1.4 - Making the Business Effective

Topic overview 

In this topic students need to continue to relate the concepts to the contexts in which an enterprise and  an entrepreneur will be operating. They must be aware of the local and national business environment  and how this might impact on a small business. Students must be aware of this topic’s relationship with  the other topics in this theme and how this might affect business decision-making. 

Business organisation 

Before the different forms of legal structures of a sole trader, partnership and a private limited  company are considered, the very important issues of “unlimited liability” and “limited liability” will be  discussed. 

Unlimited liability 

There is a big risk when operating as a sole trader or a partnership. It occurs because, in the eyes of the  law, there is no difference between the person running the business and the business itself.  When it  comes to money owed by a business, the sole trader or partners have to use their own personal funds  

to pay these debts, if there is not enough money in the business to do so. The sole trader or the  partners are, therefore, liable for any debts that the business incurs. This is called unlimited liability. 

As the sole trader or partners are personally responsible for any debts run up by the business, this  means their homes or other assets owned by the entrepreneur(s) may be at risk if the business runs into  trouble. This does happen and each year thousands of people become personally bankrupt, many of  them through failed businesses. Some businesses have however, a lower risk of failure, where the  owner avoids running up debts through buying and selling in cash, meaning there is no need to borrow  large amounts of money. 

Limited liability 

Shareholders may be individuals or other companies. They are not responsible for the company's  debts. Shareholders may only lose the money they have invested in the company if a business goes  bankrupt, to help pay off any outstanding debts or liabilities. This means that the liability of 

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shareholders is limited to the value of their investment into the company’s shares.  This concept is  called limited liability. 

It costs very little to set up a business as a private limited company and it can be set up very quickly. A  summary of the benefits to the business of limited liability are: 

🗹 Investors encouraged – the owner who normally owns shares, and all other investors who  purchase shares, are protected in the way that they can only lose the money they have put into  the business, not their personal possessions and property. This should encourage more people  to invest in the business, as there is less risk. 

🗹 Legal separation – a company has a separate legal identity to the business owners, unlike a sole  trader or a partnership where the business is seen as the same as the owners in the eyes of the  law. With limited liability any action against the business is taken against the company, not the  owners 

Remember: LIMITED LIABILITY is only a benefit to private (and public) limited companies. Sole traders  and partnerships do not benefit from this. They have UNLIMITED LIABILITY. This is a common area of  confusion, which needs revising carefully. 

Forms of Business ownership 

The vast majority of start-ups and small businesses in the UK choose to operate either as a sole trader  or set up as a private limited company.  A very small proportion of new businesses set up as a  partnership and a small proportion of small businesses grow to become public limited companies.  

Sole traders 

Most businesses in the UK are small businesses, owned and operated by one person. In most cases,  these businesses operate as a sole trader. 

Look at Yell.com or Yellow Pages (a local free business listing posted through your letterbox). You will  see lots of examples of people operating as a sole trader in your area.   Many traders in the service  sector e.g. hairdressers, gardeners, plumbers and electricians, use the sole trader option, as do people  who run part-time or seasonal businesses. 

A sole trader is a popular form of business organisation, as it is simple and cheap to set up and operate.  Most importantly the sole trader gets to keep all the profits! The sole trader, also takes all the risk and  has unlimited liability, as already discussed. 

Do not forget that a sole trader can and do employ other people to work in their business! Partnerships 

A partnership is formed where a business is started and owned by more than one person. Common  examples of partnerships are doctors, solicitors or vets.  

A legal document called a Partnership Agreement is always recommended and sets out how the  partnership is run, which covers areas such as: 

• How profits are to be shared 

• How much each partner has to invest into the business 

• How decisions are to be taken 

• What happens if a partner wants to leave the partnership or dies

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The partners own the business and have unlimited liability. 

Private limited company (Ltd) 

A company is formed when a business is set up to have a separate legal identity from its owners.  In the  vast majority of cases, the type of company created is a private limited company (ltd). These are very  common and can include small and very large businesses. There are many well-known examples of ltd  companies, such as Iceland, Virgin, John Lewis and Clarks shoes. 

If a business becomes a private limited company, it can raise funds from investors, such as friends and  family, but not from the general public, as its shares are not listed on the stock exchange. Every private  limited company must have at least one shareholder. Any money raised from new shares is  permanently invested in the business. 

In this type of business, the company's finances are separate from the owner’s personal finances.  The  owners are known as shareholders, who each own shares in the company. They receive a share of the  profits, known as a dividend, as a reward for being a shareholder. These are paid in proportion to the  number of shares that they own. If the company goes bankrupt, shareholders are protected by limited  liability.  

The business will be run by a Board of Directors, appointed by the shareholders. The shareholders may  also act as the directors. The Board of Directors runs the company on a day-to-day basis and makes all  the important decisions. 

Comparing limited companies with sole traders and partnerships  

The main differences between the different types of business ownership can be summarised as follows: 

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Choosing the most suitable legal structure for a business 

There will be several factors that will influence the type of structure chosen by a business: 

• Size of business – start-up businesses often start as sole traders, as they are easier and quicker  to set up compared to a Ltd. There is less paperwork involved. 

• Type of business – some business structures relate to the type of good or service provided. If  specialist expertise is involved such as doctors, vets or lawyers they are more likely to be  partnerships than sole traders. If significant risk is involved, the business is more likely to  become a private limited company. 

• Lender requirements – if a bank loan is needed to start a business, the bank may prefer a small  business to be set up a sole trader or partnership, to make sure they can be paid back by the  individuals if the business fails. 

• Investment protection – a private limited company may be chosen, so the investors in a new  business or an expanding business can be protected by limited liability. 

• Control – the owner, as a sole trader or a shareholder, holding the majority of shares in a  company, has total control of the business. This is shared in a partnership and at risk in a  company with a minority shareholding. 

Franchising 

A business idea for a start-up does not have to be original. Many new businesses are formed with the  intention of offering an existing business idea.  The use of franchises is a great example of that.  

The basic idea for a franchise is this.  A franchisor grants a licence, the franchise, to another business,  the franchisee, to allow it to trade using the brand or business format.  There will be restrictions on the  franchisee regarding its goods or services and its sources of materials, but it is a low risk and relatively  low cost of option that does allow a franchisee to have some independence and freedom. 

Remember that the franchisor is in charge - the franchisor is the original owner of the business idea.

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Franchises are a significant and increasing part of business life in the UK.  Based on the BFA/NatWest  franchise survey (2015) here are some quick statistics that illustrate this fact: 

• Percentage of units profitable (including new businesses): 97% 

• Franchises generated annual sales of £15.1 billion in the UK in 2015, selling through 44,200  franchised outlets, employing 621,000 people 

• There are over 901 different franchisor brands in the UK, with new franchise ideas becoming  available every year 

• Average turnover or revenue continues to rise; in 2015 over half had an annual turnover of more  than £250,000 

• Start-up costs may not be too expensive and can be as little as £10,000 and are typically about  £50,000 

• In 2015, over 97% of franchises, including new businesses, were profitable 

• Franchises are particularly popular in the service (tertiary) sector.  Franchises offering property  services, for example estate agency, cleaning, gardening, food etc are the most popular 

Examples of well-known businesses that use franchising to expand their operations include: 

• Subway • McDonalds • Starbucks • Pizza Hut 

• Thorntons • KFC 

• Europcar 

You might have noticed from the list above that nearly all those businesses provide services rather than  produce goods.  Franchising is particularly suitable for service businesses. 

Advantages of running a franchise 

For a start-up entrepreneur, there are several advantages to investing in a franchise: 

🗹 It is still the franchisee’s own business – even if they are paying royalties to the franchisor! 🗹 The investment should be in a tried and tested format and brand 

🗹 The franchisee gets advice, support and training.  The franchisor will also supply key equipment,  such as IT systems, which are designed to support the operation of the business 🗹 It is easier to raise finance - the high street banks have significant experience of providing  finance to franchises 

🗹 No industry expertise is required in most cases 

🗹 The franchisee benefits from the buying power of the franchisor 

🗹 It is easier to build a customer base – the franchise brand name will already be established and  many potential customers should already be aware of it 

🗹 The franchisee is usually given an exclusive geographical area in which to operate the franchise – which limits the competition, since operators of the same franchise are not in direct competition  with each other 

Overall, investing in a franchise is a lower risk method of starting a business and there is a lower chance  of business failure.

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Disadvantages of running a franchise 

There are several disadvantages for the franchisee: 

🗷 Franchises are not cheap!  The franchisee has to pay substantial initial fees and ongoing royalties  and commission.  He/she may also have to buy goods directly from the franchisor at a mark-up 🗷 There are restrictions on marketing activities, for example not being allowed to undercut nearby  franchises, and on selling the business 

🗷 There is always a risk that the franchisor will go out of business 

🗷 The franchise needs to earn enough profit to satisfy both the franchisee and franchisor - there  may not be enough to go round! 

There are many good franchise opportunities available for a start-up, but some poor ones too. There is  therefore, still a need for the entrepreneur to conduct market research into the franchise before  deciding to invest in one. 

A franchise is a kind of "halfway house" for a keen entrepreneur. It is a lower risk method of entering a  market and it is often easier to raise finance.  However, running a franchise does not offer the same  kind of long-term financial rewards that owning a business outright can. 

Business location 

Where to locate is an important decision for all organisations. This is especially true however, for a new  business. Should it be based at home or located in a nearby office, shop or industrial unit? How will new  technology impact on this decision? 

Location is also important for existing or growing businesses. Should they stay where they are? Do they  need bigger premises? Would it be an advantage to relocate to somewhere else, either in this country  or to a different country? Can the business use modern technology to create a “virtual business,” so  that its employees are all working from home? 

Not every kind of start-up business can be based at home.  For a new coffee shop, for example, a strong  location is vital to ensure enough customers visit the store. 

One of the most important considerations about location for any business will be cost. A start-up  business is likely to have limited financial resources and therefore will want to minimise its set-up costs,  whereas an existing business is likely to have competitors and will want to keep costs low, in order for it  to have the opportunity to compete more effectively on price. Having premises will mean that a  business will have to pay rent, rates, insurance and many other ongoing costs, as well as the rental  deposit or purchase costs. 

Other factors determining location 

Whatever the business, there are several general factors, in addition to cost, that influence the choice  of location. These are:

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There is no magic formula which can be applied in deciding the most important factors in choosing a  location.  Sometimes the convenience of the location for the entrepreneur will be more important than  even cost considerations.  

The type of business (primary, secondary or tertiary) will also be important as primary industries will  need to be located where their raw materials are and many tertiary businesses will need to be near  their customers for the service to be provided. Manufacturing businesses will be influenced by many  different factors such as availability of materials and labour, as well as distribution to their customers.  

The short term and long term objectives of the business can also be significant, for example, will a  business have enough room to expand if it needs to increase output in the future?

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Marketing mix 

Introduction to the marketing mix 

The marketing mix consists of four elements and represents the way in which a business uses the  following four factors to reach customers: 

🗹 Product - the good or service that the customer obtains 

🗹 Price - how much the customer pays for the product 

🗹 Place (distribution) – how the product is distributed to the customer 

🗹 Promotion - how the customer is found and persuaded to buy the product 

It is known as a “mix” because each ingredient affects the others and the mix must overall be suitable to  the target customer. 

For example: 

• High quality materials used in a product can mean that a higher price is obtainable • An advertising campaign carried out in one area of the country, promotion, requires distribution of the product to be in place in advance of the campaign to ensure there are no disappointed  customers 

• Promotion is needed to emphasise the new features of a product 

An effective marketing mix is one which: 

• Meets customer needs 

• Achieves the marketing objectives 

• Is balanced and consistent 

• Allows the business to gain an advantage over competitors 

The marketing mix for each business and industry will vary; it will also vary over time. 

For most businesses, one or two elements of the mix will be seen as relatively more important than the  others, as illustrated below:

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Changes to the marketing mix 

A good example of how changes take place over time is the use of e-commerce. Whereas the retail  outlets for electrical goods used to be very important, nowadays price and how quick and conveniently  delivery can be arranged is much more critical in getting a sale. Digitial communication has also changed  many aspects of promotion, with the extensive use of websites and social media now playing a critical  part of even a small business’s marketing plans. 

The popularity of online and price comparison sites have also made pricing more visible. Consumers are  now able to compare very quickly different prices, reviews about the good or service, and then make an  informed choice about which product to purchase within a matter of minutes. This means that  businesses have to constantly be aware of the information being displayed on their wesbite, as to  whether it is up to date and effective. 

Customers’ needs and wants will always be changing. This can be seen in the “keep fit” market, where  new products are constantly being developed, launched and promoted. The Fitbit for example, is priced  relatively high and has expensive promotion to support the product and the price. This often makes it  difficult for small businesses to compete, which is why they will need to look carefully for a gap in the  market or operate in a market niche where there are less competitors. 

Business plans 

In order to be successful businesses will need to plan. In most cases, this will be through the creation of  a business plan. A well-used and famous saying is “failing to plan is planning to fail”.  

What is a business plan? 

A business plan is a written document that describes a business, its objectives, its strategies, the market  it is in and its financial forecasts.  The business plan has many functions, from securing external funding, to measuring success within the business. 

Although a start-up business will need a business plan, the existence of such a document will also be  important for an existing business. In this case the plan might be for a longer period and will need to be  reviewed on a regular basis.  

Information that should be included in a business plan 

A simple business plan is suitable for a start-up business and is written by the entrepreneur. It  summarises the key aims and targets of the business and the actions required to achieve them. The plan  will include areas such as: 

• The idea - a simple description of the proposed business with its location 

• Where the idea came from and why it is a good one 

• Objectives and key aims for the business - sales, profit, growth (gives a sense of direction for the  business) ideally for the next 3-4 years 

• Finance required and sources of finance - how much from the owners, how much to be loaned  over how long and from whom 

• Market overview – results of market research, main segments, target market, market size (value,  quantity), growth, market share of main competitors (if known)

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• How the business will operate (location, premises, staff, distribution methods) • Marketing mix – description of these four elements 

• Cash-flow forecast (important to ensure the business does not run out of cash)  • Forecast revenue, costs and profits 

The purpose of business plans 

The main reasons why a start-up business should produce a business plan are: 

• Provides a focus on the business ideas - is it really a good one and why? 

• Produces a document that helps clarify thoughts and identify any gaps in information or  research 

• It encourages the business entrepreneur to focus on what the business is really about and how  customers and finance-providers can be convinced to buy and lend the business money • It helps test the financial viability of the idea by including forecasts of revenue, costs, profits and  cash-flow 

• A business plan will minimise the risk of failure - can the business achieve the required level of  profitability and not run out of cash? 

• The plan provides something which can be used to measure actual performance • A business plan is essential to raising finance from outside providers, such as investors and  banks, as it will provide evidence that any loans can be repaid 

In addition existing small businesses will use this process: 

• to review their current performance  

• allows business objectives to be modified if required 

• allows departments of the business to produce their own plans, for example marketing plan,  human resources plan.  

• to update their current business strategy or plans for the future, based on their current  performance, changes to the business environment, over which they have little control, and  revise objectives 

• overall it will help the business make informed decisions

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