Business Structures.flashcards2

Economic Sectors

Primary, Secondary, Tertiary, and Quaternary Economic Sectors

• Business activity is classified into four broad types based on the stages of turning natural resources into finished goods and services:

  • Primary sector: Firms involved in extracting natural resources (farming, fishing, oil extraction).
  • Secondary sector: Firms that manufacture and process products from natural resources (computers, brewing, baking, clothes-making, construction).
  • Tertiary sector: Firms providing services to consumers and other businesses (retailing, transport, insurance, banking, hotels, tourism).
  • Quaternary sector: Businesses providing information services (computing, web design, ICT, management consultancy, R&D in scientific fields).

• The balance of these sectors varies substantially between countries depending on the level of industrialization.

• Table 2.1 shows the differences in employment data (%) between the United Kingdom, China and Ghana in 2019 (and 2008 for Ghana):

  • United Kingdom: Primary (1.2), Secondary (18.1), Tertiary & Quaternary (80.7)
  • China: Primary (26.1), Secondary (27.6), Tertiary & Quaternary (46.3)
  • Ghana: Primary (33.8 (52.5)), Secondary (18.6 (14.2)), Tertiary & Quaternary (47.6 (33.3))

Changes in Relative Importance of Economic Sectors

• The importance of sectors changes over time and varies between different economies.

Changes Over Time

• In Ghana, the primary sector reduced, and the secondary sector increased between 2008 and 2019.

• Industrialization: The growing importance of secondary sector manufacturing industries in developing countries (increasing in Africa and Asia).

• The relative importance of each sector is measured in terms of employment levels or output levels as a proportion of the whole economy.

Consequences of Industrialization: Benefits

• Total national output (Gross Domestic Product) increases, raising average standards of living.

• Increased output of goods can result in lower imports and higher exports.

• Expanding manufacturing businesses will result in more jobs being created.

• Expanding and profitable firms will pay more tax to the government.

• Value is added to the country's output of raw materials instead of exporting them as basic, unprocessed products.

Consequences of Industrialization: Problems

• Movement of people from the countryside to towns leads to housing and social problems.

• Imports of raw materials and components are often needed, increasing the country's import costs.

• Multinational companies can have a negative impact on the economy.

Deindustrialization

• In developed economies, there is a decline in the importance of secondary sector activity and an increase in the tertiary sector. This is termed deindustrialization.

• In the UK, the proportion of total output accounted for by secondary industry has fallen from 38% to 20% in 25 years.

• Causes of deindustrialization:

  • Rising incomes lead consumers to spend more on services than goods.
  • Manufacturing businesses in developed countries face more competition from efficient rivals with cheaper labor.

Consequences of Deindustrialization

• Job losses in agriculture, mining, and manufacturing industries.

• Movement of people towards towns and cities.

• Job opportunities in service industries (tertiary and quaternary sectors).

• Increased need for retraining programs to allow workers to find employment in service industries.

• The importance of each sector varies significantly between different economies.

Public Sector and Private Sector of the Economy

• Industry may be classified by public or private sector or by type of legal structure.

• Most business activity is in the private sector in nearly every country with a mixed economy.

• The relative importance of the private sector compared to the public sector is not the same in all countries. Economies closest to a free-market system have very small public sectors, while command economies will have very few businesses in the private sector.

• Public sector: Organizations accountable to and controlled by central or local government (the state).

• Private sector: Businesses owned and controlled by individuals or groups of individuals.

• Mixed economy: Economic resources are owned and controlled by both private and public sectors.

• Free-market economy: Economic resources are owned largely by the private sector with very little state intervention.

• Command economy: Economic resources are owned, planned, and controlled by the state.

• Public corporation: A business enterprise owned and controlled by the state, also known as a nationalized industry.

• The types and sizes of businesses in the private sector vary considerably.

Public-Sector Enterprises: Public Corporations

• Important goods and services are provided by government-owned or state-run organizations because they are too significant to be left to private businesses (health, education, defense, and public law and order).

• In some countries, strategic industries (energy, water supply, and public transport) are also owned and controlled by the state as public corporations.

• Public goods are provided by the state because private-sector businesses cannot make a profit from producing them (e.g., street lighting).

• Public-sector organizations do not often have profit as a major objective.

• If public corporations are sold off to the private sector, there will nearly always be a change of objectives towards the profit motive.

Advantages of Public Corporations

• Managed with social objectives rather than solely with profit objectives.

• Loss-making services might still be kept operating if the social benefit is great enough.

• Finance is raised mainly from the government.

Disadvantages of Public Corporations

• Tendency towards inefficiency due to lack of strict profit targets.

• Subsidies from government can also encourage inefficiencies.

• Government may interfere in business decisions for political reasons (e.g., opening a new branch in a certain area to gain popularity).

Private Sector Businesses

• Businesses in the private sector may be owned by one person or by many thousands.

Sole Trader

• The most common form of business ownership.

• A single owner may employ others, but such firms are likely to remain very small.

• All sole traders have unlimited liability (the owner's personal possessions and property can be taken to pay off the debts of the business).

• Finance for expansion is a significant problem.

• The owner is dependent on their own savings, profits, and loans for capital injections.

• Most commonly established in the construction, retailing, hairdressing, car-servicing, and catering trades.

• Sole trader: A business in which one person provides the permanent finance and, in return, has full control of the business and is able to keep all of the profits.

• Unlimited liability: Business owners have full legal responsibility for the debts of the business.

Advantages of a Sole Trader

• Easy to set up (no legal formalities).

• Owner has complete control (not answerable to anybody else).

• Owner keeps all profits.

• Owner can choose times and patterns of working.

• Owner can establish close relationships with staff and customers.

• Business can be based on the interests or skills of the owner.

Disadvantages of a Sole Trader

• Unlimited liability (all of the owner's assets are at risk).

• Often intense competition from bigger firms.

• Owner is unable to specialize in areas of the business that are most interesting and is responsible for all aspects of management.

• Difficult to raise additional capital.

• Long hours are often necessary to make the business pay.

• Lack of continuity (the business does not have a separate legal status, so when the owner dies, the business also ends).

Partnership

• Formed to overcome some of the drawbacks of being a sole trader.

• Partnership: A business formed by two or more people to carry on a business together, with shared capital investment and, usually, shared responsibilities.

• It is usual to draw up a formal Deed of Partnership between all partners, providing agreement on issues such as voting rights, the distribution of profits, the management role of each partner, and who has the authority to sign contracts.

• The errors and poor decisions of any one partner are considered to be the responsibility of all the partners.

• Unlimited liability can act as a disincentive for people to become partners in a business.

Advantages of a Partnership

• Partners may specialize in different areas of business management.

• They share decision-making.

• Additional capital is injected by each partner.

• Business losses are shared between the partners.

• There is greater privacy and fewer legal formalities than in corporate organizations (companies).

Disadvantages of a Partnership

• All partners have unlimited liability (with some exceptions).

• Profits are shared.

• The partnership will have to be reformed in the event of the death of one of the partners.

• All partners are bound by the decisions of any one of them.

• It is not possible to raise capital from selling shares.

• A sole trader, taking on partners, will lose decision-making independence.

• Partnerships are the most common form of business organization in some professions, such as law and accountancy. Small building firms are often partnerships, too.

Limited Companies

• There are three distinct and important differences between companies and the two forms of unincorporated business organization that we have just studied: limited liability, legal personality, and continuity.

• Limited liability: The only liability or potential loss a shareholder has, if the company fails, is the amount invested in the company, not the total wealth of the shareholder.

Limited Liability for Owners

• The ownership of companies is divided into small units called shares. People can buy these and become shareholders, part-owners of the business.

• Share: A certificate confirming part-ownership of a company and entitling the shareholder owner to dividends and certain shareholder rights.

• Shareholder: A person or institution owning shares in a limited company.

• All shareholders benefit from the advantage of limited liability.

  • People are prepared to provide finance to enable companies to expand.
  • The risk of the company failing to pay its debts is transferred from investors to creditors such as suppliers and banks.

Legal Personality

• A company is recognized in law as having a legal identity separate from that of its owners.

• The company itself can be taken to court, not the owners.

• A company can be sued and can itself sue through the courts.

• Directors can be legally responsible if they knowingly act irresponsibly.

Continuity

• In a company, the death of an owner or director does not lead to its break-up or dissolution.

• Ownership continues through inheritance of the shares, and there is no break in ownership at all.

Private Limited Companies

• Small firms can gain protection when the owner(s) create a private limited company.

• The word 'Limited' or 'Ltd' ('Pte' in some countries) tells us that the business is a private limited company.

• Usually, the shares will be owned by the original sole trader, relatives, friends, and employees. The former sole trader often still has a controlling interest.

• New issues of shares cannot be sold on the open market, and existing shareholders may sell their shares only with the agreement of the other shareholders.

• Certain legal formalities must be followed in setting up such a business.

Advantages of Private Limited Companies

• Shareholders have limited liability.

• The company has a separate legal personality.

• There is continuity in the event of the death of a shareholder.

• The original owner is still often able to retain control.

• The company is able to raise capital from the sale of shares to family, friends, and employees.

• The company has greater status than an unincorporated business.

Disadvantages of Private Limited Companies

• There are legal formalities involved in establishing the business.

• Capital cannot be raised by the sale of shares to the general public.

• It is quite difficult for shareholders to sell shares.

• End-of-year accounts must be sent to the government office responsible for companies and are available for public inspection (so there is less secrecy over financial affairs than for a sole trader or partnership).

Public Limited Companies (plc)

• Recognized by the use of 'plc' or 'inc.' after the company name.

• The most common form of legal organization for very large businesses because they have access to very substantial funds for expansion.

• Public limited companies are in the private sector of the industry, but public corporations are not.

• A public limited company (plc) has all the advantages of private company status, plus the right to advertise its shares for sale to the general public and have them quoted on the stock exchange.

  • Public limited companies can raise very large sums from public issues of shares.
  • Existing shareholders may also quickly sell their shares if they wish to.

• This flexibility of share buying and selling encourages the public to purchase shares when they are sold by initial public offering (IPO).

• The other main difference between private and public companies concerns the separation of ownership and control.

• The board of directors controls the management and decision-making of the business.

• The shareholders might prefer measures that aim for short-term profits, whereas the directors may decide to aim for the long-term growth of the business, perhaps in order to increase their own power and status.

• It is also possible for the directors or original owners to convert a business back from a plc to private limited company status to overcome the problems of separate ownership and control.

• The owner of a private limited company can take a long-term planning view of the business.

Advantages of Public Limited Companies

• Shareholders have limited liability.

• The company has a separate legal identity.

• There is continuity.

• It is easy for shareholders to buy and sell shares, encouraging investment.

• Substantial capital sources can be accessed due to the ability to issue a prospectus to the public and to offer shares for sale (called a flotation).

Disadvantages of Public Limited Companies

• Formation entails legal formalities.

• There can be high costs of paying for advice from business consultants when creating a plc.

• Share prices are subject to fluctuation, sometimes for reasons beyond a business's control (e.g., the state of the economy).

• There are legal requirements concerning disclosure of information to shareholders and the public (e.g., annual publication of detailed reports and accounts).

• There is a risk of takeover due to the availability of the shares on the stock exchange.

• Directors may be influenced by the short-term objectives of the major investors.

Legal Formalities in Setting Up a Company

• All governments insist that certain legal stages are completed before a company may be established to protect investors and creditors.

• The following documents are commonly required:

  • Memorandum of Association: States the name of the company, the address of the head office, the maximum share capital for which the company seeks authorization, and the declared aims of the business.
  • Articles of Association: Covers the internal workings and control of the business, the names of directors, and the procedures to be followed at meetings.

• When these documents have been completed satisfactorily, the registrar of companies will issue a certificate of incorporation. Private limited companies may now begin trading.

Cooperatives

• A common form of business organization in some countries, especially in agriculture and retailing.

• It is common to differentiate between producer or worker cooperatives, which are involved with making goods, and consumer or retail cooperatives, which sell goods and services.

• Cooperative: A jointly owned business operated by members for their mutual benefit, to produce or distribute goods or services, as in consumers' cooperatives or farmers' cooperatives.

• All members can contribute to running the business and sharing the workload, responsibilities, and decision-making. In larger cooperatives, some delegation to professional managers takes place.

• All members have one vote at important meetings.

• Profits are shared equally among members.

• In agricultural cooperatives, the members arrange for the purchase of seeds and materials in bulk so that they may benefit from economies of scale. The cooperative also often buys the produce of the members and then sells it collectively to obtain a better price.

Advantages of Cooperatives

• Buying in bulk.

• Working together to solve problems and take decisions.

• Good motivation for all members to work hard as they will benefit from shared profits.

Disadvantages of Cooperatives

• Poor management skills unless professional managers are employed.

• Capital shortages because the sale of shares to non-members is not allowed.

• Slow decision-making if all members are to be consulted on important issues.

Franchises

• A franchise is not strictly a form of legal structure for a business, but it is a legal contract between a franchiser and a franchisee.

• Franchise: The legal right to use the name, logo, and trading systems of an existing successful business.

• Franchiser: A person or business that sells the right to open stores and sell products or services, using the brand name and brand identity.

• Franchisee: A person or business that buys the right from the franchiser to operate the franchise.

• This contract allows the franchisee to use the name, logo, and marketing methods of the franchiser. The franchisee can then, separately, decide which form of legal structure to adopt.

Advantages of Franchises

• There are fewer chances of a new business failing because it is using an established brand name and product.

• Advice and training are offered by the franchiser.

• The franchiser pays for national advertising.

• Supplies are obtained from established and quality-checked suppliers.

• The franchiser agrees not to open another branch in the local area.

Disadvantages of Franchises

• A share of the profits or revenue has to be paid to the franchiser each year.

• The initial franchise license fee can be expensive.

• Local promotions may still have to be paid for by the franchisee.

• The franchisee cannot choose which supplies or suppliers to use.

• Strict rules over pricing and layout of the outlet reduce the franchisee's control over their own business.

Joint Ventures

• When two or more businesses work closely together on a project

• Joint venture: Two or more businesses agree to work closely together on a particular project and create a separate business division to do so.

Reasons for Joint Ventures

• The costs and risks of a new business venture are shared.

• Different companies might have different strengths and experiences and therefore fit well together.

• They might have major markets in different countries and could exploit these with the new product more effectively than if they both decided to go it alone.

Risks of Joint Ventures

• Styles of management and culture might be so different that the two teams do not blend well together.

• Errors and mistakes might lead to one company blaming the other for mistakes.

• The business failure of one of the partners would put the whole project at risk.

Social Enterprise

• A business with mainly social objectives that reinvests most of its profits into benefiting society rather than maximizing returns to owners.

Common Features of Social Enterprises

• They directly produce goods or provide services.

• They have social aims and use ethical ways of achieving them.

• They need to make a profit to survive as they cannot rely on donations as charities do.

• Social enterprises compete with other businesses in the same market or industry and use business principles to achieve social objectives.

Changing the Form of Business Ownership

• Most businesses do not change their form of business ownership over time, but many do.

Advantages of Changing Business Ownership

• Access to more finance.

• Gaining legal identity.

• Protecting owners' capital through limited liability.

Disadvantages of Changing Business Ownership

• Legal costs and formalities.

• Some loss of control and ownership by the original owner.

• Profits are shared.