Business Section 1: Understanding Business Activity

What is the purpose of a business?

What is the purpose of a business?

To combine factors of production to make products that satisfy people’s needs and wants

Goods

Products that you can physically touch (tangible)

Service

Work that supports a business but does not produce a tangible commodity (intangible)

Needs

• A good/service that is essential to living to aid life progress

  • Water, food, clothing, shelter

Wants

• A good or service which people would like to have but is not necessary for survival

• Wants are unlimited

Basic economic problem

Unlimited wants + limited resources = scarcity

Scarcity

• A shortage of a resource

• Lack of sufficient products to fulfill the total wants of a population

The ‘real’ cause to the economic problem

Not enough factors of production to make all of the goods and services that the population needs/wants (they are in limited supply)

Factors of production

Resources needed to produce goods and services

• Land, labour, capital, enterprise

Land

• All raw materials and natural resources

  • Trees, fossil fuels

• Physical land

Labour

The number of workers who contribute to the production of goods and services

• Skills of people

Capital

Finance, investments, machinery- needed for the manufacture of goods

Enterprise

1. The skill + risks taken by an entrepreneur to make a profit

2. Bringing together the factors of production → to produce a good/service

Opportunity Cost

The next best alternative given up by choosing another item

Specialisation

When individuals and businesses concentrate on what they are best at

• This improves the efficient use of resources

Division of labour

Production process is split up into different tasks + each specialised worker performs 1 of these tasks

• Form of specialisation

Advantages of division of labour

(3 points)

1. Increased efficiency + output as the worker does the same task repeatedly

2. Save time → less time is wasted moving from one workbench to another

3. Quicker + cheaper to train workers → fewer skills need to be taught

Disadvantages of division of labour

(2 points)

1. Decreased efficiency → workers become bored doing just 1 job

2. Production is stopped if 1 specialised employee is absent (no one else can do the job)

   • If you have multiple people specializing in the same role it is not cost-effective

What causes opportunity cost?

Choices need to be made due to not having the resources to satisfy all wants

What does business activity do?

(3 points)

• Combines scarce factors of production to produce goods and services

• Produces goods + services that satisfy the needs and wants of a population

• Employs people as workers + pays them wages → allows them to consume products made by other people

Added value

The difference between the selling price of a product and the cost of bought-in materials per unit

• Extra features/enhancements a company gives to a product before offering it to customers

• ADDED VALUE IS NOT THE SAME AS PROFIT!

What happens if businesses don’t add value?

(2 points)

• Other costs cannot be paid for (labour, rent)

• No profit will be made

How do you calculate added value?

Selling price of a product - Cost to make the product = Value added

Why is added value different to profit?

• AV doesn’t include rent and staff wages

  • If a car sells for £10,000 and the cost of materials is £3,000, the value added is £7,000

• After the deduction of paying rent on the building the car was made in, staff wages, and bills = profit

Ways in which a business can increase added value

(2 points)

1. Increase the selling price but keep the cost of materials the same

   • A business must create a higher-quality image for its product or service

2. Reduce the cost of materials but keep the selling price the same

   • But cheaper materials → reduces the quality of the product

   • Customers may not be willing to pay the same price for a lower-quality product

How can you add value to a product?

(6 points)

1. Branding- desirable brand, people willing to pay higher prices

2. Quality- good quality products/personal service adds value

3. Product features- consumers pay higher prices for additional features

4. Convenience- customers pay higher prices to save time

5. After-buy service: where firms provide support for the product if something goes wrong for an additional cost

6. Customization: allows the customer to personalise the product so it suits them best

Why do businesses add value?

(5 points)

To:

• Meet customers’ needs

• So they can charge a higher price

• Be different from the competition

• Create customer loyalty

• Focus the business on its target market

Economy

The resources + wealth of a country

How are businesses classified?

1. Primary sector

2. Secondary sector

3. Tertiary sector

Primary sector

Extracts and uses the natural resources from the earth to produce raw materials used by other businesses

• Farming, fishing, and forestry

Secondary sector

Manufacturing goods using raw materials from the primary sector

• Extracted resources → usable goods

  • Car manufacturing and construction

Tertiary sector

Provides finished goods + services to consumers + the other sectors of the industry

• Transport, banking, retail, hotels

Chain of production

The process that a product moves through to get from raw materials to final consumer goods

• Primary production → Secondary production → Tertiary production

How is the importance of economic sector in a country determined

(2 points)

• % of the country’s total workers employed in each sector

• Sector with the most valuable output of goods/service

  • The proportion this is of total national output

Developed countries

• Manufacturing is imported/conducted with high standards

• Levels of employment are highest in the tertiary sector

• High income, levels of productivity, investment

Developing countries

• Low incomes and low levels of saving

• Levels of employment and output are highest in the primary sector

• Manufacturing is recently established

• Minimal demand for services like transport as most people live in rural areas

How are countries classified?

By size of different sectors of business activity

Industrialisation

The growing importance of the secondary sector in an economy

De-industrialisation

The decline of manufacturing sector + the growing importance of the tertiary sector

Disadvantages of de-industrialisation

(3 points)

• Loss of jobs in rural areas

• Break-up of rural communities → people move to cities to find work

• Need to clean up old industrial sites (demolish old buildings, remove toxic waste)

Why does the importance of sectors change

(3 points)

1. Sources of primary products (raw materials) become scarce

2. Developed economies are less competitive in secondary manufacturing

   • Factory costs (usually wages) are too high e.g., wages in China/India are cheaper

3. People spend more on the tertiary sector rather than secondary as they become wealthier

Mixed economy

When a country has a private and a public sector

Private sector

(4 points)

Businesses owned and controlled by individuals/shareholders (not the government)

• Goal = make profit

• Funds come from the owner’s savings or shareholders

• Goods are for paying customers

Advantages of the private sector

(3 points)

1. Goal = profit → so high efficiency + lower costs

2. Competition is encouraged (prices will be lower)

3. Private sector owners can invest more capital in the business than the government can afford

Disadvantages of the private sector

(2 points)

1. Levels of unemployment are higher in order to cut costs + improve efficiency

2. Some services may be closed (run out of money)

Public sector

(5 points)

Government owns + controls the business

• Goal = non-profit, benefit society

• Some services provided are free

• Provide services (some free) to the public → to benefit society rather than making a profit

• The money comes from the taxpayer (not the user)

  • Health, education,etc

Privatisation

When the government sells public sector businesses to the private sector

• Same advantages of private sector

Entrepreneur

A person who organises and takes the risk for a new business venture

Advantages of being an entrepreneur

(5 points)

• Independence: you can choose how to use time and money

• May become successful if the business grows

• May be profitable: the income can be higher than working as an employee for a firm

• Can make use of personal skills + put own ideas into practice

Disadvantages of being an entrepreneur

(4 points)

• Risk: many new entrepreneurs’ businesses fail due to poor planning

• Capital: they must put their own money into the business and find other sources of capital

• Lack of knowledge and experience in operating a business

• Opportunity cost: lost income from not being an employee of another business

Characteristics of successful entrepreneurs

1. Hard-working – Long hours of work needed to become successful

2. Risk-taker – Entrepreneurs never know if a business idea will succeed

3. Creative – Business ideas different from competitors

4. Self-confident – To convince banks and investors.

5. Effective communicator – Talk clearly to banks, customers, and employees about business

Business plan

A document containing the business objectives + important information

• Business operations, finance, + owners

Uses of a business plan

(2 points)

• To gain finance (needed to apply for loans)

• Reduces risk of failure

What would happen without a business plan?

Banks would be reluctant to lend money to the business

• Owners of the new business cannot show that they have thought about the future and planned for challenges they would meet

Advantages of a business plan

(4 points)

• Easier to run- by documenting various details

• Low chance of losing sight of the mission → objectives have been written down

• Helps motivate employees- business objectives are set

• A new entrepreneur will find it easier to get a loan

Contents of a business plan

(7 points)

1. Products and services you will sell

2. Market

3. Business location, how products will reach customers

4. Financial information

5. Business strategy

‘Description of the business’ in a business plan

Brief history and summary of the business and their objectives

Why do governments support business start-ups?

(5 points)

1. Reduce unemployment: new businesses create job opportunities

2. Increase competition: prices are lowered

3. Increase output of goods: benefits economy

4. Benefit society: social enterprises offer benefits to society other than jobs + profit

5. Can grow larger: + contribute to country

How governments support business start ups

1. Loans at low-interest rates

2. Land to set up businesses at low costs

3. Grants (money) to train employees

4. Use research facilities at public universities

5. Business advice from experts

Who and why would they find it useful to compare the size of businesses?

(5 points)

1. Investors: before deciding which business to put their savings into

2. Governments: different tax rates for small + large businesses

3. Competitors: to compare their size with other firms

4. Workers: to know how many people they are working with

5. Banks: to see how important a loan is to a business compared to its overall size

How can business size be measured?

(4 points)

• Number of employees

• Value of output

• Value of sales

• Value of capital employed

Limitations of measuring business size by number of employees

(2 points)

• Some firms produce higher output with fewer employees (capital-intensive firms)

  • They use a lot of capital at a high cost

• Should two part-time workers be counted as one employee or two?

Value of output

How much a business is earning from selling its products (sales/revenue turnover)

Limitations of measuring business size by the value of output

The value of output in a time period may not be the same as the value of sales if some goods are not sold

Value of sales

The price of products/services sold per unit

Limitations of measuring business size by the value of sales

Misleading when comparing businesses that sell very different products

• Luxury brands require fewer sales than an average firm to make the same profit

Value of capital employed

The value of long-term finance invested in a business to buy assets like factories

Limitations of measuring business size by the value of capital employed

Inaccurate- businesses have different methods of production

• Some firms invest higher amounts into machinery than others (labour intensive) with fewer employees (capital-intensive firms)

Market share

The % of total market sales held by one brand/business

Limitations of measuring business size by market share

The size of the market each business operates in is very different

Why do businesses grow?

(4 points)

1. Higher profits

2. More status for owners + employees → higher salaries due to control of larger businesses

3. Economies of scale result in lower average costs

4. Larger market share

   • Firms: more influence when dealing with suppliers

   • Customers are attracted to ‘big names’ in an industry

Economies of Scale

A reduction in average costs as a business increases in size as production becomes more efficient

Internal growth

When a business expands its existing operations by increasing production or through new markets

• Slow but easier to manage

• Growth is paid for by profits of the existing businesses

External growth

Merger or takeover with another business

Takeover (acquisition)

When one business buys out the owners of another business

Merger (external growth)

When the owners of 2 businesses agree to join their firms together to make one business

Horizontal merger (integration)

When firm merges / takes over another one in the:

• Same industry at the same stage of production (sector)

Vertical merger (Vertical integration)

Same industry but at different stages of production

Forward vertical integration

Same industry but at a later stage of production (closer to the consumer)

• Manufacturing → retail

Backward vertical integration

Same industry but at a earlier stage of production (closer to the raw material )

Conglomerate merger (integration)

Different industry

• Known as diversification

Benefits of a horizontal integration

(3 points)

• Merger: Reduced number of competitors in the industry

• More opportunities for economies of scale

• The combined businesses will have a bigger market share

Benefits of a vertical integration

(4 points)

You get more control over the distribution of goods and services

• Merger: assured outlet for its product

• The profit margin made by the retailer is absorbed by the expanded business

• The retailer could be prevented from selling competing models

  • BV: Supplier, supplying other manufacturers

• Information about consumer needs obtained directly from the manufacturer

Benefits of a conglomerate integration

(2 points)

• Diversified its activities: the risks taken by the firm are spread →

• Expanded customer base

• Transfer of ideas between the different sections of the business → helps improve the quality + demand for both products

Problems resulting from business expansion

(4 points)

1. A larger business is difficult to control (diseconomies of scale)

2. Larger business → poor communication

3. Expensive expansion costs → business is short of finance

4. Integrating with another business can be difficult → due to different management styles

How would you overcome the issue ‘a large business is difficult to control’ due to expansion?

Operate the business in smaller parts

• Form of decentralisation

How would you overcome the issue ‘a large business has poor communication‘ due to expansion?

1. Operate the business in smaller units

2. Use technology to communicate (emails)

How would you overcome the issue ‘a firm is short of finance‘ due to expansion costing so much?

1. Expand slower + use the profits from the slowly expanding business to pay for further growth

2. Ensure sufficient long-term finance is available

How would you overcome the issue ‘integrating with another business is more difficult than expected‘ due to expansion

Introduce a different style of management

Why do some businesses remain small?

(3 points)

1. The type of industry the business operates in

2. The market size

3. The owners’ objectives

Why do businesses remain small due to the type of industry they operate in?

• Businesses that offer personalised services/products → grow too large → difficult to offer the close and personal services demanded by the customers

• In these industries, it is easy to set up new businesses → creates new competition

  • Hairdressers, car repairs, and catering

Why do businesses remain small due to the market size?

• Total number of customers is small like in rural areas → no need for it to expand

• These businesses produce specialised products that appeal to a limited number of consumers

  • Luxurious cars, expensive clothing, shops in rural areas

Why do businesses remain small due to the owners’ objectives?

Some owners want to:

• Keep control of a small business

• Have personal contact with staff and customers

  • To avoid the stress of running a large firm

Causes of business failure

(4 points)

1. Lack of management skills

2. Changes in the business environment

3. Liquidity problems/poor financial management

4. Over-expansion

How does having a lack of management skills lead to business failure?

• Lack of experience → bad decisions

  • Locating the business in an area with high costs but low demand

How do changes in the business environment lead to business failure?

(2 points)

• Failure to plan for change adds to the risks of operating a business

• Firms must be ready to change their products to meet the demands of customers (failure to do so leads to customer loss)

  • External shocks (economic change, legal + social change), new technology, + new competitors cause failure if they are not responded to effectively

How does poor financial management lead to business failure?

• Failure to forecast cash flows cause a shortage of cash (lack of liquidity)

  • Workers, suppliers, landlords, + the government cannot be paid what they are owed

How does over-expansion lead to business failure?

• Business expands too quickly (over its optimum level) → major management and financial problems

• Causes diseconomies of scale

Reasons specifically for why new businesses fail

(4 points)

1. It is difficult to test a business model without trading

2. Easy to be over-optimistic in the business plan

3. Competitor response is aggressive

4. Management may lack experience

Why are new businesses at a greater risk of failing than well-established ones?

(3 points)

• Lack of finance and other resources

• Poor planning and inadequate research

• They lack the experience and decision-making skills of managers who work for larger businesses