having tourist services companies in

their portfolios of affiliates.

Data from longitudinal research (over seven years in 14 Spanish provinces) come from the electronic

platforms of the loyalty program and from the analyzed retail chain. The sample consisted of 1,200 people, of

whom 32% had redeemed their points. In order to achieve the objectives, the study is divided into two parts:

The first part is a theoretical review of the literature; and the second one is setting out the empirical analysis

carried out and its conclusions and implications for the tourism sector in the use of these programs.

Literature Review and Hypothesis

According to the literature review about the effect of rewards in the performance of loyalty programs,

there are many authors who admit their positive influence (Dowling & Uncles, 1997; Yi & Jeon, 2003; Smith

& Sparks, 2009a; Villacé et al., 2011), even Meyer-Waarden and Benavent (2006) highlight the ability of the

rewards to influence purchasing behavior. Specifically, they state that satisfaction with the rewards influences

more on behavioral loyalty than on the attitudinal one, because satisfied customers have more spending, more

visits, and their preferences for the retailer’s brand are higher than for those who are not satisfied with the

reward (Demoulin & Zidda, 2008).

However, against these points of view, researchers such as B. Sharp and A. Sharp (1997) and Bolton,

Kannan, and Bramlett (2000) show their misgivings about whether rewards influence the development of

loyalty or not. Shugan (2005) reaffirming his negative opinion about loyalty programs, even notes that the

programs fail to choose the right person to rewarded for his purchasing behavior, rewarding the person who

takes the decision to buy rather than the payer, this is the case of business travelers.

Kivetz (2005) maintains an intermediate position, on the one hand, he says that incentives attract

consumers to loyalty programs, so they are very important, but, on the other hand, consumers may develop

rejection to the brand. This is because customers want to act freely, without external constraints, and the reward

of a program can be considered as an external impulse to act (Brehm & Cole, 1966). Therefore, to get a positive

effect to the brand, the rewards should be designed to increase the intrinsic motivation of the client to achieve

the reward, reducing the external pressure. Thus, the incentives which the customer has in his mind, without the

marketing efforts made by the company, will be better valued by customers than incentives obtained from the

program, without premeditation (Jakobson, 2004).

Other investigations about rewards show that redemption of points accumulated through the use of the

loyalty program, is not directly related to greater behavioral loyalty by its members. However, it appears that

customers who redeem their points have better values in all variables of purchase behavior in comparison to

customers who do not do it (Villacé Molinero, 2010). In fact, customers who redeem their points show a greater

basket’s volume, a higher frequency (a higher average annual number of visits), and a greater number of

categories and items purchased. The most significant increases were seen in the average price and annual

expenditure compared with non-members of the program. This trend supports the results achieved by Long and


177

Schiffman (2000) and Moore and Sekhon (2005) and the premises on which the present study are based.

Influence of the Type of Reward Chosen in the Redemption of Points on the Behavioral Loyalty

The literature review shows that it is the type of reward which really influences the outcome of loyalty

programs. For a better comprehension, the different classifications of incentives are set out in Table 2, most of

the studies use these types of rewards. However, some researchers note that these classifications are insufficient

and too general (Mimouni & Volle, 2003). For this reason, authors such as Reinares and Blanco (2008)

expanded it, incorporating tourism, ecological, and solidarity rewards among others.

Table 2

Academic Classification of the Types of Rewards or Incentives Authors Types of rewards

Barlow (1996) Benavent and Meyer-Waarden (2001)

Economical and tangible (hard rewards). Emotional and intangibles (soft rewards).

Dowling and Uncles (1997) Immediate or deferred. Strong or weak association with the brand.

Kim et al. (2001) Inefficient incentives (high cost to the company). Efficient incentives (marginal cost).

Jorna, Bijmolt, Van Heerde, and Smidts (2002) Direct and indirect.

Kivetz and Simonson (2002) Monetary or luxury.

Roehm, Pullin, and Roehm (2002) Strong or weak association with the brand. Tangibles and intangibles rewards.

Wansink (2003) High rewards. Modest rewards. Low rewards.

Benavent and Meyer-Waarden (2001)

Informatives. Functional. Hedonistic. Economical rewards. Relational.

Mimouni-Chabane and Volle (2010) Utilitarian. Hedonistic. Recognition and symbolic.

Note. Source: Adapted from Reinares and Blanco (2008).

Regarding the relationship between the different types of rewards and the purchasing behavior, it is

necessary to point out that for some researchers like Roehm et al. (2002) or Cedrola and Memmo (2010),

utilitarian tangible rewards based on price reductions and discounts, despite producing higher levels of

satisfaction, are not the most effective in improving behavioral loyalty, as improvements occur only in the short

term. At the same time, these rewards are usually related to the volume and not to the frequency of purchase, so

they are less interesting to develop customer loyalty (Shug, 2005). Otherwise, intangible rewards or “soft

rewards” (such as travel and experiences) are more effective in terms of attitudinal loyalty (Rosenbaum,

Ostrom, & Kuntze, 2005; Ponzoa & Reinares, 2010b).

However, Mimouni-Chaabane and Volle (2010) are against these claims. Their research shows that

utilitarian benefits explain the loyalty better than other types of incentives; rewards based on preferential

treatment are not significant.


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On the other hand, when there is a high involvement to the product purchased, incentives directly related

to it are preferred (i.e., free flights in a loyalty program of an airline) (De Wulf & Odekerken-Schröder, 2003),

even immediate and intangible incentives are preferred (Yi & Jeon, 2003) and vice versa. Overall, it can be said

that the immediate rewards are preferred for behavior modification, at least in the short term (McCall &

Voorhees, 2010).

Against this point of view, some investigations show that in situations in which loyalty program requires

high efforts by consumers, they prefer hedonistic and luxury incentives, such as travels or hotels. Moreover,

hedonic rewards are especially preferred among consumers who have a sense of guilt associated with the

consumption of non-necessities (as they feel that they do not spend their savings on luxury goods, but are

rewarded for their purchasing behavior). For the same reason of guilt, customers who make use of loyalty

programs for professional purposes (hotel stays, car rentals, etc.) also prefer hedonic rewards instead of cash.

By contrast, incentives based on needs (usually of a monetary nature) are more attractive when the effort to

participate in the program is low.

Regarding the cost of the incentive for the company, Wansink (2003) argues that the most expensive

incentives are the most inefficient ones in terms of cost-outcome, being also those which have the least

influence on loyalty. To Mimouni-Chaabane and Volle (2010) what matters is the perception of the clients

about the investment that is holding the company to get their loyalty, not the intrinsic value of the reward. In

the travel industry, program rewards (flights, hotel rooms, etc.) are seen as having high added value for

customers, while for sponsoring companies they represent a small additional cost. According to Leenheer, Van

Heerde, Bijmolt, and Smidts (2007), valuable incentives only serve to encourage new members to the program.

In this regard, Reinares and García de Madariaga (2007) claim that if the objective of a company is to attract

new members, the rewards should be intangible and more specifically, they should be related to leisure.

The lack of consensus about the existing differences in behavioral loyalty based on the type of reward

chosen by customers to redeem their points, lead us to make two hypotheses:

H1: In loyalty programs, there are significant differences in behavioral loyalty depending on the type of

reward in which the customer redeems the points accumulated.

H2: Rewards based on experiences and travels show the best results in terms of buying behavior.

H2a: Customers who redeem their points on travels have a higher volume of annual basket in the store.

H2b: Customers who redeem their points on travels have a higher frequency of purchase at the store.

H2c: Customers who redeem their points on travels make a greater average annual expenditure in the

store.

Methodology

Many authors such as Smith, Sparks, Hart, and Tzokas (2003) or Lewis (2004) believe that to measure the

success of a longitudinal research, is needed to allow observation of purchasing behavior over a given time

compared with transverse research which provide a static view of consumer behavior. Even authors like Mägi

(2003) highlight the unreliability of the survey to measure the effectiveness of loyalty programs. For this reason

in the present study, the collection of information had a longitudinal dimension.

The data were obtained through the electronic platform of the loyalty program and the retailer’s

transactional platforms. Monitoring data was performed by assigning them a code; personal or sensitive data

were deleted because they did not provide relevant information for the analysis.


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For the two big multi-sponsor loyalty programs in the leisure sector in Spain, one of them was selected to

analyze it. The selection was based on the suitability of its formal characteristics to fulfill the intended goals, as

well as typological representativeness of Spanish households. Different types of retailers took part in the

selected program such as travel agencies, hotels, banks, gas stations, opticians or supermarkets. For the analysis

only one brand, not related to tourism, was selected: an optician chain (all its shops were included in the study)

but with different kind of incentives, such as travels.

Data of the study were compiled throughout seven years (from April 1, 2002 until May 9, 2009) from the

transactional data bases of the loyalty program and the analyzed retailers. A random sample of 1,200 program

members was selected, where 383 of them had redeemed their points. The geographical scope of the sample

was focused in 14 towns scattered in different parts of the Spanish geography.

The variables used to measure behavioral loyalty were calculated from the transactional data obtained

from platforms, and based on existing literature. In this sense, the variables used in the analysis were:

(1) Volume of annual basket: VOLAB (Verhoef, 2003; Lewis, 2004; P. Reinares, & E. Reinares, 2005;

Liu, 2007; Yuping, 2007; Lacey, 2009).

(2) Average purchase price: APPRICE (García Gómez et al., 2006; Meyer-Waarden, 2008; Smith &

Sparks, 2009a; Ponzoa & Reinares, 2010b)

(3) Average time inter-shopping: ATIME (Benavent et al., 2000; Lewis, 2004; P. Reinares, & E. Reinares,

2005; Yuping, 2007).

(4) Number of items and categories per purchase: NARTIC and NCATEG (adapted from Benavent et al.,

2000; García Gómez, 2009; Smith & Sparks, 2009b).

(5) Annual number of visits to the store: ANVISIT (B. Sharp, & A. Sharp, 1997; Benavent & Crié, 2000;

Lewis, 2004; P. Reinares, & E. Reinares, 2005; Yuping, 2007; Smith & Sparks, 2009b).

(6) Average annual expenditure: AAEXPEN (Adapted from García Gómez et al., 2006; Meyer-Waarden,

2008; Smith & Sparks, 2009b).

Moreover, to analyze the redemption of points, dichotomous variables were used: (1) RED, shows if the

customer has redeemed the accumulated points (Lewis, 2004; Ponzoa, 2007, Smith & Sparks, 2009b); (2)

ACCRED, represents the average monthly accreditation from signing up in the program (Lewis, 2004; Ponzoa,

2007; P. Reinares, E. Reinares, & Mercado, 2010; Smith & Sparks, 2009b); and finally the types of rewards: (3)

LEISURE; (4) TANGP (tangible products); (5) TRAVEL (it includes flights, hotel stays, discounts in car

rental); (6) NGO (Non Governmental Organizations); and (7) EXPER (experiences) (Reinares & García de

Madariaga, 2007; Bridson, Evans, & Hickman, 2008; Reinares & Blanco, 2008; Smith & Sparks, 2009b).

To contrast the proposed hypotheses, three types of tests were implemented: T-test for related samples;

Wilcoxon test (nonparametric analysis) to confirm the results obtained with the T; and for independent samples

the test Kruskal-Wallis was carried out.

Results and Main Findings

First of all, and in order to study whether there are significant differences in behavioral loyalty depending

on the type of reward in which the customer redeems the points accumulated, the results for the variables

related to buying behavior depending on the type of incentive are analyzed.

As it is shown in Table 3, rewards chosen by the most number of individuals are the tangible products and

travel, selected by 217 and 109 individuals respectively. The other types of rewards are significantly less


180

chosen, this is the case of redemption in leisure (32), experiences (14) or NGO’s (11). Overall it shows that the

rewards associated with better outcomes in the buying behavior variables are the experiences and travel. In this

way, higher volume of the basket is seen in the experience category (4.51) and in the travel category (3.30).

Due to the high standard deviations obtained, the median value was also checked. Although it is not shown in

Table 3, it confirms that customers who redeem on travel rewards show a greater volume of the basket (2.73),

accepting therefore the hypothesis H2a.

Table 3

Average of Buying Behavior Variables Depending on the Chosen Type of Reward Points Redemption

NGO EXPER LEISURE TANGP TRAVEL

M DT M DT M DT M DT M DT VOLAB 3.24 2.54 4.51 4.81 2.37 1.62 2.65 2.13 3.30 2.49APPRICE 162.7 142.3 199.6 367.6 234.2 473.5 179.7 346.9 136.6 135.2 ATIME 544.7 421.6 559.7 597.3 550.1 386.5 568.7 477.1 487.9 483.2 NARTIC 2.70 0.60 2.14 0.75 2.29 0.71 2.33 0.87 2.20 0.77NCATEG 1.70 0.54 1.37 0.37 1.48 0.46 1.51 0.47 1.45 0.45ANVISIT 1.22 0.93 2.36 2.67 1.16 1.02 1.27 1.21 1.69 1.50AAEXPEN 141.0 76.0 181.2 156.4 177.9 294.8 139.6 120.8 142.5 95.6 N 11 14 32 217 109

The same applies to the variable time inter-shopping, the reward based on travel corresponds to a shorter

time between purchases (mean: 487.9; median: 271.6). So, the hypothesis H2b concerning the frequency of

purchase at the retail outlet is confirmed. In addition, customers with the highest number of store visits per year

are those who choose experiences as reward in the first place (mean: 2.36; median: 1.36); the second place is

for travel rewards (mean: 1.69; median: 1.34).

On the other hand, the highest average annual expenditure is for customers who also redeemed

experiences (mean: 181.2; median: 142.55). However, leisure rewards are associated with higher average prices

of the basket, 234.2 Euros on average, followed by the experiences (199.6). In this case, the hypothesis H2c

should be rejected, although these results are also interesting for the tourist industry.

Finally, the greatest number of articles and categories purchased at each visit to the store is shown in

customers who have redeemed their points on NGOs and tangible products. Customers who redeemed to help

NGOs buy 2.70 products on average at the retail outlet (median: 2.67), representing 1.70 categories purchased

on average (median: 1.50). In addition, those who redeemed for tangible products also have a high number of

articles and categories purchased.

In order to test the first hypothesis, the Kruskal-Wallis test is performed, in which no differences were

found between the above mentioned means. The p-values, all of them above 0.05, lead us to accept the null

hypothesis of equality of means (see Table 4).

Therefore, the hypothesis H1 is rejected: There is no significant difference in behavioral loyalty depending

on the type of reward in which the customer redeems the points accumulated. The hypothesis H2 has to be

rejected also, at least partially. Although customers who redeem their points on travel rewards show the highest:

(1) volumes in the basket; (2) average annual expenditure; and (3) average number of visits to the store and

therefore less time inter-shopping, these differences found between the mentioned means are not statistically

significant.


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Table 4

Analysis of the Influence of the Type of Reward Chosen in the Redemption on Behavioral Loyalty:

Kruskal-Wallis H Test

Variable H p df

VOLAB 7.33 0.20 5

APPRICE 2.74 0.74 5

ATIME 7.93 0.16 5

NARTIC 7.14 0.21 5

NCATEG 3.88 0.57 5

ANVISIT 7.91 0.16 5

AAEXPEN 3.36 0.64 5

Conclusions

Although the analysis of the types of rewards, in which the customer redeems its points, shows that there

are not statistically significant differences in behavioral loyalty based on this variable, the conducted research

highlights the importance of the inclusion of rewards related to tourism in the current loyalty programs. That is

because the best results in the buying behavior variables have been reached on rewards based on experiences

and travel. Confirming the results of Roehm et al. (2002) or Cedrola and Memmo (2010), the intangible

rewards are more effective in improving behavioral loyalty.

These findings have several implications in tourism business. First, for tourism companies, it is relevant to

emphasize the importance of travel agencies, hotels or car rental services in the composition of the portfolio of

companies belonging to a multi-sponsor loyalty program. In this sense, even tourism companies which have

their own loyalty programs (monosponsor) should consider the option of joining to a multi-sponsor program.

This way, with their own programs can reward their loyal customers and with adherence to a multi-sponsor one

can attract new clients (Leenheer et al., 2007; Reinares & García de Madariaga, 2007). Their tool to negotiate

with the loyalty programs is that the inclusion of incentives based on travel and leisure experiences, improve

the volume of the basket, purchase frequency and average expenditure made at the retail outlet.

Secondly, there are important implications for loyalty programs. Given these results, it seems obvious that

the need to include tourism companies as partners in the program, where customers can accumulate points and

redeem them. Moreover, from the point of view of implementation and monitoring programs, it is important to

have different sections of points for each category of product or service offered as a reward. In this way,

customers can be encouraged by all of them. This price range has to be included in the most preferred rewards

such as travel and leisure experiences, so it would be necessary to deepen into this categorization of tourist

incentives.

Moreover, loyalty programs should offer a greater variety of types of rewards due to the heterogeneity of

the participants (Reinares & García de Madariaga, 2007), including the incentives and gifts based on travel

experiences. This heterogeneity, in reference to the categories or types of awards, must be accompanied by a

certain stability in the prizes offered over a period, so changes do not frustrate the efforts of the owner (in the

sense when they are next in achieving the desired award, it disappears or it is replaced by a less appealing or

interesting reward to the owner). However, managing multiple rewards can generate an operative problem for

the program management (Ponzoa, 2007).

Among the limitations of the study, it is necessary to note the need to use variables taken on its mean


182

rather than on its absolute value. This decision was based on the difficulty of handling the large volume of

transactional data that it was available. Although numerous studies applied the same way of data reduction

(Meyer-Waarden, 2008) and use the same variables, it is true that standard deviations detracted from the result

provided by this measure of central position, which is used very often.

Finally, based on the obtained results an important number of future researches are raised. Firstly, given

the current development of monosponsor loyalty programs with partners, it seems appropriate to test whether

the results obtained here would be the same in this type of program. On the other hand, it would be interesting

to deepen into what kind of travel and experiences are most appropriate to include in loyalty programs, so

segmentation and categorization of relational rewards would be more efficient.

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71(4), 19-35.


Religion as an Influential Factor in Corporate

Governance Structures

Paul Diaconu, Dan Dumitrescu Bucharest Academy of Economic Studies, Bucharest, Romania

The apocryphal quote ascribed to Andre Malraux “The 21st century will be a religious one or it will not be at all” grinds the contemporary scientific world and finds adepts or critics in the most various areas of knowledge development. This economic crisis marked by the toxicity of derived products traded on security markets followed by the crisis of sovereign debts shows besides the end of a secular cycle in the current economic evolution—the end of the consumer society, and represents a turning point in the development of human society in general. The credibility of multinational large financial institutions’ reality and seriousness of the product they are selling to the public has been deeply affected once with the great bank failures in the years 2008-2010, a fact that raised the question of improving internal control and public supervision mechanisms, with a direct impact on the corporate governance solutions adopted by these organizations.

Although the current economic crisis seems far from being over, economist’s preliminary conclusion is that it has

been triggered by the lack of morality of large financial institutions in developed countries that have infested the

world public finance with toxic financial products. This lack of morality of the business environment seems to be a

consequence of the suboptimal action of large financial companies that have put their short-term business interest

above the general interests of the society they were part of, triggering the current world economic situation. The

present article seeks to assess if perhaps religion, as the most effective means of imposing social morality has had

an impact on the corporate governance decisions of corporations in countries with different religions. To this end,

we have used the macroeconomic indicator GDP and its growth rate as a measure of corporations’ managerial

policies collective action. Those policies are/can be more or less influenced by the major religious precepts in the

society where they act. Using these relationships we have attempted to give an assessment of the religious

phenomenon impact (as an element imposing a moral conduct in the society) on the macroeconomic outcomes in

different countries of the world (as a measure of managerial decision). The article’s conclusion is that one of the

efficient “law enforcement” ways is accepting religion in the social-economic space, so that the managerial

decision in any corporate governance system will also have a moral component, meant to censor the immoral or

antisocial decisions of managers.

Keywords: corporate governance, religion, policies enforcement, morality, ethic, social-economic space

Introduction

Paul Diaconu, Professor, Faculty of Accounting, Bucharest Academy of Economic Studies. Dan Dumitrescu, Professor, Faculty of Accounting, Bucharest Academy of Economic Studies. Correspondence concerning this article should be addressed to Paul Diaconu, Preciziei Boulevard, No. 11, 6th District,

Bucharest City, Romania. E-mail: [email protected].

DAVID PUBLISHING

D

RELIGION AS AN INFLUENTIAL FACTOR IN CORPORATE GOVERNANCE STRUCTURES

186

The fundamental problem of corporate governance theories is that they fail to penetrate by the proposed methods the consciousness of executives, but attempt, by creating bureaucratic tools at ensuring a climate of good governance in the organization. Governance systems, either monist or dualist, recommend increasing the role of audit committees, audit parts composition, and are as many concerns that, though having improved the governance climate within organization have failed to avoid the great managerial risks and at the same time the great bankruptcies in recent years. The transition to a new stage, in the present economic thinking is required, in our opinion, one to control a larger extent the human consciousness of the decision-makers by using two basic tools also used in the past to control human consciousness: ethics and religion. Both concepts call for the need to control the cultural capital of individuals and how this can be exploited for the good of the community. If religion pertains to the embodied form of cultural capital as described in fundamental works such as “Protestant ethic and the spirit of capitalism” by Weber (Weber, 1904), ethics can be found more often in the institutionalized form of cultural capital, set by school under the condition of using the terms established by Bourdieu (1979).

In the present paper we start from the premise that the best measure of assessing corporate governance policies, viewed in the broad sense is the added value generated by companies, regardless of their size in the economy. Furthermore, we believe that the general social expectation is to maintain general welfare and to inspire a slightly trend upward increasing trend (the tendency of “blue chips” at the society’s overall level). Therefore, we appraised that a statistic financial indicator which would the impact of corporate governance policies and systems is represented by the Gross Domestic Product (GDP) of the country where the various economic entities operate—the respective companies.

One of the most critical moments in social life is the moment of economic crisis. Then the developments generally accepted by society: the tendency of blue chips (slightly increasing); changes and an economic decline occurs with a significant adverse impact on the society in general (see the current economic crisis).

Starting from the premise that the measure of corporate governance policies seen in the broad sense is the respective country’s GDP evolution, we intend to test the impact of religion as an instrument to impose overall welfare in the society on the corporate governance policies. We appreciate that a demonstration of this influence can be tested scientifically, by applying the general principle of cause variation and following the way in which the outcome is affected. Thus, in order to vary the religion indicator, we propose an analysis of the way in which the indicator has been affected by the outcome (GDP) in countries of a different religion (cause indicator) in the context of the current economic crisis. This is the way in which we can assess the effects of religion on the activities carried out by corporate governance actors in conditions of economic turbulence and how their overall decisions, over time, have a positive or negative consequence on the society’s evolution economically, on long term.

Literature Review Concerns about improving corporate governance mechanisms are standing in the scientific world and the

new turmoil generated by the current economic crisis showed the limits of all previous conceptual constructions. However, one of the directions in which the western society has not advanced is enhancing the role of ethics and/or religion in determining a behavior of managers to the good of the shareholders community and of the general public. Important steps in raising awareness on the religion’s role in managerial decision have been taken by authors of Islamic religion who emphasized in their works that the role played by Divinity in


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economic decision-making. This comes as an application of economic capital’s development and exploitation in the context of recognizing the existence of a different cultural capital in the countries of a traditional Muslim religion. The role of Islam in the modern companies’ system of management accounting can be found explained in works such as “Elimination of Riba through Tzakiyah (Purification) of the cash flow concept: a study from the Indonesian Islamic business habitus” presented by Mulawarman (2011) where the managerial thinking process features three phases:

First to integrate the mind and soul; second to integrate the results of the integration of mind-soul with the Owner (n.a. Allah) of the mind and soul; third, to derive the result of integration from the second level in the form of formalistic prayers as well as to read, understand, interpret and seek symbols of the Holy Qur’an to determine decision as result of integration. It is clear that business decisions are not only based on calculations of financial prediction, but the peak is on intuition and inner soul atmosphere. (p. 121)

Baydoun and Willett (2000) develop a theory about the form and the content of the financial information that should be contained in Islamic financial statements. The theory suggests that the presence of the Islamic religion as a cultural variable affects the way certain accounting measures are interpreted and the manner in which accounting information should be disclosed. Two important criteria for disclosure in Islamic accounting are identified: a form of social responsibility and the rule of full disclosure. This leads to modification of the form of the conventional western set of financial statements (ICR’s). The specific recommendations are that ICR’s should contain a value-added statement as the focus of performance of the accounting entry and the current value balance sheet in addition to the historic cost balance sheet. This will serve more Islamic code. The authors draw a comparison between Islamic accounting and the western conventional one in the 2000s. Thus, if western conventional accounting is underpinned by economic rationality, it is secularized, individualist, based on profit maximization and rationalism in addressing business, and concerns property as an absolute concept, Islamic accounting is based on the unity of God, with religion that masters all accounting concepts, is subject to common good, is considering a reasonable profit for the owner, is fair and regards shareholders as relative owners of the company.

Abu-Tapanjeh (2009) in “Corporate governance from the Islamic perspective: A comparative analysis with OECD principles” published in Critical Perspectives on Accounting states is a growing concern emerged with a great profile regarding the Islamic principles of corporate governance. A major ethical component of any economic activity in Islam is to provide justice, honest and fairness and to ensure all parties their rights and dues. Islamic economy has progressed a great deal during these last two decades with impetus as an important concern in developing an Islamic corporate system. Paper concluded that the dimension of Islamic perspectives of corporate governance has broader horizon and cannot compartmentalize the roles and responsibilities in which all actions and obligations fall under the jurisdiction of the divine law of Islam whereas, the OECD principles implements a firm with six different issues and obligations.

In the paper “Culture and Corporate Governance” by Aras and Crowther (2008), Riham states that culture has long been recognized as a likely determinant of business practices and ethical values (Hofstede, 1980; Gray, 1988; Perera, 1989). Traditionally religion has had a role in shaping and enforcing ethical behavior such as truthfulness, honesty, and social justice.

Hasan (2012) makes a comparison between occidental corporate governance system and Islamic corporate governance system, insisting on the role of ethics as an essential incident on corporate governance. He suggest that only after the incident of significant corporate failures and financial scandals due to lack of ethical


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consideration, there were suggestions to integrate ethics into corporate governance frameworks such Drennan (2004), Cladwell and Karri (2005), Arjoon (2005), and Sullivan and Shkolnikov (2007) cited by Hasan (2012).

In western literature, the role of religion is taken by ethics and its role in corporate governance structure or of the corporations’ social responsibility policy. Thus, authors such as Epstein (1987), Verma and Prakash (2011), Griseri and Seppala (2010), Muchlinski (2008) discuss issues in business ethics and its impact on organization’s welfare that should be institutionalized by the organization’s culture, ethos, and operational rules. The concept of business ethics should assist companies and their leaders to incorporate value considerations and social performance issues into ongoing organizational or individual policies and practices by providing an integrative analytical framework which draws upon and fuses key elements of the older concepts of business ethics, corporate social responsibilities, and corporate social responsiveness.

Bonini, Alkan, and Salvi (2012) found in their works that corporate governance is the essential mechanism allowing proper management of financial and corporate resources by aligning incentives of employees and investors. Yet, corporate governance rules and mechanisms are costly and have different effectiveness across countries. The paper’s results provide guidance to investors in selecting the appropriate set of governance provisions conditional on a set of investment-specific factors.

Nordberg (2004) in his paper seeks to reframe the discussion about corporate governance in terms of the ethical debate between consequential, teleological approaches to ethics and idealist, deontological ones, suggesting that directors are—for good reason—more inclined toward utilitarian judgments like those underpinning shareholder value. But the problems with shareholder value have become so great that a different framework is needed: strategic value, with an emphasis on long-term value creation judged from a decidedly utilitarian standpoint.

Current literature in the field of business ethics and corporate governance is extremely well represented and dwells, from various angles on the ethics role in defining corporate governance policies, insisting on the need to establish implementation and control mechanism of ethical precepts in managerial decision. Such works, as the ones of Zimmerli, Richter, and Holzinger (2007), Reinz (2007), Brink (2011) or Abdullah and Benedict (2009), Veldman (2011), Hahn (2012), Judge (2012) discuss at length the issues of ethics in corporate governance. Yet, the great advantage of the Islamic system of corporate governance, even if it is not structured as the western one, consists in the force and determination by which it succeeds in implementing Islamic precepts, close to the ethical precepts in business management.

The role of this paper is to attempt at identifying correlations between the predominant religion and its related social tools meant to impose morality in the society and at the same time generating specific social perceptions of the individuals and economic evolution of the respective countries.

Hypothesis The predominant religion of a society leaves a mark on the respective nation’s way of thinking. Depending

on how the religious precepts manage to impose themselves in the society in general and particularly in economic life causes certain attitudes and a certain climate of morality and interaction with the other co-participants in the economic life. Given the philosophy of each of the four major religions: Christian, Buddhist, Hindu, and Islamic, the authors tried to identify the possible causality relations between the religion nature and the economic behavior of community’s members during the last economic crisis by means of the GDP and GDP/inhabitant indicator in the period 2008-2010. The hypotheses the authors want to demonstrate


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are the following: There is a correlation between the evolution of GDP indicator and the religion of the respective nation; If Hypothesis 1 is right, which are the religions that managed better during the economic crisis the social

processes, so that the decisions of the managers responsible for corporate governance do not impair the overall economic welfare of the society?

Methodology The statistic data has been obtained based on the information provided by Google statistics and

complementary from www.indexmundi.com. In the view to assessing the impact of corporate governance policies on the macroeconomic outcomes, we used the GDP indicator and GDP evolution, rectified by inflation rate. We appraised as a given fact that corporate governance policies have a direct impact on companies’ economic outcomes, and the companies, by their economic outcomes, affect directly the GDP evolution (the added value generated by those being a GDP component) on the one hand, and on the other hand, the current economic crisis has caused the GDP decrease due to a lower mass of the added value generated by the companies in the respective countries, we think that the outcomes of corporate governance policies have a direct impact on GDP. We started from the different way of addressing business in various geographic areas and sought to stratify the sociological populations (nations) on religious grounds. We appraised that inspires a certain behaviour in the society, and a certain way of thinking related to social ethics, a fact that would be implicitly found also in the corporate governance policies.

We also thought that where a religion is the major (exceeds 50% of a country’s population) this imposes the predominant social conduct. We considered the following religions according to which we classified the countries in the world: Christian, Buddhist, Hindu, and Islamic. A series of states had a religious mix between Buddhism, agnosticism, and Universal Chinese. We considered the respective state as being Buddhist having regard to the roots and basic philosophy of the respective religion. In order to assess the impact on the respective countries’ GDP, we evaluated the GDP growth rate in constant values compared with the previous year, thus appraising the society’s basic expectation: continual slightly increasing developments of this indicator.

Findings As to Hypothesis 1:

There is a correlation between the GDP indicator evolution and the respective nation’s relation. To test the first hypothesis we checked that the correlation coefficient is zero or different from zero. Mathematical calculations revealed that the correlation coefficient is significantly different from zero,

being equal to 0.23. Then we tried to classify countries, according to the GDP growth rates in the years 2008-2010 in uniform

populations and then to test if possibly in thus formed growth rate classes any preponderant religion is identified for each of the formed clusters. We conducted tests for uniform populations of four clusters and after analysing the results thus obtained, we identified the fact that two of the populations were preponderantly populated with countries of a predominantly Christian religion, and the Hindus and Buddhists had significantly similar developments, which caused regrouping countries into three clusters in order to concentrate developments on the three basic directions: one significantly variable with a significant decrease of the GDP


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growth rate up to negative values; one with a slowdown of the GDP growth rate up to value close to zero, dominated by Islamic religion; and one with sustained growth rates of over 4% dominated by countries predominantly Buddhist and Hindus as it is represented in Figure 1.

Plot of Means for Each Cluster

Var1 Var2 Var3 Variables

Figure 1. Plot of means for each cluster.

To test the relevance of this classification in the three categories of countries, we have used the ANOVA test that revealed the following shown in Table 1.

Table 1 Analysis of Variance Between df Within df F Significance SS SS p 0.159532 2 0.195703 182 74.1810 0.000000 0.282842 2 0.226832 182 113.4700 0.000000 0.095094 2 0.161953 182 53.4328 0.000000

Since the p indicator value is zero, it comes out that the stratification into in three clusters is a significant one.

By correlating the results of the two mathematical determinations it comes out that Hypothesis 1 is confirmed. GDP indicator is also influenced by the major religion of the respective country and, therefore, the corporate governance policies as a tool of GDP generating and GDP development is influenced by the religion predominant in the society.

As to Hypothesis 2: If Hypothesis 1 is correct, which are the religions that managed better the social processes during the

economic crisis so that the decisions of the managers responsible for corporate governance do not impair economic welfare of the society in general?

-0.10 -0.08

-0.06

-0.04

-0.02 0.00

0.02

0.04

0.10

0.08

0.06

0.12

Cluster 1 Cluster 2 Cluster 3


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A general statistical analysis related to the structure by religions of GDP and the grow rates can be concentrated in Table 2.

Table 2 A General Statistical Analysis Related to the Structure by Religions of GDP and the Grow Rates Countries 2008 2009 2010 Total 60,126.26 56,913.83 61,710.42 Total GDP average rate % 1.94 (2.00) 4.00 Buddhist countries Total GDP value by category 10,242.65 10,868.28 12,347.34 GDP average rate by category % 3.92 1.00 7.00 Percentage of total GDP 17% 19% 20% Hindu countries Total GDP value by category 1,238.21 1,399.06 1,750.31 GDP average rate by category % 4.95 9.00 9.00 Percentage of total GDP 2% 2% 3% Islamic countries Total GDP value by category 4,182.39 3,804.91 4,484.34 GDP average rate by category % 4.57 1.00 5.00 Percentage of total GDP 7% 7% 7% Christian countries Total GDP value by category 44,260.91 40,646.19 42,911.09 GDP average rate by category % 1.13 (4.00) 3.00 Percentage of total GDP 74% 71% 70%

It is noted that the countries of Christian religion were mostly affected by the crisis, recorded in the year 2009 a decrease of the GDP rate of 4%. Moreover, the proportion of Christian economies in the world GDP is in this period decreasing. The less affected ones, according to the statistics above, are the Buddhist and Hindu economies, followed by the Islamic ones that record lower average rates, but still positive.

We complete this general statistical classification with the mathematical statistical analysis based on clusters. This analysis by which we have grouped the world countries in three clusters depending on GDP growth rates for the years 2008-2010 has the following conclusions:

(1) Within cluster three countries with sustained GDP growth rates of over 4% in constant values are shown. The countries of a preponderantly Buddhist and Hindu religion particularly had such values, like: China, Bhutan, India, Laos, Macao, Singapore, Sri Lanka, or Vietnam. These represent 76% of total GDP of the respective cluster and 51% of total countries of Buddhist and Hindu religion. A percentage of 13% is represented by countries in the Islamic area, like: Afghanistan, Azerbaijan, Bangladesh, Cape Verde, Egypt, Gambia, Laos, Lebanon, Niger, Oman, Qatar, Sudan, Tajikistan, Turkmenistan, and Uzbekistan. They represent 31% of total GDP PIB produced by Islamic countries. The remaining 10% are representing Christian countries.

(2) The second states category, belonging to median cluster two are the ones where the growth rates were also maintained in the peak year of crisis, positive rates, they did not record negative values of GDP evolution, but only slowdowns in the growth. This group of states is predominantly Christian, 56% of the GDP collected within the cluster, but only 11% of GDP total generated by the Christian countries. This leads to the conclusion that the predominant place of the Christian countries is not in this middle cluster, but in clusters one whose data is shown below.


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On the second place within the cluster are Islamic countries, whose GDP represents 24% of total GDP of the respective cluster. These countries of a predominantly Islamic religion that populate cluster two are: Albania, Algeria, Saudi Arabia, Bahrain, Comoros, United Arab Emirates, Guinea, Guinea Bissau, Jordan, Iraq, Iran, Kazakhstan, Kirgizstan, Kosovo, Libya, Malaysia, Maldives, Mali, Morocco, Mauritania, Pakistan, Senegal, Sierra Leone, Syria, Tunisia, and Yemen. But they represent 50% of total GDP of the Islamic countries, a fact that confirms the primary statistical analyses through which we reached the conclusion that these countries recorded positive developments of GDP, only recording a slight decrease of the growth rate, yet also maintained in positive values in the year 2009.

(3) The last group is represented by the one belonging to cluster one, where countries with growth rates that recorded negative values in the year 2009 are grouped. They are the countries most profoundly marked by the economic crisis and that recorded economic turmoil in full. They represent 71% of the world economy. Within this group of countries, 86% of the GDP proportion of the cluster is represented by the countries of Christian religion. Among these we mention: Austria, Bahamas, Belgium, Botswana, Bulgaria, Canada, Denmark, Switzerland, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxemburg, Great Britain, Mexico, Norway, New Zeeland, the Netherlands, Portugal, Romania, Russia, Serbia, Spain, United States of America, the Ukraine, Hungary, Venezuela, and Zimbabwe. The following category of countries within the cluster is represented by the Buddhist countries with 12% of the total, represented by Japan, a country strongly dependent on the Christian western economy where it exports most of its high technology products. On the last place the Islamic countries are situated, with 2% of the proportion.

The analysis by clusters comes to demonstrate the preliminary conclusions that confirm the adverse impact of the economic crisis on Christian economies. The study continues the hierarchy by grouping the states that recorded positive growth rates, but of an average intensity up to 4% GDP growth rate/year where the Islamic economies are major from the representation point of view, and in the last category we can find the countries with sustained growth rates, of over 4% of the cluster’s average mean, where the countries of Buddhist and Hindu religion are preponderant.

Conclusions The study has started from the need to identify new ways to impose in the organization’s corporate

governance structures, but also how to conduct business in general, ethical, moral precepts meant to harmonize individual with the collective welfare. Starting from the analysis of means by which, over time, the society has tried to manage the collective human behaviour, we identified besides the legislative, normative system where we situated ourselves and with the current corporate governance system, also other means meant to penetrate people’s consciousness and control their actions, in order to get them act both for the individual good and for the collective one. The experience of traditionalist Islamic economies where, in the Islamic financial companies, there are the so-called groups of Islamic (religious) supervision that censor from the religious point of view the current or long term economic decisions, represents an experience worthy to be analyzed more profoundly by the secularized western capitalist society, having regard to the sequential failure generated by abuses at the corporate governance structures level of large western corporations (see the sale of toxic financial derived products on the stock exchanges around the world).

The return to religious morality, meant to control human consciousness, the only one able to make the best decisions for itself, but also for the society in general in the long term, seems to be the determined statistical


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solution that allows a better application of decisions in terms of corporate governance. In fact the only thing we are doing is to reconfirm a conclusion that the human society has cyclically reached, namely, the philosophy of goodness can only be promoted by consciousness control. Consciousness control can only be achieved through religion in general and particularly through ethics. If ethics has an action scope limited to the population cultivated on this purpose and has as single coercive tool going out of morality, religion proposes a more powerful instrument, the one of resistance in front of the divine superhuman force. Cultivating Divinity’s force, generally accepted by religion as being supreme and irremovable, is done differently, its method and means customizing each individual religion.

From the study presented above, the most inefficient from this point of view comes out to be the Christian religion, exactly due to the fact that the Christian society is one preponderantly secularized. Christian religion does not have at present the means of consciousness coercion meant to ensure the promotion of common good in the society, exactly due to religion withdrawal from the society’s active life in general, but especially its failure to get involved in economic life. On the other hand, Christian economy in the economic growth periods is the most dynamic by the fact that individual good is not opposed to the need to ensure community’s good, only to the extent of the legislative system’s observance.

From this point of view, the Buddhist and only the Hindu religion is the most efficient in promoting man’s integration in the surrounding environment, determine a logic of a more harmonious existence that implicitly requires a moral conduct also in the economic life course in general and how the corporations are governed in particular. The way in which these populations conduct business starts from the premise of trust between partners and of a good balance in the exchanges between them. That is why the cognitive matrix of a manager will always be marked by the need of trust in the business partner, which requires a good balance in business and much fewer turbulences generated by this fact.

Islamic religion, given its coercive system of imposing goodness in the society manages to cause in a significant manner, a good balance in the society, which allows, during periods of economic crisis generated by lack of trust in the business partners, positive developments without notable turbulences. Islamic experience in the financial companies, represented by the committees of Islamic supervision, is a solution to the current morality crisis generated by the managerial decisions of the corporate governance structures.

We appraise that future studies will be able to test in the western society the opportunity of these committees or the implementation of other means by which management consciousness should be channeled towards the collective good, whether this is called shareholders’ profit or overall social welfare.

Limitations of the Study These are caused by the fact that, though the study analysis the impact of corporate governance policies on

economic environment, taking into account the morality level existent in various societies imposed by the society’s predominant religion, yet, in many states of the world, given the relatively low level of economic development, also the corporate governance policies are at an incipient developmental level, and so, how they act on economic decisions are questionable. However, we cannot deny the existence of corporate governance policies, whether they are rudimentary in each economy of the world. But this diminishes the evaluation of religion’s role in imposing a moral social conduct.


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http://www.ssrn.com/�


Social Media Network—A Seminal Paradigm

for Interactive Marketing

Kumarashvari Subramaniam

Multimedia University, Cyberjaya, Malaysia

T.R. Gopalakrishnan Nair

Prince Mohammad bin Fahd University, Al Khobar, Saudi Arabia

In the era of globalization, effective communication between the enterprises and the target audience is a crucial

issue in achieving strategic targets in business. However, with the advancement in the technology, especially the

introduction of Internet in the 20th century, marketing communication channels are subjected to a quiet transition

incorporating the facilities of the social media networking. This paper discusses the transition scenario of marketing

communication channels from traditional architectures to social media networking. It is an undeniable fact that the

traditional channels like newspaper, billboards, radio, etc. are still in vogue. However, the presences of the social

media networking started influencing the way enterprises communicate with their target audience. It has become

quite evident now that more individuals and enterprises are engaged in communication using the social media

networking sites for business transactions. At the same time, large number of end users makes use of social media

networking in reading “reviews” and the post-purchase feedback notes. The changing scenario in this domain of

marketing communication has influenced this research and it involved a study spanning one year (September

2011-October 2012). This paper also intends to highlight the uniqueness of the social media networking. It also

depicts how the user oriented applications manage and influence the purchase decisions of the audience. The

statistical analysis is carried out to study the influential properties of social media networking and it involves the

quantitative analysis of the user preferences. The samples organized for this study portrays the involvement of

enterprises in the utilization of social media networking. It can be concluded that the existence of social media

networking not only augments to social interaction but also extends the experience of having a desirable shopping

experiences for the consumers. It also offers the enterprises an opportunity to interact with their target audiences

resulting in the transfer of marketing messages.

Keywords: traditional marketing communication, social media networking, virtual shopping

Introduction

One of the major concepts of modern marketing is to rely on an appropriate mix of business aspects like

commodities, cost, convenience, and communication. The marketing mix consists of everything that the firms

can plan and implement in order to create a demand for its product. Enterprises commonly identify themselves

Kumarashvari Subramaniam, Institute of Postgraduate Studies, Faculty of Management, Cyberjaya, Malaysia. T.R. Gopalakrishnan Nair, Aramco Endowed Chair, Prince Mohammad bin Fahd University. Correspondence concerning this article should be addressed to Kumarashvari Subramaniam, Female Campus, College of

Business, Prince Mohammad bin Fahd University, PB 1664, 31952, Al Khobar, Saudi Arabia. E-mail: [email protected].

DAVID PUBLISHING

D

SOCIAL MEDIA NETWORK—A SEMINAL PARADIGM FOR INTERACTIVE MARKETING

196

as sellers of products and customers distinguish themselves as the buyers of these products or solutions.

The current trend in the world indicates that a normal customer is no more bound to a “just” price of the

product but he/she is driven by intriguing desires of utility and a pertinent attitude to know about the total cost

of ownership of the product. This is a change in the consumer awareness which is continually fueled by the

advancement of information technology and as such the social media networking. The world is moving more

and more towards internet bound, the desire for awareness is directly or indirectly controlled by scenarios

mainly created by Internet based interactions.

Usually it is of two types: the first one belongs to the unidirectional read enabled interactions; whereas the

second type belongs to the bi-directional expression and exchanges of opinions and viewpoints. The enterprises

are now targeting a large population who are interacting with the internet under these two modes of operations.

Therefore, the study of the communication or promotion field demands more focus, as it is a vital agenda

for enterprises. Conventionally, the field of Integrated Marketing Communication (IMC) consists of several

approaches such as sales promotion, trade fairs, public relations, bill board, and printed media. However, in the

21st century, the field of IMC can be categorized into several segments as follows.

Personal Communication This form of transaction refers to communications by an enterprise with a target audience either through

message delivered by a sales person in a face to face way or by a person to an audience through the media like

telephone, email, couriers, and smart phones or through a chatting using web-cam. Enterprises take various

steps to stimulate personal communication for their offerings and brands in the segmented market across the

globe.

Hybrid Communication This form of transaction refers to the usage of traditional and conventional marketing communication

platform for the purpose of “reaching out” to a target audience and to persuade the target audiences to involve

in a purchase decision. These forms of communication include printed media (magazines, billboards,

newspapers), electronic media (CD-ROM, electronic email, short messaging systems), and enterprises arranged

events such as exhibitions, sponsorship, trade fairs etc.

Social Media Networking (SMN) SMN is a web-based application that allows anyone to construct any web contents, from uploading photos,

videos to descriptions like personal, organizational, or employers’ details. More interestingly it can publicly

display a list of other users with whom they can share connection (Boyd & Ellison, 2007). In the recent years,

SMN has evolved in a fast pace as a media to create communication between individual to individual or

enterprises to an individual. The Internet has enabled SMN sites to grow in a fast pace and it is becoming as

one of the most rapidly influencing platform in the history of information technology.

Research Background The SMN application allows individuals to share information and communicate on the network regardless

of time or geographical restriction. According to Kaplan and Haenlein (2010), social media as an Internet based

applications, allows people of all age regardless of geographical area or time to actively share their information.

Additionally, research by Cann, Dimitriou, and Hooleyl (2011), claims that social media is a suitable internet

based application, that allow users to generate contents too.


197

The internet has revolutionized the information technology world to an extraordinary level. A study by Ria

novosti Internet User Report (2012), indicates there are about two billion internet users worldwide in the year

2011 and about 45% of the Internet users live in Asia. China seems to be leading with about 485 millions of

internet users. It is evident that the Social Media (SM) network is growing in a fast pace and is becoming one of

the most rapidly growing media or mode in the history of Internet. The Internet has transformed the information

technology world to a level having a multiplying effect on competence. The number of internet users will

continue to escalate and it is projected to reach 2.8 billion users worldwide soon (Melanson, 2011).

The SMN sites such as FaceBook®, My Space®, Second Life® all allow individuals of all age to share

their information and daily activities (Hove, 2010). The escalating number to SMN sites has changed the way

individuals and enterprises interact within a commercial perspective (N. D. Barnes & F. R. Barnes, 2009).

Therefore, the evolutions of SMN sites and on the other hand the involvement of consumers with them are

escalating rapidly. Table 1 indicates different SMN sites in use with number of users and nations that actively

get involved with this application.

Table 1

Social Media Networking Sites With Heavily Involved Region—2012 Statistics Sites World users (million) Heavily involved region

FaceBook® 850 Tunisia

Twitter®

Friendster® Mixi®

Flickr® My Space®

Ren Ren® Orkut®

465

100 23

50 63

130 65

Brazil

Philippines Japan

United Kingdom United States

China India

During the ending period of 20th century, the Internet was perceived as a “perfect virtual notice board” but

in the recent years, since 2007 or 2008 it has gone a step ahead with the evolution of SMN sites. Even though,

during the year 2010, many SMN sites were closed their operations, such as Team Sugar and Propeller, this

phenomena did not affect brands such as Facebook® and Twitter®. Additionally, RenRen® has become the

key social network giant in China and Orkut® in India for some time. Other sites like Friendster® have a great

diffusion in the Philippines, and Mixi® has become one of the most popular sites in Japan. The same is the case

with MySpace® in the USA and it seems to lead the scenario regionally.

Facebook® has the highest number of users, reaching 850 million users in 2012. The other SMN sites that

sharing the pie with Facebook® are Orkut®, Linked In®, Mixi®, Pinterest® etc. The SMN channels were well

received by individuals and it has clearly positioned in the mind set of a large population. Its unique properties

such as enabling users to access the channel from anywhere on the globe and to track information from

different platforms have lead to the success of SMN. SMN sites allow individuals to gather information and

search for post purchase feedback, virtually in a very comfortable pace, according to Safko and Brake (2009).

It is also an unquestionable fact that the advancement in the digital technology has enable enterprises and

individuals to communicate with millions of people through the SMN sites (Mangold & Faulds, 2009). There is

a pervading transition taking place in marketing communication and it happens through the invisible medium

enveloping the mind of people, across the globe through the power of social media networks.


198

A study by Nair and Subramaniam (2012) claimed that evolution of individual’s consumerism through the

SMN has caused pressure for extensive migration by business organization towards SMN sites. On the other

hand, the Zenithoptimedia report (2012) predicts that the global advertising expenditure in these channels will

reach US$464 billion soon, 3.5% higher than in 2010, and then should accelerate to around US$486 billion, a

4.7% growth despite the economic recession in Europe and debt crisis prevailing in many regions. In this

segment, internet alone grows from US$73 billion to US$84 billion. The study clearly indicates the increased

spending attitude of enterprises to the virtual world for realizing effective communication.

Uniqueness and Accessibility The usage of SMN channel continues to grow briskly, as it provides a conduit to connect, share, shop and

network among people. Additionally, increase in the number of mobile phone usage has lead to an increase in

the access rate of SMN sites. According to the New Media Trend Watch (2012) nearly two in five social media

users’ access to the SMN sites from their mobile phones.

It is reported that mobile phones subscription has escalated to five billion in number. It is absolutely

undeniable that under the Traditional Marketing Communication (TMC), an individual has only limited ways to

learn about a product like printed media, television or billboards.

However, now with the advancement available in the information technology, the knowledge about a

product can be learned in numerous ways such as SMN and multimedia sites. As a result of various innovations,

the SMN sites can be accessed through personal computer, laptop, iPhone, tablet or any other ordinary cell

phone that has an internet connection. Table 2 indicates a number of access channels to the SMN sites that is

used by individuals.

Table 2

Access Channel to the Social Media Networking Sites Item Access channels Score (%) Ranking 1 Computer 97 1 2 E-reader 2 5 3 Gaming Console 3 3 4 Handhold Media Player 1 7 5 Internet Enable TV 2 5 6 iPad 3 3 7 Mobile Phone 37 2

Its unique characteristics give individuals an easy access and interactive options to a large population

regardless of location and time. In line with it, enterprises are embracing SMN in order to closely and directly

interact with their target audience. Additionally, offering a potential and valuable advertising platform for

enterprises. It is also noted that about 84% of Fortune 100 companies and about 81% of the top Asian companies

are using branded social media channels for the purpose of reaching out its target audience, according to the

Burson-Marsteller Asia Pacific (2011).

It is clear that SMN sites continue to play an important part in the marketing communication field. Even

though at some point SMN sites may reach the saturation point, but it does not look like that point will arrive any

time soon. According to Arno (2012), there will be 1.43 billion SMN account users in the year 2012, which

represent 19.2% increase over 2011 figures.

Additionally to the Booz & Company and Buddy Media (2011) reported that a survey result indicates that 96%


199

of companies would be increasing their investments into the SMN sites. The source further claimed that the SMN

sites were used for the purpose of product advertisement and to maintain long-lasting customer relationships.

However, the benefits are not limited as to communication purpose alone. It has also been used for the purpose of

conducing marketing research activities and as a human resources recruitment tool. Additionally, the source

claimed that 83% of enterprises considered social media as an important communication tool for their businesses.

A number of factors have contributed for the easy penetration of SMN. To begin with, the advantages gained

by business organizations include low set-up cost, worldwide accessibility at any time, user adaptability,

guidance, and help features. In addition to that, individuals enjoy reading the post purchase feedback and they can

exchange various types of information from personal to work related. Figure 1 indicates the factors that

contribute to purchase decision process.

Figure 1. The factors that contribute to purchase decision process.

In the past, consumers were influenced by cultural, social, personal, and psychological factors in the

decision making process. However, with the “birth” of user generated applications, www.facebook.com,

www.twitter.com, consumer decision-making process is not only depending on those four traditional factors,

but also getting empowered with SMN sites and feedbacks along with post-purchase reviews.

The factors that empowered by SMN provides an opportunity to consumers to review the post-purchase

experience and comments which are considered to be powerful tips for any potential buyers. The multimedia

sites such as YouTube® and MyVideo® enable enterprises to upload promotional clips while dissatisfied

customers can capture scenes of collapsed service or damaged products and uploaded into the YouTube®.

According to Mershon (2012), the SMN sites allow enterprises to engage in dialogue with customers.

Consequently, it tends to boost the amount of sales for enterprises and lead to powerful brand awareness. The

SMN sites uniqueness and various easily accessible channels will continuously embrace individuals to involve

with the platform.

On the other hand, business organizations will continuously involve in preparing an effective strategic

planning for the purpose of communicating with their precious customers through the SMN sites. It is an

undeniable fact that SMN is becoming one of the prominent pathways of social communication in the 21st

century. It can be easily subsumed that SMN turns out to be a vital attribute of the consumer purchase decision

making process. It is noteworthy that the SMN sites are bringing enterprises and their target audiences much

closer.

Traditional Factors

Cultural, Social, Personal &

Psychological

Social Media Networking Sites: Facebook, Youtube,

Flickers, Pinterest

Product Information

Product Performance

Purchase Decision

Factors empowered by SMN

(Information Unrelated to Product)

(Information Closely Related to Product)

http://www.facebook.com/�

http://www.twitter.com/�


200

Increasing Dependency The SMN sites have attracted a huge number of individuals who engage themselves in the network and the

number is building up tremendously. In line with that, enterprises are continuously making improved

investments in the SMN sites in order to gain high return on marketing investment.

According to a survey carried out by Madden and Zickuhr (2011), among 2,277 respondents found that

65% of adults that have access to the Internet use social networking sites such as Facebook® and MySpace®,

and this number is getting increased when compared with 61% in the 2010. The survey further revealed that 61%

of adults who are under 30 years old use SMN sites at least once in a day. On the same lines, population that

falls under the age category of 50-64 years now uses SMN sites actively. The percentage of usage increased

from 20% in the year 2010 to 32% in the year 2011.

According to the Borell Associations (2011), the Small and Medium Enterprises (SME) intends to double

their social media advertising budget in 2012. It is estimated to reach US$2 billion in the United States alone. It is

undeniable that enterprises around the world are taking part in the “race” in order to communicate and build long

lasting customer relationship. Table 3 indicates category of online advertisement spending for the year 2011 and

it also shows that social media ranks third in online advertising spending.

Table 3

Category of Online Advertisement Spending for the Year 2011 Channel Percentage Ranking Audio 3.10 11 Banner—Run of Sites 7.20 7 Banner—Targeted Display 8.50 5 Business Directory 12.00 4 Email 17.40 1 Mobile 5.50 8 Search Engine 15.10 2 Social Media 13.70 3 Sponsorship 5.10 9 Streaming Videos 8.10 6 Others 4.40 10

The Facebook® sales in 2009 were US$226 million and in the year 2010 and 2011 it increased to US$606

million and one billion respectively. The 50% of the sales generated was through advertising and 20% from its

Zynga game. On the other hand, Twitter® advertising revenue for 2012 is projected to reach US$259 million and

continue to reach US$540 million in 2014.

The details in the Figure 2 was gathered through a survey that participated by 3,800 marketers (Stelzner,

2012). Many of the SMN sites users are engaged in a multiple SMN platforms. The feedback clearly indicates

that Facebook® is leading all other SMN sites (see Figure 2).

According to Eric (2011), the overall market for virtual goods in the United States is headed towards

US$2.9 billion for 2012. That’s up from US$2.2 billion in 2011 and US$1.6 billion in 2010. Virtual goods on

Facebook® are continuing to comprise more than half of that, going from US$835 million in 2010 to US$1.2

billion in 2011 to US$1.6 billion in 2012. The report estimates that mobile virtual goods (for games only) made

US$350 million in 2011, and will grow to US$500 million in 2012.

Additionally, SMN sites can help boost business in the Middle East to a greatest level due to its


201

extraordinary penetration in the region, reported by Khaleej Times (2012). The growth in this user generated

sites continues to be astounding. According to Forrester Research (2010), one third of adults post at least once a

week something to SMN sites such as Orkut®, Facebook®, and Twitter® and about 70% read blogs and tweets

while a others watch videos on YouTube®.

Figure 2. Commonly used SMN sites by enterprises for the year 2012.

A study indicates that Netflix®, Toyota®, Scottrade®, AT&T®, and Experian are some of the top five

online advertisers. However, in the fast moving consumer goods industry some of the highly ranked names are

Procter & Gamble®, Mars®, General Mills, Kraft Foods etc. On the other hand, Google® dominated the

Internet advertising, which has increased its share from 34.9% in 2006 to 44.1% in 2010 (Jacques, 2011). In

addition to that, its early competitors Microsoft®, AOL®, and Yahoo® all have plunged to cope with race,

their combined market share fell from 33.1% in 2006 to 13.8% in 2010. However, Facebook® increased its

market share from just 13.5% in 2008 to 46.3% in 2010 and continues to capture 62% in 2012.

In the past, enterprises did not have such opportunities to talk to millions of customers that scattered

around the globe so easily or even send out messages and get feedbacks in a second with relatively low cost. In

this digital age, the Internet access becomes easily and widely available in many countries. Additionally, the

traditional communication media are not equipped with features such as recommending products by

independent persons or enable a click to “like” a brand. Therefore, the SMN sites have empowered enterprises

with ways and means to harness and absorb opinion flow. According to a survey carried out by

Businesswire.com (2010), it is claimed that more than 79% of the 2,100 organizations surveyed said that they

are currently using SMN channel in order to communicate with their consumers.

SMN sites are not only used for the purpose of social interaction but its usage is moving towards doing

business transactions, from communicating business offerings to provide service after sales. The study governs

that SMN sites can be used as an effective communication tool in order to reach out panoramic target audience.

Conclusions The advent of internet-based SMN sites has ushered a new kind of reach out feasibility and relationship

building process among enterprises and consumers. It is challenging the prevailing ideas about marketing and

brand management while creating new platforms to communicate with customers and building a sustainable

customer relationship. The rapid growth in the SMN sites and the increased involvement of consumers with

Twitter, 82%

Linkedin, 73%

Blogs, 61%YouTube, 57%

Google+, 40%

PhotoSharing Sites, 19%

Facebook, 90%


202

them now triggered the evolution of new forms of marketing communication. Therefore, it becomes inevitable

for the 21st century enterprises to involve themselves in the SMN process. In conclusion, it needs to be

emphasized that the SMN is fast transforming the modern marketing communication channel.

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Examining the Attitudes Towards Mobile Advertising Messages:

A Field Research on Turkish Consumers

Fatih Geçti

Yalova University, Yalova, Turkey

Niyazi Gümüş

Kastamonu University, Kastamonu, Turkey

The purpose of this study is to examine consumers’ attitudes towards mobile advertising messages. In order to

achieve this purpose, a survey was conducted on consumers in Yalova and Kastamonu cities of Turkey. Empirical

findings show that informativeness, permission advertising, boredom, word of mouth communication, affection,

and reliability are determined as the main factors that explain the consumers’ attitudes towards these messages.

Additionally, some of these factors vary with some demographic variables. The findings provide insights for both

academics and practitioners working on this area.

Keywords: mobile advertising message, consumer attitude, Turkish consumers

Introduction

The competition among compaines has been shifted from local to global with the globalization that quick

development caused at communication technology. Companies have been using the last technology and

marketing applications to reach the consumers. One of the last communication tools that has been used by

companies is mobile devices which almost everybody has. Companies try to direct the consumers towards their

own products and brands with the advertising messages. With the new developments in mobile communication,

mobile devices have become significant gadgets enabling marketing experts to communicate with their

customers one to one. Radio, television, newspaper, and magazines are among the traditional advertisement

tools and these tools have important restrictions on some issues such as timing, location, size, and

customization of the advertisement (Park, Shenoy, & Salvendy, 2008). On the other hand, mobile advertising

obtains the ease and advantages to determine the target group, to adjust the content of the message with regards

to the choice of customers and to communicate with the users. When the traditional advertising areas are

compared with the mobile advertising, it can be observed that mobile advertising enables personalization and

interaction. Marketing experts can easily locate the customer in any time period via mobile advertising tools,

thus, the message, intended only for that customer, can be delivered directly to him/her. Constant mobility,

personalization, and space advantages enable mobile phones to be a tool for mobile advertising applications.

Mobil advertisements can be adjusted to the location, time, and personal preferences of customers and then sent

Fatih Geçti, Ph.D., Lecturer, Department of Management, Yalova University. Niyazi Gümüş, Lecturer, Accounting and Tax Programme, Kastamonu University. Correspondence concerning this article should be addressed to Fatih Geçti, Yalova University, Faculty of Economics and

Administrative Sciences, Department of Management, Safran Campus, 77100, Yalova, Turkey. E-mail: [email protected].

DAVID PUBLISHING

D

A FIELD RESEARCH ON TURKISH CONSUMERS

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to them (Kurkovsky & Harihar, 2006). Mobile ads provide enterprises to communicate with their customers

without time and location constraints. Mobile phones and personal digital assistants increase the availability,

frequency, and speed of communication. The technology associated with these devices, which let marketers

personally communicate with consumers, continues to evolve (Scharl, Dickinger, & Murphy, 2005). Using of

the mobile devices as advertisement facilities by marketing experts has just been a new application. That is why

it should not forget the applications which have been occurred by mobile devices are based on traditional

marketing. Furthermore it is thought that mobile devices will give peculiar applications a show by developing

fast (Huang & Symonds, 2009).

The purpose of this study is to examine consumers’ attitudes towards mobile advertising messages. In this

context, a field research on consumers using mobile phones in two different cities of Turkey was conducted.

The paper is organized as follows: A brief literature review on mobile advertising is provied; then, the research

methodology is described; finally, the findings of current research are demonstrated.

A Brief Literature Review on Mobile Advertising

Mobile advertising is defined as a form of advertising that is communicated to the consumer/target via a

handset (Mobile Marketing Association, 2011). In the literature, there are vast majority of publications

concerning mobile advertising and related fields. Researches examining the issue of mobile advertising in

different streams are generally scattered across various publications especially marketing and information

technology journals.

Since the first mobile advertising in the form of text messaging appeared in Finland in 1997, text-based

mobile advertising has become almost ubiquitous in Europe and Asia. SMS ads mix one-to-many mass

communication and point-to-point interpersonal communication (Wei, Xiaoming, & Pan, 2009). As mobile

technology continues to diffuse, the numbers of mobile subscribers continue to grow. The mobile phone and

network is promptly becoming a feasible marketing channel as mobile phones facilitate the exposure to

advertisements deliver through a variety of mobile technologies (Koury & Yang, 2010). Dickinger et al. (2004)

discussed SMS which belong to the first and one of the most successful forms of mobile data transmission.

Bamba and Barnes (2007) examined the phenomenon of consumers’ willingness to give permission to SMS

advertisement and found that consumers’ perception of SMS ads were rather negative. Okazaki and Taylor

(2008) examined the factors associated with the intention of multinational corporations operating in Europe to

implement SMS advertising.

Mafe, Blas, and Mesias (2010) analyzed the key drivers of consumer acceptance of SMS to participate in

television programmes in different countries. According to their findings, while perceived value, attitude, and

affinity towards television programmes determined SMS acceptance to participate in television programmes in

Spain, subjective norm, perceived value, and attitude were the key drivers of SMS acceptance in Colombia.

A research about the contents of advertising conducted in London with a thousand mobile phone user

reaches to a conclusion indicating that a good mobile advertising message, according to the level of

significance, should be short and relevant with its aim, entertaining, adequate for the target group, appealing,

informative in terms of rewarding and publicity (Scharl et al., 2005). Okazaki (2008) focused on the role of

trust in mobile advertising acceptance and found that trust in mobile advertising and in brand both directly and

positively affect attitude towards the ad, which in turn determine attitude towards the brand. Merisavo et al.

(2007) examined the drivers of consumer acceptance of SMS based mobile advertising and found that utility


206

and context were the strongest positive drivers of consumer acceptance of mobile advertising. According to a

research in New Zealand, permission, content of the message, control of the supplier on message, the

distribution time, and density of messages were found importantly effective on the acceptance of mobile

advertising (Usta, 2009). Leppaniemi, Karjaluoto, and Salo (2004) mentioned about the success factors of

mobile advertising value chain and developed 5C model (content, cross-media marketing, campaign

management, customer database, and carrier cooperation) describing the critical success factor of mobile

advertising value chain. Tanveer, Azam, and Panikar (2007) presented an enabling advertising technology that

uses wireless medium for transmitting content. Tahtinen (2005) found a term that covers the essential elements

of mobile commercial communication. Haghirian, Madlberger, and Tanuskova (2005) investigated the

relevance of mobile advertising value and found that the message content was of greatest relevance for the

perceived advertising value, while a high frequency of message exposure had a negative impact on it. A reseach

conducted on mobile phone users in Europe, the US and India found that 78% of the users were happy with

getting mobile advertising messages they were interested in (Xu, Liao, & Li, 2007).

Research Methodology

The current study has descriptive character and aims at examining the consumers’ attitudes towards

mobile advertising messages. In order to achieve the goal of the study, a survey was carried out in two cities of

Turkey. In this regard, all consumers using mobile devices and living in Kastamonu and Yalova constituted the

population. Taking into account financial and time constraints, 402 consumers were selected through

convenience sampling method. The data were collected with structured questionnaire and the survey was

conducted face to face. The statements in the questionnare were adapted from the literature. Questionnaire form

consists of two sections. In the first section, there are questions related to the demographic characteristics of the

sample. The second section includes the statements about the consumer’ attitudes towards mobile advertising

messages. The research questions of this study are as follows:

What are the factors affecting consumers’ attitudes towards mobile advertising messages?

Do factors affecting consumers’ attitudes towards mobile advertising messages vary with the demographic

features?

The data were analyzed via SPSS 20 program.

Findings

Profile of the Respondents

The demographic features of the respondents are given in Table 1.

Table 1

Demographic Features

n % n %

Gender Education level

Male 205 51 Primary school 41 10.2

Female 197 49 High school 157 39.1

Marital status College 55 13.7

Married 153 38.1 University 108 26.9

Single 249 69.9 Post graduate 41 10.2


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(Table 1 continued)

n % n %

Age Occupation

18-25 218 54.2 Worker 24 6

26-35 111 27.6 Civil servant 85 21.1

36-45 41 10.2 Retired 18 4.5

46-55 24 6 House wife 15 3.7

56 + 8 2 Student 140 34.8

Monthly income Self employment 24 6

Below 500 Turkish Lira (TL) 128 31.8 Unemployed 43 10.7

500-1,000 TL 114 28.4 Private sector employee 53 13.2

1,001-1,500 TL 83 20.6 City

1,501-2,000 TL 59 14.7 Kastamonu 185 46

Over 2,001 TL 18 4.5 Yalova 217 54

According to Table 1, 51% of total respondents were male, 38.1% were single, 81.8% were under 35 years

old, 60.2% had up to 1,000 TL montly income, 39.1% had high school degree, 34.8% were students. In terms

of residence, 54% of total respondents were consumers in Yalova and 46% were consumers in Kastamonu.

Determining the Factors Affecting Consumers’ Attitudes Toward Mobile Advertising Messages

Factor analysis was conducted in order to determine the respondents’ attitudes towards mobile advertising

messages. According to the result of the analysis, the sample was sufficient (KMO = 0.88) and data were

distributed normally (Bartlett test: p > 0.000). The result of factor analysis is shown in Table 2. According to

the results, six factors were determined to explain the respondents’ attitudes towards mobile advertising

messages. These factors are: informativeness, permission advertising, boredom, word of mouth communication,

affection, and reliability. Total variance explanation rate of these six factors is 0.80. It means that 80% of the

respondents’ attitudes towards mobile advertising messages are explained by these six factors and with the rest

occurs by affecting of other factors. These six factors were named after reviewing the past studies in the

literature.

Table 2

Result of Factor Analysis

Factors/Items Factors loads Variance explained

Informativeness α = 0.879 0.165

Mobile advertising messages provide useful informations about products and campaigns. 0.809

Mobile advertising messages are good resources in order to provide information on time. 0.799

Mobile advertising messages are useful information resources. 0.781

Permission advertising α = 0.843 0.157

I trust the mobile advertising messages that are sent by getting permission. 0.798

I carefully read mobile advertising messages that are sent by getting permission from me. 0.783 Mobile advertising messages that are sent by getting permission from me affect my buying behavior.

0.706

Boredom α = 0.846 0.144

Mobile advertising messages annoy me. 0.913

Mobile advertising messages upset the people. 0.880

Reading the mobile advertising messages is a waste of time. 0.824


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(Table 2 continued)

Factors/Items Factors loads Variance explained

Word of mouth communication α = 0.908 0.130

I share the mobile advertising messages concerning the campaigns with the people in my environment

0.890

I share the mobile advertising messages concerning the discounted products with the people in my environment

0.884

Affection α = 0.833 0.112

Mobile advertising messages including my area of interest affect my buying behavior. 0.765 Mobile advertising messages affect my buying behavior. 0.719 I think that mobile advertising messages coming to my mobile phone contain useful informations 0.442 Reliability α = 0.689

0.092

I trust mobile advertising messages 0.793 I admit mobile advertising messages as a good reference for shopping. 0.609 Total variance explained 0.80

Factor means are shown in the Table 3.

Table 3

Factor Means Factors Means Informativeness 3.48 Permission Advertising 3.61 Boredom 3.08 Word of Mouth Communication 3.53 Affection 3.44 Reliability 3.22 Note. 1—Strongly disagree to 5—Strongly agree.

According to Table 3, it is possible to mention that permission advertising is relatively crutial factor for

consumers. Respondents will probably accept the messages which they are interested in. Another important

point is word of mouth communication. Word of mouth communication, which has a big importance on

consumers’ decisions, can be made through interesting advertising messages. Thus, companies will be able to

reach many consumers through word of mouth communication.

Examining the Factors Affecting Consumers’ Attitudes Towards Mobile Advertising Messages in Terms

of Demographic Variables

t-test analysis was conducted for determining whether there were significant differences between the

consumers in Kastamonu and Yalova. The results are shown in Table 4.

Table 4

Result of t-test

Factors Cities t df p St. Deviation

Informativeness Kastamonu Yalova 4.885 400 0.000 0.097

Permission advertising Kastamonu Yalova 2.527 400 0.012 0.099

Boredom Kastamonu Yalova 3.758 400 0.000 0.098

Word of mouth communication Kastamonu Yalova 0.819 400 0.413 0.100

Affection Kastamonu Yalova 0.046 400 0.964 0.100

Reliability Kastamonu Yalova 3.015 400 0.003 0.099

Note. p < 0.05.


209

According to Table 4, there were significant differences between the consumers in Kastamonu and Yalova

in terms of informativeness, permission advertising, boredom, and reliability factors. Anova analysis was

conducted to test the relationship between demographic features (age groups, education levels, income levels,

and occupations) and the factors affecting consumers’ attitudes towards mobile advertising messages. The

results are shown in Table 5.

Table 5

Results of Anova Test

Factors

Demographic variables

Age groups Education levels Income levels Occupations

F value Sig. value F value Sig. value F value Sig. value F value Sig. value

Informativeness 0.340 0.851 0.978 0.419 1.111 0.351 0.938 0.477

Permission advertising 0.830 0.507 2.047 0.087 1.064 0.374 2.837 0.007

Boredom 0.835 0.504 6.217 0.000 2.443 0.046 3.267 0.002 Word of mouth communication

0.676 0.609 6.669 0.000 6.536 0.000 3.045 0.004

Affection 1.455 0.215 1.672 0.156 0.937 0.442 0.657 0.708

Reliability 2.102 0.080 2.330 0.055 1.003 0.406 0.865 0.535

Note. p < 0.05.

Significant differences were found among the respondents from different education levels in terms of

boredom and word of mouth communication factors. Besides, there were significant differences between the

different occupation groups in terms of permission advertising, boredom, and word of mouth communication

factors. Moreover, significant differences were also found among the respondents from different income level

groups in terms of boredom and word of mouth communication factors.

Conclusions

In this study, the factors that explain the consumers’ attitudes towards mobile advertising messages were

examined. There also investigated whether these factors differ in terms of demographic variables. Six main

factors (informativeness, permission advertising, boredom, word of mouth communication, affection, and

reliability) were determined to explain consumers’ attitudes towards these messages. Significant differences

were found between the consumers in two cities in terms of informativeness, permission advertising, boredom,

and reliability factors. Additionally, while boredom and word of mouth communication factors vary with

education levels, permission advertising and word of mouth communication factors vary with different

occupations. Moreover, significant differences were found among the consumers from different income level

groups in terms of boredom and word of mouth communication factors.

It is estimated that revenues of the mobile advertising market will increase every year by multitude and it

will be a good income for mobile phone operators. Marketers must notice consumers’ preferences and

differences that can be come out in their tastes about goods and services in the future. It is unavoidable that

mobile advertising messages are some parts of marketing strategy especially for local scale firms.

Limitations and Suggestions

This study is limited to the consumers using mobile devices in the cities of Kastamonu and Yalova in

Turkey. Therefore, generalization may not be made. The convenience sampling method was used in this study.


210

In this context, the sample that was selected may not represent the population in a powerful way. Thus, using

any probability sampling method with a larger sample size in further studies will naturally raise the value of the

researches.

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China-USA Business Review (ISSN 1537-1514) Vol.12, No.2, 2013

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