Section 1 NOTES : Understanding Business Activity
Business Activity
• Needs: goods or services that are essential for survival.
• Wants: goods or services customers desire but are not essential for survival.
• Economic Problem: unlimited wants but limited resources to satisfy the wants.
• Scarcity: the lack of sufficient products to fulfil the total wants of the population.
• Factors of production: resources needed to produce goods and services; they are:
o Land – any natural resource used in production.
o Labour – mental and physical efforts of employees.
o Capital – finance, machinery and equipment needed for the manufacture of
goods.
o Enterprise – individual/s who manage/coordinate the three other factors, make
decisions and take risks.
• Opportunity Cost: the next best alternative is given up by choosing another item.
• Due to scarce resources, a choice has to be made; this leads to opportunity cost.
Importance of Specialisation
Specialisation: When people and businesses focus on what they are best at.
• Division of labour is when production is split into different tasks, and each worker
performs one of these tasks. It’s a form of specialisation.
Advantages Disadvantages
Workers are trained in one task and repetitive tasks can cause boredom and burnout for
specialise in this, increasing productivity employees, reducing motivation and job efficiency
and efficiency
Specialisation with division of labour will If a worker is not present, production will be disrupted,
result in better quality output causing a waste of time and resources, as well as less
output and efficiency.
An increase in efficiency will lead to Specialised workers require higher wages, and training
economies of scale. current employees will increase costs.
Workers become more skilled and
experienced, reducing waste of time and
resources.
Purpose of Business Activity
• Businesses combine scarce factors of production to produce goods or services to
satisfy people’s needs and wants.
• Business Activity:
o Combines scarce factors
o Produces goods and services
o Employs people
Added Value
• Added value is the difference between the cost of purchasing bought-in material and the
price of the finished goods.
Added Value = selling price – total cost
• For example, by transforming cotton into a T-shirt, the business adds value to the
cotton, as the same material can be sold for more after the transformation.
• It is NOT the profit because added value does not include the expenses of producing
this good (e.g. labour, electricity, machinery, etc.)
Advantages Disadvantages
Maybe able to make a profit if these other costs come Increasing the product's price can lead to lower
to a total less than the added value sales and, perhaps, profit.
It can be used to pay other expenses.
To increase added value, a business can either:
• Increase the selling price by increasing the quality of goods and services to convince
customers/consumers
• Reduce the cost of materials but keep the price the same.
Classification of Businesses
• Businesses can be classified into three sectors:
o Primary Sector: Industry extracts and uses the earth's natural resources to
produce raw materials for other businesses.
o Secondary Sector: The industry manufactures goods using the raw materials
provided by the primary sector.
o Tertiary sector: The Industry provides services to consumers and other industry
sectors.
• Developing Countries: where the primary sector is the most important, as more
employees and output are produced than in secondary and tertiary sectors
• Developed Countries: where the output of the tertiary sector is often higher than the
other two sectors combined.
• De-industrialisation occurs when there is a decline in the importance of the secondary
sector.
• Reasons for changes in the relative importance of the three sectors over time:
o When sources of some primary products become depleted
o Developed economies are losing competitiveness to newly industrialised
countries.
o Due to the rise in living standards, consumers spend more of their income on
services such as travel and restaurants than on manufactured goods.
Mixed Economy
• Has both a private sector and a public sector.
o Private Sector: Businesses NOT owned by the government will decide what and
how to produce. The main aim is to make profits.
o Public Sector: Owned by the government. Government will decide what and
how to produce (i.e. healthcare, education, defence, public transport). The main
aim is to provide a service to customers.
• Privatisation refers to selling a public sector business to the private sector.
Arguments for Privatisation Arguments against Privatisation
Costs can be controlled because the private Increased unemployment as private sector
sector’s main objective is profit. businesses may want to cut costs.
More efficient use of capital Less likely to focus on social objective
Competition between private sector businesses will
help improve product quality.
Enterprise, Business Growth and Size
• An entrepreneur is a person who organises, operates and takes risk to make the
business better
• Characteristics of Entrepreneurs:
o Hard-working
o Risk Takers
o Creative
o Effective Communicators
o Optimistic
o Self-confident
o Innovative
o Independent.
Advantages and Disadvantages of being an Entrepreneur:
Advantages Disadvantages
Independent, able to choose how to entrepreneurs will have to put their own money into the
use time and money business.
Able to put own ideas into practice many entrepreneur’s businesses fail (risky)
It may become successful and very Lack of knowledge and experience in starting and operating a
profitable if the business grows business
Able to make use of personal interests Lost income from not being an employee for another business
and skills (Opportunity cost)
Profits to themselves, no need to They will have to invest their savings as well as find other
share them with anyone sources of finance, which is time-consuming and expensive
Income is higher than a regular
employee
Business Plans
• Business Plan: a document containing the business objectives and essential details
about operations, finance and owners of the new business.
• Contents of business plan:-
o Description of the product
o Products and services
o The market
o Business location and how products will reach customers
o Organisation structure and management
o Financial information
o business strategy
• Business plans assist entrepreneurs because:
o It helps gain finance. Banks will ask for a business plan before agreeing to a loan
or overdraft for the business
o It forces the entrepreneur to plan carefully, which reduces the risk of the
business failing.
Government Support for Start-Ups
• Governments encourage entrepreneurs to set up a business because start-ups:
o reduce unemployment
o Increase competition
o Increase output
o Benefit society
o Further growth of the economy
• Governments may give support to entrepreneurs by:
o Business ideas & help, organising training for entrepreneurs that gives advice,
and support sessions.
o Finance, they may lend loans at low-interest rates or grants, as well as low-cost
premises
o Governments provide grants for training employees to make them more
efficient and productive
o Governments allow entrepreneurs to use research facilities in Universities
Business Size
• Why is it beneficial to compare business size?
o Investors can decide which business to invest in.
o Government, different tax rates for small and large firms.
o Competitors, to compare size and importance with other firms.
o Workers, to have an idea of the number of employees needed.
o Banks, the importance of the loan compared to business size.
• There are several different measurements of business size, and they all have
limitations:
Measurements Limitations
The number of people employed in the business Capital-intensive firms employ fewer people but
(accessible to calculate) produce high levels of output.
Measurements Limitations
The value of the output of the business (useful Does not take into account the value of goods sold
for same industry Businesses) and the sale of goods.
The value of sales (useful for retail businesses, different businesses sell different products
especially if similar products) (expensive and cheap)
The total value of capital employed (takes into Some businesses use Labour-intensive methods,
account all values of capital) which require less capital, more workers
• Capital Employed: the total value of capital used in the business
• No method of measuring the size is considered correct, as each method gives different
answers. Businesses choose the method they think is the best. Therefore, businesses
may use more than one method.
Business Growth
• There are several ways of measuring the size of the business
o Number of Employees
o Capital Employed
o Output or sales
o Market Share
• Benefits of the expansion of the business:
o The possibility of higher profits for the owner.
o More status and prestige for owners and managers.
o Lower average costs.
o A larger share of its market portion of total market sales it makes is greater.
Ways of Business Growth
• Businesses can either grow by:
o Internal Growth
o External Growth
• Internal Growth is when the business expands its existing operations by purchasing
additional equipment, increasing the size of its premises and hiring more labour if
needed.
• External Growth is when the business takes over or merges with another business.
o Takeover: When one business buys out the owners of another business, which
then becomes part of the ‘predator’ business.
o Merger: When two owners of a business agree to join their businesses together
• There are three types of External Growth:
o Horizontal Integration: The same industry and stage of production firms merge
or take over.
▪ For example, a chocolate manufacturer takes over another chocolate
manufacturer.
▪ Benefits:
▪ Reduces the number of competitors in the industry
▪ Opportunities for economies of scale
▪ A bigger share of the total market can be achieved
▪ Problems include diseconomies of scale and difficulty in controlling and
managing the business
o Vertical Integration: when one business merges or takes over another business
in the same industry but at different stages of production, it can be forward or
backwards.
▪ Forward integration is when merging/takeover is done with the next stage
of production, Ex. a chocolate manufacturing company (secondary
sector) merging with a chocolate shop (tertiary sector)
▪ Benefits for forward:
▪ The merger provides an assured outlet for its products
▪ The expanded business absorbs the profit margin made
by the retailer/Manufacturer.
▪ Information regarding consumer needs and preferences
can be obtained directly from the manufacturer.
▪ Backward integration is when merging/takeover is done with the
previous production stage, Ex. a chocolate manufacturing
company takes over a cocoa farm.
▪ Benefits for Backward:
▪ Merger gives an assured supply of essential
components
▪ The expanding business absorbs the profit margin
of suppliers.
▪ A supplier could be prevented from supplying to
other manufacturers.
▪ Costs of components and supplies are
controlled.
o Conglomerate Merger: a firm merging/taking over another firm in a different
industry. (also known as ‘diversification’)
▪ For example, a chocolate manufacturer is merging with a photography
company.
▪ Benefits:
▪ Activity in more than one industry will diversify and spread the
risk taken by the business.
▪ Transferring ideas to different sections can help the business.
Disadvantages Caused by Business Growth
• Control and management get harder with expansion (can be prevented by carefully
planning expansions and adjusting management style and hierarchy).
• Larger businesses lead to poor communication (stronger and more efficient
communication channels can prevent it).
• Expansion costs are high and can result in a shortage of finance for businesses (A
financial plan must be prepared in anticipation of expansion; it can include short/long-
term loans to compensate for financial loss).
• Integrating with another business can cause conflicts and difficulties, such as business
culture and style of management. (Compromises will have to be made, or a new style of
management can be applied altogether, which can help reduce conflicts)
Why Small Businesses Remain Small?
• The size of their market is small
• Access to capital is limited
• Personal Choice of the owner
• The size and cost of technology
Why Businesses Fail
• Lack of Management Skills – from lack of experience, poor choice of managers (family
business), bad decisions can occur
• Failure to plan for change – businesses must adapt to an ever-changing business
environment. It would be best if risks were taken.
• Over-Expansion – (diseconomies of scale)
• Poor financial management and liquidity issues
• Competition with other businesses – intense competition in the market can make it
hard for new businesses to set up, as already established businesses can drive newly
established businesses out of the market with their low, competitive prices.
Legal Identity
• Unincorporated Business: A business that does not possess a separate legal identity
from its owner. These Businesses usually have:
o Unlimited liability: the owner can be held responsible for the business's debts.
o Greater risk, as owner is putting his personal possessions and living at risk.
• Incorporated Business: Business with a separate legal identity. Private/Public limited
companies. These Businesses usually have:
o Limited liability: the liability of shareholders in a company is limited to only the
amount they invested
o Less risk, as the owner is only risking the capital they invested, as well as any
legal charges effect only the business and not the owner directly
Sole Trader
• It is a business owned and controlled by one person- the owner, who is the sole
proprietor. It is a form of an unincorporated business.
Advantages Disadvantages
Few legal regulations (Easy to set up) Decisions can be hard to make
Complete control No separate legal identity, unlimited liability
Flexible working time May not be able to raise funds to expand
business
Ability to respond quickly to the needs and wants of May have to work long hours
customers
All profit goes to the owner Difficult to compete with large firms
Complete secrecy in Business matters May not have the proper skills to run a
business
Partnerships
• Partnerships: A form of business in which two or more people agree to own a business
jointly. It can be set up by creating a partnership deal. It’s a form of unincorporated
business.
• Deal of partnership: The written and legal agreement between business partners. It is
not essential but is recommended
• Contents of Partnership Agreement:
o Amount of capital invested by all partners
o Tasks to be done by each partner
o The way profits are shared out
o How long partnership will last
o Arrangements for absence, retirement and how partners could be let known
Advantages Disadvantages
Easy to set up a deed of partnership Unlimited liability
Greater access to funds Share the profit
shared decision-making Business ceases to exist if one partner leaves
shared management and workload Decisions binding on all partners
Difficult to raise finance
Private Limited Company (LTD)
• Private Limited Company: Business owned by shareholders but cannot sell shares to
the public (can only sell to family and friends).
• Shareholders: Owners of a limited company who buy shares represent part-ownership
of the company.
Advantages Disadvantages
Raise capital from the sale of shares Cannot sell shares to the public
Limited liability for shareholders Legal formalities
Separate legal identity Accounts are available for the public to see
Continuity Not easy to transfer shares
• Articles of Association: Contains the rules for managing the company.
• Memorandum of Association: Contains vital information about the company and the
directors.
These also apply to a public limited company.
Public Limited Company (PLC)
• Public Limited Company: Businesses owned and controlled by the shareholders, but
they sell to the public, and their shares are tradeable on the stock exchange.
Advantages Disadvantages
Can sell shares to the public Legal Formalities
Rapid expansion possible/specialist managers Disclosure of accounts and other
appointed information
Limited liability Divorce between ownership and control
Continuity Expensive to ‘go public‘
• Annual General Meeting (AGM): A yearly meeting where shareholders may attend to
vote for a Board of Directors for the upcoming year.
• Dividends: Payments made to shareholders from the profit of a company. They are the
return for investing in the company.
Franchise
• Franchise: An agreement of a business based upon an existing brand/business
• Franchisee: the company that received permission to conduct business using the
company’s name and brand. Have to pay an original fee to the franchisor and a
percentage of its profit for the privilege
• The Franchisor: the company that allows another company to conduct business using
the company’s name and brand.
Advantages to franchisor Disadvantage to franchisor
Franchisee buys the licence, which means Bad reputation if one branch has poor management
another source of finance
Expansion is faster The franchisee keeps some profit
Management is the responsibility of the Training, some aspects of administration, and
franchisee advertising are paid by the franchisor
Percentage of sale revenue is given to the
franchisor every year
Advantages to franchisee Disadvantages to franchisee
Chances of business failure are reduced Less independence
The franchisor pays for advertising Unable to make decisions that would suit the local area
Fewer decisions to make with an The franchisor has the power to withdraw the agreement and
independent business can prevent the use of the premises
The franchisor provides training for staff
and management
Banks are often willing to lend to
franchisees due to the low risk.
Joint Venture
• Joint Venture: is when two or more businesses join together to create a new business
Advantages Disadvantages
Sharing of costs Profits have to be shared if the project is successful
Knowledge and experience can be shared Conflict in decision-making
Risks shared Different methods of running a business can create conflict
Public Corporations
• Public Corporations: a business in the public sector owned and controlled by the state
of government (By appointing a board of directors and setting objectives).
Advantages Disadvantages
Government ownership may be essential to some The profit objective is not as powerful or important
countries' industries, such as water supply and as in private-sector industries.
electricity generation.
Ensure consumers are not taken advantage of Inefficiency because managers rely too much on
the government
Advantages Disadvantages
Reduce wasteful competitors It can be unfair to the private sector if subsidies are
provided to the public sector.
Can help stabilize failing businesses to create job Lack of close competition can decrease many
opportunities activities
Important public services It can be used for political reasons, preventing the
business from opportunities like other profit-
making businesses.
Business Objectives
• Business Objectives are aims or targets a business works towards
• Businesses need objectives to help them be successful. However, they don’t guarantee
success.
• Benefits of having business objectives:
o A clear target to work towards, thus improving Motivation.
o It can help in decision-making.
o It helps unite the whole business towards the same goal.
o It can be used to compare how the business performs through objectives.
• Private sector business objectives:
o Business Survival - Adjust to business environment, change price of products if
necessary
o Generating profit (total income of business revenue subtracted by total cost)–
pay a return to owners or provide finance to invest further in business
o Returns to shareholders - discourage shareholders from selling their shares.
This can be done by increasing profit or increasing the share price
o Growth of business – increase salaries, economies of scale. This is only
achieved if customers are satisfied with the product
o Market Share (the total percentage of total market sales held by one brand or
business) - gives good publicity and more influence over suppliers and
customers.
▪ Calculation=100×Company SalesTotal market ShareCalculation=100×To
tal market ShareCompany Sales
• Why business objectives can change:
o It will work towards profit after being set up and stable.
o After achieving a high market share, it aims to “return to shareholders”.
o A profit-making business hit with a crisis now has the short-term objective of
survival.
o Changes in consumer tastes and spending patterns
o Technological changes
o New Sources of Competition
Social Objectives
Objectives of Social Enterprise
• Social Enterprise: an enterprise with social objectives and aims to make a profit to
reinvest in the business. It has three objectives:
o Social: to provide jobs and support for disadvantaged groups
o Environmental: to protect the environment.
o Financial: to make a profit to reinvest in the enterprise and expand its social
work.
Objectives of Public Sector Businesses
• Financial: Meet profit targets set by the government - either reinvested or funded back
to the government.
• Service: meet quality targets the government sets and provide services to the public.
• Social: protect or create employment in certain areas.
Stakeholder Objectives
• Stakeholder: any person or group with a direct interest in the performance and
activities of a business
• There are two types of stakeholder groups:
o Internal Stakeholders work/own the company (owners, managers, workers)
o External Stakeholders are outside the business (consumers, government,
banks,
suppliers, Wider community, Pressure groups, and competitors)
• Each stakeholder group has different objectives for the performance of the business
• Internal Stakeholder (Owners, managers and employees) objectives are payments or
profits; they want business growth, so the value of investment increases, or they get
higher status/power
• Customers' objectives are reliable products, value for money, good quality, good design
and good service
• Government objectives include money from taxes, employing more people, increasing
the country’s output
• The bank’s objectives are to make a profit out of loans and the payback of interest.
• Since different stakeholders have different objectives, it may cause conflict, to try to
please all the stakeholders
• For example, customers want cheap products, but workers want higher salaries.
• Therefore, managers must compromise to decide which objectives are best for the
company.