A business is an organisation that uses resources (land, labour, capital, enterprise) to produce goods or services that people want. This chapter looks at what businesses are, how they are classified and organised, and what they are trying to achieve.
1.1 Business activity
Needs, wants, scarcity and opportunity cost
- Needs are things essential for survival (food, water, shelter). Wants are things people would like but can live without.
- Scarcity: resources are limited but wants are unlimited. So people and businesses must choose.
- Opportunity cost is the next best alternative given up when a choice is made. If a business spends $50,000 on a new machine, it cannot also spend it on advertising: advertising is the opportunity cost.
Specialisation
Specialisation means workers, businesses or regions concentrate on what they do best (division of labour). It raises output and productivity because workers become skilled and faster. Limitations: boredom, and workers who rely on one skill may find it hard to move jobs.
Purpose of business activity
Businesses produce goods and services to satisfy needs and wants, to make a profit, and to provide employment. They do this by adding value.
Adding value
Added value = selling price – cost of the bought-in materials and services.
Ways to increase added value: raise the price (through branding, quality, packaging), cut the cost of inputs (find cheaper suppliers) or produce a higher-quality or more convenient product.
1.2 Classification of businesses
Economic sectors
| Sector | Activity | Examples |
|---|---|---|
| Primary | extracting or growing natural resources | farming, fishing, mining, oil extraction |
| Secondary | manufacturing and construction: processing raw materials into products | car factories, bakeries, building |
| Tertiary | services | banking, teaching, transport, retail, healthcare |
A bakery that grinds its own flour combines sectors, and many businesses fit more than one. Classify by the main activity.
Changing importance: in developing economies the primary sector is usually largest; as an economy develops, the secondary sector grows (industrialisation), and in developed economies the tertiary sector is the largest, as incomes rise and people spend more on services and manufacturing moves abroad.
Private and public sector
- Private sector: businesses owned by individuals or groups whose main aim is usually profit (sole traders, companies).
- Public sector: businesses owned and controlled by the government (public corporations such as a state railway or national health service), usually aimed at providing a service.
- A mixed economy has both.
1.3 Enterprise, business growth and size
Enterprise and entrepreneurship
An entrepreneur is a person who takes the risk of starting a business. Enterprise is the skill of doing so.
Characteristics of successful entrepreneurs: risk-taker, hard-working, determined, creative or innovative, confident, good at communicating and organising, willing to learn from failure.
A business plan is a written document setting out the business's aims and how it will achieve them. It usually contains: the business idea and aims, market research and the target market, the marketing plan, operations plan, staffing, sources of finance and a cash-flow forecast. It helps entrepreneurs by making them think through the idea, and persuades banks and investors to lend.
Why and how governments support start-ups: because new businesses create jobs, tax revenue and competition. Support includes grants, low-interest loans, training schemes, advice and tax breaks.
Measuring business size
| Method | Limitation |
|---|---|
| Number of employees | misleading if the business is highly automated (few workers but large output) |
| Value of output (sales) | prices and inflation distort comparisons |
| Capital employed (money invested) | different industries need different amounts of capital |
| Market share | depends on how the market is defined |
(Profit is not a measure of size: a small business can be highly profitable.)
Why businesses grow, and remain small
Why owners want growth: higher profits, economies of scale (lower average costs), more market share and power, lower risk through diversification, and the owner's status.
Ways to grow:
- Internal (organic) growth: expanding from within, by selling more, opening new outlets or launching new products. Slow but low risk and keeps control.
- External growth: merging with or taking over another business. Fast, but costly and risky (clashing cultures).
Problems of growth: diseconomies of scale, poor communication, loss of control, cash-flow problems from heavy investment. Solutions: improve communication, delegation, careful financial planning, hire skilled managers.
Why some stay small: the owner wants control and a quiet life; a niche or personal-service market; not enough finance; the market is too small.
Why businesses fail
Causes: lack of management skills, poor cash flow (liquidity problems), changes in the business environment (new competitors, changes in fashion, recession), low demand, poor location, rising costs. New businesses are at greater risk because they have no track record or reserves, are short of finance, lack experience and customer loyalty, and may be hit by cash-flow problems early on.
1.4 Types of business organisation
The main forms
| Form | Features | Advantages | Disadvantages |
|---|---|---|---|
| Sole trader | owned and run by one person; unlimited liability | full control, keeps all profit, simple, private | unlimited liability, limited finance, long hours, no continuity |
| Partnership | two or more owners (usually 2–20); unlimited liability; deed of partnership | shared skills, finance and workload | unlimited liability, disagreements, shared profits |
| Private limited company (Ltd) | shareholders own it; shares cannot be sold to the general public; limited liability | limited liability, raises more capital, continues if owner leaves | shares hard to sell, less control for owner, more legal rules, accounts available |
| Public limited company (plc) | shares sold on the stock exchange; limited liability | can raise large sums, easy to sell shares | takeover risk, loss of control, costs and strict rules, short-termism (pressure for quick profit) |
| Franchise | a business (the franchisee) pays to use a well-known brand and system from the franchisor | tested business idea, brand and support | fees and a share of profits, limited independence |
| Joint venture | two businesses share a project and its costs, risks and profits | shared risk and expertise, access to new markets | disagreements, profits shared |
Unincorporated businesses (sole traders, partnerships) have no separate legal identity from their owners, so the owners have unlimited liability: they are personally responsible for all debts, even if that means selling their home. Limited companies are separate legal entities: shareholders can lose only the money they invested. This is limited liability.
Risk and ownership: the greater the owner's personal risk, the greater the control, but the more they stand to lose.
Public sector organisations include public corporations (owned by the government, run by a board, funded partly by the state, aims such as providing services and jobs).
1.5 Business objectives and stakeholder objectives
Business objectives
Objectives are targets that give direction and let managers measure success. They can change over time (a new business aims for survival; once secure it targets growth).
| Objective | Meaning |
|---|---|
| Survival | staying in business, especially for new firms |
| Growth | increasing size, sales or the number of outlets |
| Profit | revenue minus costs; the main aim of most private firms |
| Market share | the percentage of total market sales a firm has |
| Others | customer satisfaction, social and environmental goals, quality |
Social enterprises exist mainly to achieve a social or environmental purpose (for example, employing disabled people, fair-trade coffee), reinvesting their profits, while still needing to make enough money to survive.
Stakeholders
A stakeholder is anyone affected by or with an interest in a business.
| Group | Type | Typical objective |
|---|---|---|
| Owners / shareholders | internal | profit and dividends, growth in value |
| Managers | internal | salary, status, job security |
| Employees | internal | good pay, job security, good conditions |
| Customers | external | quality, low prices, good service |
| Suppliers | external | regular orders, prompt payment |
| Lenders (banks) | external | repayment with interest |
| Government | external | taxes, jobs, obeying the law |
| Local community | external | jobs, no pollution or noise |
Conflicts: stakeholders' objectives often clash. Owners want higher profit, which may mean lower wages for employees or higher prices for customers; customers want low prices, suppliers want high prices; the community wants less pollution, which raises costs.
Private and public sector objectives
Private sector: mainly profit, growth, survival, market share. Public sector: mainly to provide a service (healthcare, transport) at an affordable price, create employment, and cover costs rather than maximise profit.
Practise this chapter
Every past-paper question on these topics, with the mark scheme.