Unit 1 - Understanding business activity

The "what you should know" section for each sub-unit

Concepts of needs, wants, scarcity and opportunity cost

Concepts of needs, wants, scarcity and opportunity cost

• Needs: basic items that are essential for survival (food, water, shelter, warmth)

• Wants: items that people desire to make their lives enjoyable but aren’t needed

• Scarcity:

  • The basic economic problems (limited resources) leads to the scarcity of the resources required to produce (unlimited) needs and wants

  • Natural resources which are highly sought after are limited and not renewable

• Opportunity cost: businesses making a choice over another leads the the loss of an opportunity

Factors of production

• Land: anything that comes naturally from the planet (crops, wood, trees, oil, gas, fish)

• Labour: manpower needed to produce products and services

• Capital: the financial investment, machines and equipment required to produce products and services

• Enterprise: the people who come up with business ideas and take risks when putting the other factors of production together (entrepreneurs)

Importance of specialisation

• Specialisation (when a business focuses on a particular activity or offers a particular product/service) => more efficient

  • Because of the less wastage of resources as fewer mistakes are made + products are often produced faster

    => Business can make same amount of products with fewer resources

  • Important bc resources are scarce so maximising them is important to produce as much as possible

  • Division of labour: employees focus on a particular task within the production process => highly skilled in the task => increases efficiency (but lost motivation/bored => slow down whole process)

• Benefits:

  • More products produced at lower cost

  • Quality of products is higher bc of fewer mistakes

  • The production process is faster

• Limitations:

  • Business is unable to change production to take advantage of market trends (not flexible)

  • Employees may demand higher wages

  • If the production process is closely linked, a delay at one stage of the process will delay the whole process

Purpose of business activity

• To identify consumer needs and wants

• Combine the factors of production to produce finished goods or services which are provided to consumers at a price higher than their costs (added value) => profit

Adding value and how added value can be increased

• Selling price - cost of materials and/or components = added value

• Added value is the increase in value that a business creates by combining the factors of production in the manufacturing process

• Other ways to add value: building a brand, delivering excellent service, product features and benefits, offering convenience

Basis of business classification, using examples to illustrate

• Primary Sector: natural resources are extracted from the land or sea

  • Ex.) forestry, fishing, mining, agriculture

  • Majority of the workforce are employed in LDCs

  • Typically low-skilled jobs and poorly paid because the value of the materials is also low

• Secondary Sector: the raw extracted resources are combined in the production process to make the finished goods through manufacturing, refining and construction

  • Ex.) assembly of smartphones, food processing, construction of homes

  • Employment levels increase when primary sector's employment levels increase too (since more resources => more manufacturing jobs)

• Tertiary Sector: businesses provide services to other businesses and consumers

  • Ex.) banking, insurance, gas and electricity

  • Mainly provided to consumers

    • Ex.) hairdressers, doctors, public transport

  • More developed economies => more demand for services

Reasons for the changing importance of business classification

1. Availability of raw materials

   • Raw materials are scarce and limited

   • As economies grow, they use up their supply quicker => people working in primary sector are no longer needed

2. Increase in national wealth

   • As the average wealth of a country increases, people tend to look for jobs with greater security and higher pay (primary sector → secondary sector → tertiary sector)

   • Ex.) India & China → people in primary sectors working in manufacturing jobs (secondary sector)

3. International competitiveness

   • As activity increases in secondary and tertiary sectors => increase in wages => businesses move their operations away bc cost of employment too high

   • Ex.) Majority of textile manufacturing in the UK moving to Asia because it’s cheaper => UK creating more opportunities in the tertiary sector

4. New demands

   • Individuals in developed countries demand services like restaurants and theatre shows, or services to help their daily lives (ex. accountants & bankers)

   • Tertiary sector exceeding secondary sector in terms of employment and value of output (deindustrialization)

Classify business enterprises between private sector and public sector in a mixed economy

• Private sector: all organisations owned by individuals or groups of individuals

  • Earn profits → compensate the owners for their investment in the business

• Public sector: often created by governments to provide public services

  • Central gov. → transportation infrastructure

  • Local gov. → own and run schools, hospitals, police and fire departments

  • Most cases, governments help these organisations using tax revenue (revenue from taxes) but the could also use their revenues to cover their expenses fully since the services provided are necessary for society to function

Characteristics of successful entrepreneurs

1. Risk-takers

2. Self-motivated

3. Confident

4. Innovative

5. Leadership

6. Creative

Contents of a business plan and how business plans assist entrepreneurs

1. Aims and objectives

2. The product

3. The market

4. The structure of the business

5. Human resources

6. Production and operations

7. Finance

• Helps entrepreneurs by setting clear objectives, support applications for bank loans, identify gaps in their information, identify the risks involved in starting the business and ensuring that the business will be profitable

Why and how governments support business start-ups (grants, training schemes)

1. Grants

   • Government payments made to businesses that offer a product that can improve the quality of life for its citizens or that will increase employment in an area that needs it

   • Only given when the product/service is really needed

2. Training schemes

   • Government can provide training programmes like teaching them skills involved in running a business

   • Usually free but some governments might charge for this service

3. Tax breaks

   • Entrepreneurs pay a lower rate of tax than established businesses

   • Only available for a limited period of time

Methods of measuring business size

1. Number of employees

2. Value of output (sales revenue)

3. Capital employed (investment, capital)

4. Market share (the % of total sales that a particular company has in their overall industry)

Limitations of methods of measuring business size

1. Number of employees

   1. A business that employs few people can be large because it’s capital intensive (employs more machines than people)

2. Value of output

   1. Small businesses can generate large amounts of revenue but they sell their products at a high price

3. Capital employed

   1. A business can be labour intensive (they employ more people than machines)

4. Market share

   1. Depends on the size of the industry

      1. A business can have the characteristics of a large firm but have a small market share

5. Industry

   1. The businesses studied need to be in the same industry, otherwise they will have different levels of revenue and different uses of capital equipment

Why the owners of a business may want to expand the business

1. Diversification

   • Diversifying their product or service offering => if one falls out of favour with customers, they still have other products/services to get sales

2. Increase customers

   • More customers => more revenue and market share

   • Help them remain competitive and survive in the long term

3. Economies of scale (scale of operations increase and unit costs decreases)

   1. Purchasing economies (buying more units is cheaper)

   2. Financial economies (more preferential interest rates and investment from banks and other lenders bc they’re established)

   3. Marketing economies (don’t need to spend too much on promoting themselves bc they’re big and well-known)

   4. Managerial economies (afford specialists to be more efficient in managing)

   5. Technical economies (afford up-to-date tech => efficient production & improved customer service)

   6. Increase market share (higher market share => benefit from purchasing economies of scale and makes it easier to sell bc they’re better known)

   7. Increase profit (when a business grows, it is likely to increase sales => revenue => profit)

Different ways in which businesses can grow

1. Internal growth

   1. A business uses its own resources to expand its operations

      1. Developing new products

      2. Buying more capital equipment

      3. Selling its products in new markets

2. External growth

   1. Mergers: two businesses agree to become one larger business

   2. Takeovers: two businesses join together and one business buys the majority of shares in another

3. Integration

   1. Horizontal: a business joins together with another business in the same industry and at the same stage of production

   2. Vertical: a business joins together with another business in the same industry but different stages of production

      1. Backward vertical: if a business joins with a supplier (a business at an earlier stage of production)

      2. Forward vertical: if a business joins with a retailer (a business at a later stage of production)

   3. Conglomerate: a business joins together with another business in a different industry

Problems linked to business growth and how these might be fixed

1. Increased costs

   • Need additional finance to pay for capital equipment and extra labour for the expansion

   • How to fix: Growing the business slowly

     • Stop too much working capital being used up too quickly + more time to manage finances

2. Difficult to control

   • Communication and organising resources become more difficult

   • Increase costs if resources and time are not managed efficiently

   • How to fix: Employ more managers so the workload can be distributed (more costs tho), allow managers to delegate to staff (staff would need specific training tho)

3. Lower quality

   • Management of business more difficult => more mistakes => lower quality of product

   • How to fix: Increase the quality control methods, use additional staff training

Why some businesses remain small

1. The market

   • Some businesses sell a very specialised product that meets a very specific need => small market => no need to expand

2. The owner’s objectives

   • Some business owners might just want to earn enough money to make a living or to maintain control in the business

3. Lack of capital

   • The finances required for internal growth are not available to them

Causes of business failure

1. Lack of management skills

   • Management can include a range of skills like managing finances, people and resources and the marketing of a product or the processes of production

   • Managers of larger businesses can be specialists in one area but smaller businesses are unlikely to have that due to the costs

2. Changes in the business environment

   • Out of the business’s control

     • Changes in the economy

     • New consumer tastes/fashions

     • Influence of new technology

   • If the business doesn’t anticipate and respond to these changes quickly, they may lose out to the competition

3. Liquidity problems

   • Liquidity: the amount of cash a business needs to cover its day-to-day expenses

   • Many business can experience problems because they run out of cash (working capital) => unable to pay back debts to suppliers and lenders

4. Overtrading

   • Happens when a business expands too quickly

   • The business spends too much money on equipment => lack of working capital

   • The business produces too many goods that they can’t sell => high storage costs + lack of revenue

Why new businesses are at a greater risk of failing

1. Lack of skills

   • Lack of skills to make product into successful business

2. Lack of accurate record-keeping

   => unable to manage their finances accurately => debt

   => problems with meeting customer needs and damage business’s reputation

3. Difficulty in raising sufficient finance

   • Having limited sources of finance available to them => forced to borrow money to raise finances needed to start the business

   • Borrowing has to be repaid and if they aren’t paid back, the business will fail

   • The lack of available finance => entrepreneur not able to develop their products

4. Insufficient market research

   • Not identifying the potential number of customers => product doesn’t generate enough sales to make a profit

Sole traders, partnerships, private and public limited companies, franchises and joint ventures

• Sole traders: businesses that are owned and operated by one person

  • Legal requirement → register their profits so they can pay taxes on what they earn

• Partnerships: businesses that is owned and operated by at least 2 people

  • Formed because they raise more capital than a sole trader and/or the business may need to undertake more specific functions and partners can specialise in different aspects of the business

  • Sleeping partners: some partners who invest in the business and don’t take an active part in running the business or make any decisions

• Private limited companies: businesses that break up their ownership into shares and sell them in order to raise finance

  • Usually shares are sold to friends and family => owners can retain control of the business

• Public limited companies: businesses that break up their ownership into shares and sell them in order to raise finance, however, their shares are made available to the public through the use of the stock exchange => can’t refuse to sell shares and must sell them to whomever wants to buy them

  • Owners (shareholders) have little control over the decisions made by the managers of the business because there are so many of them

  • Managers make decisions and consult the shareholders once a year at their annual general meeting (AGM)

• Franchise: a form of business agreement where a business owner (franchisor) sells the right to supply their goods and services under their recognised brand name to the franchisee

  • The franchisor → successful and proven business model that wishes to expand

  • Franchisees → pay upfront fees and royalties to the franchisor

• Joint ventures: when 2 businesses work together to complete a project but don’t integrate to become a larger business

  • Common with businesses that want to expand internationally

    • Bc they can provide foreign businesses with access to domestic business which have access to detailed market knowledge but may not have the capital to expand themselves

Differences between unincorporated businesses and limited companies

Incorporated businesses/Limited companies → limited liability

Unincorporated business → unlimited liability

Concepts of risk, ownership and limited liability

• Unlimited liability: the owner is responsible for the debts of the business (all unincorporated businesses)

  • If the business fails or has any outstanding loans, the trade payables can call on the owner to give up their personal assets to pay off the value of those loans

    => Owners of the business can lose their personal possessions if the business can’t pay its debts

    => High risk

• Limited liability: the business is registered with the government as a company => shareholders receive a separate legal identity

  • All of the assets, profits and debts belong to the company and not to the owners => lower risk

  • Shareholders can only lose the money have invested in the shares if the business fails

Recommending and justifying a suitable form of business organisation to owners/management in a given situation

1. Level of control

   • As organisations get larger, the owners have less control

   • If the owner wants to have a high degree of control, they’ll choose a smaller structure like as a sole trader, partnership or private limited company

2. The amount of finance needed

   • If the business requires a large amount of finance over a long period of time, then they’ll likely operate as a limited company because it has the option of selling shares to raise finances

3. The amount of risk/liability involved

   • Unincorporated businesses carry a higher risk because they have unlimited liability

   • Limited companies have limited liability => lower risk

4. The growth plans for the business

   • If the business has plans for slow growth and expansion, then the owners are likely to use either an unincorporated or incorporated business model

   • If they wish to expand quickly, then franchising is likely to be used

   • If they wish to expand overseas, joint ventures are more common

Business organisations in the public sector (Public corporations)

Public corporations: businesses that are owned and operated by the government/state

• Non-profit, funded by taxes

• Aim: provide specific services to benefit society that wouldn’t exist in the private sector

  • Why?

    1. Services are too important to be provided by the private sector (ex.police & military)

    2. Private sector wouldn’t provide these goods because they aren’t profitable (ex. public goods → street lighting or fire service)

    3. Some goods and services are beneficial for society but are under-consumed in the private sector because customers can’t see the full benefit for them

       1. Too expensive to provide

          1. Merit goods (ex. museums or art galleries)

Need for business objectives and the importance of them

Business objective: a goal that an organisation wants to achieve in order to reach its long-term targets

• Helps employees and owners understand what needs to happen and how

• Helps to ensure that everyone in the organisation is aiming for the same goal

Different business objectives

1. Survival

   • Relevant for small businesses that might suffer cash flow problems in the early years of operation

   • Larger organisations can be vulnerable as well to competition, changes in consumer tastes, cash flow problems and natural disasters

2. Growth

3. Profit

   • Businesses are dependent on profits for survival, growth and to keep owners and shareholders happy

     => improving profits is a common objective

   • Can be achieved by increasing revenue or decreasing costs

4. Market share

   • If a business is larger than the competition, it is likely to benefit from the economies of scale

Objectives of social enterprises

Social enterprise: a business that exists to benefit society in some way but it generates revenue and profit like a commercial business to fulfil its social cause

• Objectives are based on their social cause and not on profits

Main internal and external stakeholder groups

1. Internal

   1. Employees

   2. Managers

   3. Shareholders

2. External

   1. Customers

   2. Trade payables

   3. Suppliers

   4. Governments

   5. Compeititors

   6. The local community

   7. Pressure groups

Objectives of different stakeholder groups

1. Internal

   1. Employees

      1. Motivated to work and paid for their time and expertise

      2. Secure job

   2. Managers

      1. Understand the needs of the owners and employees

      2. Feel motivated themselves to fulfil their management tasks

   3. Shareholders

      1. Need to know that the business is profitable, growing and has enough market share to be competitive

      2. Looking for dividends from their shares

      3. Interested in the profitability of a business to ensure maximum dividends

2. External

   1. Customers

      1. Good value and customer service

   2. Trade payables

      1. Paid on time with interest

      2. A business’s ability to pay its debts

   3. Suppliers

      1. Regular orders for their products or service and paid on time

   4. Governments

      1. Receive the correct amount of tax

      2. Business to provide employment for people

   5. Competitors

      1. Interested in all of a business’s activities and how to do better

   6. The local community

      1. Wants a business to benefit them

      2. Not to produce too much pollution

      3. Not to generate waste that can’t be disposed of

   7. Pressure groups

      1. Businesses to act sustainably

      2. Not to take advantage of people or the planet for financial gain

How these objectives might conflict with each other

1. Owners and pressure groups

   • Owners → maximise profits and growth

   • Pressure groups → businesses to grow sustainably and put people and planet first

2. Employees and owners

   • Employees → secure job, high/stable pay

   • However, employees are expensive assets for a business so to reduce costs, owners could reduce training, wages or the number of employees

3. Customers and employees

   • Customers → treated with respect, have their queries/problems dealt in their best interest

   • Employees → solving problems int he best interests of their employer, not the customer

4. Competitors and owners

   • If 2 businesses feel they are too similar to each other or if one business feels the other holds a monopoly on customers => conflict

Differences in the objectives of private sector and public sector enterprises

Public sector: (objectives similar to social enterprise)

• Provide a service (like public transport) to improve infrastructure and the mobility of people and businesses

• Improve health and well-being of citizens through the running of public hospitals

• Improve education and literacy through the running of public schools

• Support vulnerable communities by providing jobs for people who might otherwise struggle to find employment

• Profit to reinvest the money back into the sector + to pay the government => more money to invest in other interests and services