Preview Cambridge International AS and A Level Business Coursebook by Cambridge International Education

Peter Stimpson and Alastair Farquharson

Cambridge International AS and A Level

Business Coursebook Third Edition

University Printing House, Cambridge cb2 8bs, United Kingdom One Liberty Plaza, 20th Floor, New York, ny 10006, USA 477 Williamstown Road, Port Melbourne, vic 3207, Australia 4843/24, 2nd Floor, Ansari Road, Daryaganj, Delhi – 110002, India 79 Anson Road, #06–04/06, Singapore 079906 Cambridge University Press is part of the University of Cambridge. It furthers the University’s mission by disseminating knowledge in the pursuit of education, learning and research at the highest international levels of excellence. Information on this title: education.cambridge.org © Cambridge University Press 2015 This publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published 2002 Second published 2010 Third edition published 2015 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 Printed in Dubai by Oriental Press A catalogue record for this publication is available from the British Library isbn 978-1-107-67736-4 Paperback Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. notice to teachers in the uk It is illegal to reproduce any part of this work in material form (including photocopying and electronic storage) except under the following circumstances: (i) where you are abiding by a licence granted to your school or institution by the Copyright Licensing Agency; (ii) where no such licence exists, or where you wish to exceed the terms of a licence, and you have gained the written permission of Cambridge University Press; (iii) where you are allowed to reproduce without permission under the provisions of Chapter 3 of the Copyright, Designs and Patents Act 1988, which covers, for example, the reproduction of short passages within certain types of educational anthology and reproduction for the purposes of setting examination questions. The questions, answers and commentary in this title are written by the authors and have not been produced by Cambridge International Examinations.

Contents

Contents Introduction

Unit 1 Business and its environment

1: Enterprise

2: Business structure

3: Size of business

4: Business objectives

5: Stakeholders in a business

6: Business structure (A Level)

7: Size of business (A Level)

8: External influences on business activity (A Level)

9: External economic influences on business behaviour (A Level)

Unit 2 People in organisations

124

10: Management and leadership

125

11: Motivation

137

12: Human resource management

159

13: Further human resource management (A Level)

170

14: Organisational structure (A Level)

187

15: Business communication (A Level)

200

Unit 3 Marketing

212

16: What is marketing?

213

17: Market research

231

18: The marketing mix â&#x20AC;&#x201C; product and price

252

19: The marketing mix â&#x20AC;&#x201C; promotion and place

273

20: Marketing planning (A Level)

297

21: Globalisation and international marketing (A Level)

318

iii

Cambridge International AS and A Level Business

Unit 4 Operations and project management

330

22: The nature of operations

331

23: Operations planning

339

24: Inventory management

366

25: Capacity utilisation (A Level)

376

26: Lean production and quality management (A Level)

385

27: Project management (A Level)

403

Unit 5 Finance and accounting

416

28: Business finance

417

29: Costs

434

30: Accounting fundamentals

443

31: Forecasting and managing cash flows

464

32: Costs (A Level)

476

33: Budgets (A Level)

486

34: Contents of published accounts (A Level)

495

35: Analysis of published accounts (A Level)

505

36: Investment appraisal (A Level)

518

Unit 6 Strategic management

534

37: What is strategic management? (A Level)

535

38: Strategic analysis (A Level)

543

39: Strategic choice (A Level)

556

40: Strategic implementation (A Level)

568

41: Preparing for your examinations

587

Index

593

Acknowledgements

602

Introduction

Introduction Who is this book for? The third edition of this book accurately and comprehensively follows the new Cambridge International AS and A Level Business syllabus (9609). If you are a student studying this syllabus, or a teacher of the syllabus, you can be confident that the book provides complete coverage of the course to the appropriate level. Other students of Business or Business and Management could also benefit greatly from the subject content, activities and advice that this book contains. Students following the AQA, OCR or EDEXCEL A Levels, the Cambridge Pre-U course or the International Baccalaureate Higher and Standard Diploma Programme will also fi nd this an invaluable resource. The first and second editions were also used in higher education institutions as an introductory text for Management and Business Studies degree courses. The changes and additions made to this third edition will reinforce its usefulness for this purpose.

What makes this book different? The key distinctive feature of this book is the international perspective it gives to the study of businesses, strategies and decisions. There are many references to case studies, data and examples from countries all around the world. This is deliberate − very few large businesses operate today in a narrow national marketplace and, as a Business Studies student, you are encouraged to look at business organisations and business decisions from an international viewpoint that accurately mirrors the real world. The focus on business strategic decision-making in the final unit means that the book also highlights some very important aspects of business management: ■

■

Strategic decision-making is holistic and cannot be undertaken effectively by studying a series of unconnected subject areas. There is no one perfect solution to a business problem – a variety of different strategic solutions might exist that reflect the objectives of the business, the external environment and the cultures of both the organisation and the country in which it operates.

Differences between AS and A Level There are two important differences between the AS and A Level syllabus: 1 More subject content is examined at A Level than at AS. 2 The examination skills are weighted differently – much more emphasis is placed on subject knowledge at AS Level but A Level puts greater emphasis on analysis and evaluation. These differences are reflected in the types of questions contained in this book and in the suggested answers on the Teacher’s CD-ROM that accompanies it.

Students who are only taking the AS Level examinations do not need to study the A Level chapters in this book or the associated activities. A Level students and their teachers must remember that the A Level syllabus includes all AS content and, therefore, all sections of this book need to be followed. A Level students should tackle both the AS and the A Level questions in the book.

What are the key features of this book? ■ ■

■ ■ ■ ■

■ ■

Learning objectives – identifying the content and concepts covered in each chapter. ‘Introducing the topic’ case studies – raising important areas for discussion and giving context to the business applications of the material to be covered in each chapter. Clearly laid-out text – with easy-to-follow subsections, many tables of data and ‘key advantages and disadvantages’. Top tips – helping avoid common errors made by students. Key concept links – explaining how the topics are integrated with the key concepts for this subject. In-chapter activities – giving practice at applying what is being learned, using evidence and data taken mainly from actual business examples. Learning outcomes – reinforcing the issues that should be understood by the end of each chapter. Examination-style questions – testing the skills of knowledge and understanding, application, analysis and evaluation, using international business situations. Examination-style essay questions – giving practice at writing longer, discursive answers. The timings given for each examination-style question are intended as a guide to students to help them practice under timed conditions; please note that they are a guide only.

Cambridge International AS and A Level Business

What is the CD-ROM for?

Key concepts in Business

The CD-ROM attached to this book provides invaluable support to students. It contains:

All Cambridge International AS and A Level syllabuses contain certain key concepts that underpin them and bind the subject together. The key concepts in Business are:

■ ■ ■ ■ ■ ■ ■ ■ ■

a full glossary of all the key definitions in the book exemplar marking grids revision mind maps for every chapter examination and assessment guidance worksheets and answers hundreds of multiple choice questions and answers revision advice and checklists for every chapter sample exam papers and marks schemes. There is a teachers’ CD available too (ISBN 9781107677364, which provides detailed answers to all of the activities, case studies and examination questions in the book along with suggestions for further reading.

Skills needed by students of Business The key skills you will develop during your course (and will ultimately be tested on in examination) are:

1 Knowledge and critical understanding of the syllabus content. 2 Application of this knowledge and critical understanding of problems and issues that arise from both familiar and unfamiliar situations. 3 Analysis of problems, issues and situations. This skill can be demonstrated by: ■ ■ ■

distinguishing between statements of fact and opinion explaining trends in data and the likely causes of them examining the implications of a suggested idea or strategy.

4 Evaluation and judgement. This skill can be demonstrated by: ■ ■ ■ ■

weighing up the reliability of data discussing and debating issues and arguing points to reach an appropriate decision discriminating between alternative explanations and strategies judging the usefulness of the main concepts and models of Business Studies.

All of these skills will be developed as you progress through this book, especially if you work through the many questions that are presented for your self-assessment. The student CD-ROM gives further details of how the four skills are assessed and how to prepare for examinations.

Change – is the only constant in business. New enterprises are often created in response to economic, cultural or technological changes. Existing businesses must adapt to change if they are to survive and grow. Management – is relevant to every person in a business. Good leadership, strong motivation in workers, effective systems and clear communication are hallmarks of successful businesses. Customer focus – means a business will design and produce goods and services that people want to buy. Customers provide the revenue that sustains a business. Successful businesses really understand their customers and strive to provide products that their customers love. Innovation – enables a business to reinvent itself and stay ahead of the competition. The business world is dynamic and companies must seek to innovate through product development, more efficient processes and finding better ways to ‘do business’. Creating value – is the core reason why any business exists. Effective organisations aim to maximise stakeholder value. For many businesses this will be about maximising shareholder value, but social enterprises have other, non-financial aims. Stakeholders also need to measure the value that is being created. Strategy – is about knowing where you are, where you want to get to and how you are going to get there. Managers need to think about, decide on and put into action major long-term plans – such as buying another business, entering a new market or developing a new technology.

These concepts are the guiding principles on which the subject – at A Level and beyond – is based. A business organisation could not be successful without its leaders being conscious of, and responding to, these important ideas. They are also inter-related and making efforts to link them in answer to questions shows that students understand the complex and integrated nature of successful business operations. If students are able to develop the ability to see how different strands of the syllabus can be pulled together within one key concept then this a high level skill. The ways in which these concepts can be used to bind together the subject of Business is referred to at different stages of this book through ‘Key concept links’. It is important to make clear that there will no specific

Introduction

assessment of the principle of key concepts – no questions, for example, will use the expression ‘key concepts’. However, an awareness of the interconnected nature of Business and successful business decisions will help students to succeed in their course and provide a strong foundation for future study or practical application of skills.

Using the book Even the keenest student is unlikely to read this textbook from cover to cover in one evening. Instead, it should be used to support and guide your learning as you progress through the syllabus. Make use of the many activities and revision questions to support and assess your learning. The authors hope that the book, as well as providing essential subject support, will achieve two further objectives. First, that it will encourage students to be observant and curious about all forms of business activity. Second, that, as a consequence, they will be keen to discover what is happening in business organisations, at international, national and local levels, and to bring these

findings into their studies. To this end, there is also the expectation that students will update their knowledge through the frequent use of libraries, newspapers, businessoriented television programmes and the Internet.

Peter Stimpson (coursebook author) Peter Stimpson is former Head of Business Studies at Hurtwood House School, Surrey. He has more than 35 years’ experience in teaching Economics and Business Studies to A Level standard. He is an experienced examiner and he also trains teachers overseas in A Level course development, teaching methods and examination skills.

Alastair Farquharson (CD-ROM author) Alastair Farquharson is a teacher at Torquay Boys’ Grammar School and has taught A Level Economics and Business Studies for more than 20 years. He is an experienced examiner and has provided training for teachers overseas in A Level course development, teaching methods and examination skills.

vii

Unit 1: Business and its environment Introduction This unit focuses on understanding the nature and purpose of business activity. It identifies and analyses the structures, functions and objectives of different business organisations. Central to an understanding of business and its internal and external environments is a recognition that the world in which businesses operate is in a constant state of change. This key concept can also be linked to the creation of value, as the most successful businesses are able to continue to create value despite the impact of political, economic, social, technological and environmental changes.

Enterprise

This chapter covers syllabus section AS Level 1.1.

On completing this chapter, you will be able to: ■ ■

■ ■

understand what business activity involves recognise that making choices as a result of the ‘economic problem’ always results in opportunity cost analyse the meaning and importance of creating value recognise the key characteristics of successful entrepreneurs

■

assess the importance of enterprise and entrepreneurs to a country’s economy understand the meaning of social enterprise and the difference between this and other businesses.

Introducing the topic Introduction DULIP STARTS HIS BUSINESS Dulip lives in a large country with many natural resources, such as coal and timber. He plans to start a business growing and cutting trees to sell as timber. He wants to buy a forest from a farmer and cut down a fixed number of trees each year. As Dulip is concerned about his environment country’s, he will plant two new trees for each one he cuts down. He has been planning this business venture for some time. He has visited a bank to arrange a loan. He has contacted suppliers of saws and other equipment to check on prices. Dulip has also visited several furniture companies to see if they would be interested in buying wood from the forest. In fact, he did a great deal of planning before he was able to start his business. Dulip is prepared to take risks and will invest his own savings, as well as using the bank loan, to set up the business. He plans to employ three workers to help him to start with. If the business is a success, then he will also try to sell some of the timber abroad. He knows that timber prices are high in some foreign markets. After several months of planning, he was able to purchase the forest.

Points to think about: ■ ■ ■ ■

Why do you think Dulip decided to own and run his own business rather than work for another firm? Why was it important to Dulip that he should do so much planning before starting his business? Do you think Dulip will make a successful entrepreneur? Are new businesses such as Dulip’s good for a country’s economy?

Many business managers are paid high salaries to take risks and make decisions that will influence the future success of their business. Much of this book is concerned with how these decisions are made, the information needed to make them and the techniques that can assist managers in this important task. However, no student of Business can hope to make much progress in the study of this subject unless they have a good understanding of the economic environment in which a business operates. Business activity does not take place in isolation from what is going on around it. The very structure and health of the economy will have a great impact on how successful business activity is. The central purpose of this whole unit, ‘Business and its environment’, is to introduce the inter-relationships between businesses, the world in which they operate and the limits that governments impose on business activity. This first chapter explains the nature of business activity and the role of enterprise in setting up and developing businesses.

The purpose of business activity A business is any organisation that uses resources to meet the needs of customers by providing a product or service that they demand. There are several stages in the production of finished goods. Business activity at all stages involves creating and adding value to resources, such as raw materials and semi-finished goods, and making them more desirable to – and thus valued by – the final purchaser. Without business activity, we would all still be entirely dependent on the goods that we could make or grow ourselves – as some people in virtually undiscovered native communities still are. Business activity uses the scarce resources of our planet to produce goods and services that allow us all to enjoy a very much higher standard of living than would be possible if we remained entirely self-sufficient.

Cambridge International AS and A Level Business

What do businesses do? Businesses identify the needs of consumers or other firms. They then purchase resources – or factors of production – in order to produce goods and services that satisfy these needs, usually with the aim of making a profit. Before we go on, it will be useful to explain some important business terms that have either already been used, or will be referred to soon, in this chapter. Business activity exists to produce consumer goods or services that meet the needs of customers. These goods and services can be classified in several ways. Timber is a natural resource

Capital equipment can be very complex

KEY TERMS

Consumer goods: the physical and tangible goods sold to the general public – they include durable consumer goods, such as cars and washing machines, and non-durable consumer goods, such as food, drinks and sweets that can be used only once. Consumer services: the non-tangible products sold to the general public – they include hotel accommodation, insurance services and train journeys.

What do businesses need to produce goods and services? Factors of production These are the resources needed by business to produce goods or services. They include: ■

■ ■

■

Land – this general term includes not only land itself but all of the renewable and non-renewable resources of nature, such as coal, crude oil and timber. Labour – manual and skilled labour make up the workforce of the business. Capital – this is not just the finance needed to set up a business and pay for its continuing operations, but also all of the man-made resources used in production. These include capital goods, such as computers, machines, factories, offices and vehicles. Enterprise – this is the driving force, provided by risktaking individuals, that combines the other factors of production into a unit capable of producing goods and services. It provides a managing, decision-making and coordinating role.

All businesses need labour

The concept of creating or adding value All businesses aim to create value by selling goods and services for a higher price than the cost of bought-in materials, this is called ‘creating value’. If a customer is prepared to pay a price that is greater than the cost of materials used in making or providing a good or service, then the business has been successful in creating value. Th is can also be referred to as ‘adding value’. The difference between the selling price of the products sold by a business and the cost of the materials that it bought in is called ‘added value’. Without creating value a business will not be able to survive as other costs have

KEY TERM KEY TERMS

Capital goods: the physical goods used by industry to aid in the production of other goods and services, such as machines and commercial vehicles.

Businesses have many other needs before they can successfully produce the goods and services demanded by customers. Figure 1.1 shows the wide range of these needs.

Creating value: increasing the difference between the cost of purchasing bough-in materials and the price the finished goods are sold for. Added value: the difference between the cost of purchasing bought-in materials and the price the finished goods are sold for.

1: Enterprise

Site for buildings

Raw materials

Finance

Factories/offices

Land

Capital

Machines

Roads/Rail/Airports Customers

A business needs

Government

Law and order

Suppliers Schools/Colleges

Labour

Enterprise

Permanent

Skilled Unskilled

Temporary

Risk takers

Decision makers

Coordinators

Figure 1.1 What businesses need

to be paid and, usually, a profit must be made to justify staying in operation. The concept of creating added value can be illustrated by an example taken from the building industry â&#x20AC;&#x201C; see Figure 1.2.

Cost of input/materials

From the value created or added by the business, other costs have to be paid, such as labour and rent, so value created by a business is not the same as profit. However, if a business can create increased value withoutÂ increasing its costs, then profit will increase.

Production process adds value

Figure 1.2 Creating value by building a house from bought-in materials

Value of output of finished goods

Cambridge International AS and A Level Business

Here are two examples of how different businesses could create added value to their products: 1 Jewellers – well-designed shop-window display, attractive shop fittings, well-dressed and knowledgeable shop assistants and beautiful boxes offered to customers to put new jewellery in. These features might allow an increase in jewellery prices above the additional costs involved. 2 Sweet manufacturer – extensive advertising of the brand of sweets to create an easily recognised name and brand identity, attractive packaging, selling through established confectionery shops and not ‘cheap’ vending machines. Higher prices as a result of successful branding should create added value.

leaving out those things of less value to us. This need to choose is not exclusive to people as consumers. All economic units have to make choices – governments, businesses, workers, charities and so on.

Opportunity cost This need to choose leads to the next important principle of our subject – opportunity cost. In deciding to purchase or obtain one item, we must give up other goods as they KEY TERM

Opportunity cost: the benefit of the next most desired option which is given up.

ACTIVITY 1.1 [12 marks, 25 minutes] Explain how the following businesses could create added value to the goods they buy in: a hotel [3] b car dealer [3] c clothing manufacturer [3] d fast-food restaurant. [3] 6 KEY CONCEPT LINK

If consumers choose to buy the smart phone, then the trainers become the opportunity cost

Creating value requires effective management of resources. The most successful businesses in terms of creating value tend to be customer-focused. Many customers are prepared to pay relatively high prices for products which exactly meet their needs – creating more value for the business.

Economic activity and the problem of choice We live in a world of great wealth and great scarcity. Very poor people are unable to obtain the basic requirements of life – food, clean water, shelter – and they have many unsatisfied needs and wants. Even very rich people may not be able to satisfy all of their wants for luxury goods and services. It should be clear to us all that there are insufficient goods to satisfy all of our needs and wants at any one time; this is known as ‘the economic problem’. It is the purpose of economic activity to provide for as many of our wants as possible, yet we are still left wanting more. This shortage of products – together with the resources needed to make them – lead to us all having to make choices. As we cannot satisfy all of our wants, then we must choose those which we will satisfy now and those which we will forgo. If we are careful and rational, we will choose those things that give us the greatest benefit,

If government chooses to build the fighter plane, then the hospital becomes the opportunity cost

1: Enterprise

cannot all be purchased. The next most desired product given up becomes the ‘lost opportunity’ or opportunity cost. This concept exists for all economic decision makers: consumers, businesses and government.

their business idea that they would bounce back from any setbacks. Risk taking: Entrepreneurs must be willing to take risks in order to see results. Often the risk they take is by investing their own savings in the new business.

The role of the entrepreneur New business ventures started by entrepreneurs can be based on a totally new idea or a new way of offering a service. They can also be a new location for an existing business idea or an attempt to adapt a good or service in ways that no one else has tried before. In this chapter, we will be looking at several examples of people who have set up their own new business and have shown skills of ‘entrepreneurship’. They have: ■ ■ ■ ■

had an idea for a new business invested some of their own savings and capital accepted the responsibility of managing the business accepted the possible risks of failure. KEY TERM

Entrepreneur: someone who takes the financial risk of starting and managing a new venture.

Characteristics of successful entrepreneurs The personal qualities and skills needed to make a success of a new business venture include: Innovation: The entrepreneur may not be an inventor in the traditional sense, but they must be able to carve a new niche in the market, attract customers in innovative ways and present their business as being different from others in the same market. This requires original ideas and an ability to do things differently – this is the skill of innovation. Commitment and self-motivation: It is never an easy option to set up and run your own business. It is hard work and may take up many hours of each day. A willingness to work hard, keen ambition to succeed, energy and focus are all essential qualities of a successful entrepreneur. Multiskilled: An entrepreneur will have to make the product (or provide the service), promote it, sell it and keep accounts. These different business tasks require a person who has many different qualities, such as being keen to learn technical skills, being able to get on with people and being good at handling money and keeping accounting records. Leadership skills: The entrepreneur will have to lead by example and must have a personality that encourages people in the business to follow them and be motivated by them. Self-confidence and an ability to bounce back: Many business start-ups fail, yet this would not discourage a true entrepreneur who would have such belief in themselves and

KEY CONCEPT LINK

Innovative entrepreneurs can often create much value for their business as long as their new ideas for goods or services are customer-focused.

ACTIVITY 1.2

Bangalore enterprise blossoms Rama Karaturi gained the idea for his rose-growing business when he searched, without success, for a bouquet of roses for his wife in Bangalore. The city was a rose-free zone, so he decided to start growing them himself. Initially, he opened two greenhouses growing just roses. He used his own savings, so took a considerable risk, but his confidence in the growth of flower-giving at times of major festivals encouraged other investors too. He sold the flowers in India, but his business also became one of the first in India to start exporting flowers on a large scale. Rama worked long hours to make his business a success. The business, called Katuri Networks, has grown at a tremendous rate, helped by Rama’s all-round business skills. He recently bought out a large rose-grower in Kenya and his business is now the world’s largest cultivator of roses – and Rama achieved this in a little over ten years. [9 marks, 15 minutes] 1 Rama is an example of a ‘business entrepreneur’. Explain what is meant by this term. [3] 2 Outline any three characteristics of Rama’s personality that led to the success of his enterprise. [6]

Major challenges faced by entrepreneurs Identifying successful business opportunities Identifying successful business opportunities is one of the most important stages in being an effective entrepreneur. Many people say that they ‘want to work for themselves’, but they do not make the leap into entrepreneurship successfully because they have not been able to identify a market need that will offer sufficient

Cambridge International AS and A Level Business

demand for their product to allow the business to be profitable. The original idea for most new businesses comes from one of several sources including: ■

■

Own skills or hobbies – e.g. dress-making or car bodywork repairing. Very often, these skills will enable an entrepreneur to offer them to friends and relatives and this could be the start of the business. Previous employment experience – working for a successful hairdresser, for example, allows a potential entrepreneur to see the working of such a business and judge whether they could set up a similar business themselves. Franchising conferences and exhibitions – these offer a wide range of new business start-up ideas, e.g. fast-food restaurants, which also give the potential benefits of the support of a much larger franchiser business. Small-budget market research – the Internet allows any user to browse business directories to see how many businesses there are in the local area offering certain goods or services. Such small-scale research might indicate gaps in local markets that could be profitably filled by the entrepreneur.

Sourcing capital (finance) Once the entrepreneur has decided on the business idea or opportunity, the next task is to raise the necessary capital. In an International Labour Organization survey of new business start-ups, the problem of finance came top of the list of replies from entrepreneurs regarding the main difficulty. So why is obtaining finance such a major problem for entrepreneurs? ■

■ ■

■

Lack of sufficient own finance – many entrepreneurs have very limited personal savings, especially if they are setting up their own business because they were previously made redundant. Lack of awareness of the financial support and grants available. Lack of any trading record to present to banks as evidence of past business success – a trading record would tend to give a bank confidence when deciding to lend money or not for a new venture. A poorly produced business plan that fails to convince potential investors of the chances of a business’s success.

business. This has the great advantage of keeping costs low, but there are drawbacks: ■ ■ ■ ■

The cost and position of the location chosen could have a big impact on the business entrepreneur’s chance of success. New businesses that offer a consumer service need to consider location very carefully. Whereas a website designer could operate from home very effectively, as communication with customers will be by electronic means, a hairdresser may need to consider obtaining premises in an area with the biggest number of potential customers. An alternative is to visit customers in their own homes – this way, the entrepreneur may avoid the costs of buying or renting their own premises altogether.

Competition This is nearly always a problem for new enterprises unless the business idea is so unique that no other business has anything quite like it. A newly created business will often experience competition from older, established businesses, with more resources and more market knowledge. The entrepreneur may have to offer better customer service to overcome the cost and pricing advantages that bigger businesses can usually offer. Building a customer base This is linked to the previous point about competition. To survive, a new firm must establish itself in the market and build up customer numbers as quickly as possible. The longterm strength of the business will depend on encouraging customers to return to purchase products again and again. Many small businesses try to encourage this by offering a better service than their larger and better-funded competitors. This better service might include: ■ ■

Determining a location Perhaps the most important consideration when choosing the location for a new business is the need to minimise fi xed costs. When finance is limited, it is very important to try to keep the break-even level of output – the output level that earns enough revenue to cover all costs – as low as possible. This will greatly increase the business’s chances of survival. Operating from home is the most common way for entrepreneurs to establish their

It may not be close to the area with the biggest market potential. It lacks status – a business with its own prestigious premises tends to generate confidence. It may cause family tensions. It may be difficult to separate private life from working life.

■

personal customer service knowledgeable pre- and after-sales service providing for one-off customer requests that larger firms may be reluctant to provide for.

Why do new businesses often fail? Even if an entrepreneur has all of the qualities listed above, success with a new business can never be guaranteed. In fact, many businesses fail during their first year of operation. The most common reasons for new enterprises failing are:

1: Enterprise

Lack of record keeping The lack of accurate records is a big reason for business failure. Many entrepreneurs fail to pay sufficient attention to this need as either they believe that it is less important than meeting their customers’ needs, or they think they can remember everything. The latter will be quite impossible after a period of time. How can the owner of a new, busy florist shop remember: ■ ■ ■

■

when the next delivery of fresh flowers is due? whether the flowers for last week’s big wedding have been paid for? if the cheque received from the government department for the display of flowers in its reception area has been paid into the bank yet? how many hours the shop assistant worked last week?

There are many other examples that could be given to illustrate the crucial importance of keeping accurate and upto-date records of business transactions and other matters. With the falling cost of computing power, most businesses, even newly formed ones, keep records on computer. It is always advisable to keep hold of paper records too – when these exist – for example, receipts from suppliers or details of big deliveries. Not only can these act as a check or back-up system if the computer should fail, but they can also provide evidence to the tax authorities if they dispute the entrepreneur’s own tax calculations.

Lack of cash and working capital Running short of capital to run day-to-day business affairs is the single most common reason for the failure of new businesses to survive the first year of operation. Capital is needed for day-to-day cash, for the holding of inventories and to allow the giving of trade credit to customers, who then become trade receivables. Without sufficient working capital, the business may be unable to buy more supplies, or pay suppliers offer credit to important customers. All these factors could lead to the business closing down. Serious working capital deficiencies can usually be avoided if several simple, but important, steps are taken as the business is being established: ■

■

Construct a cash flow forecast so that the liquidity and working capital needs of the business can be assessed month by month. Keep this updated and also show it to the bank manager. Inject sufficient capital into the business at start-up to last for the first few months of operation when cash flow from customers may be slow to build up. Establish good relations with the bank so that short-term problems may be, at least temporarily, overcome with an overdraft extension.

■

Use effective credit control over customers’ accounts – do not allow a period of credit that is too long, and regularly chase up late payers.

Poor management skills Most entrepreneurs have had some form of work experience, but not necessarily at a management level. They may not have developed: ■ ■ ■ ■ ■ ■

leadership skills cash handling and cash management skills planning and coordinating skills decision-making skills communication skills marketing, promotion and selling skills.

They may be very keen, willing to work hard and have undoubted abilities in their chosen field, e.g. an entrepreneur opening a restaurant may be an excellent chef, but may lack management skills. Some learn these skills very quickly once the business is operating, but this is quite a risky strategy. Some organisations exist to provide support for new entrepreneurs in the form of advice and training. Some entrepreneurs ‘buy in’ experience by employing staff with management experience, but how many newly formed businesses can afford this expensive option? It is wrong to think, just because a business is new and small, that enthusiasm, a strong personality and hard work will be sufficient to ensure success. This may prove to be the case, but often it is not. So potential entrepreneurs are usually encouraged to attend training courses to gain some of these skills before putting their hard-earned capital at risk, or to first seek management experience through employment. KEY CONCEPT LINK

The section above introduces some of the important functions of and skills required by good managers, suggesting why the key concept of management is so important.

Changes in the business environment Setting up a new business is risky because the business environment is dynamic, or constantly changing. In addition to the problems and challenges referred to above, there is also the risk of change, which can make the original business idea much less successful. Change is a key feature of Business syllabuses and, therefore, of this book – indeed there is a whole section on change in Unit 6, Chapter 40. It is enough to observe at this stage that new businesses may fail if any of the following changes occur,

Cambridge International AS and A Level Business

which may turn the venture from a successful one to a loss-making enterprise: ■ ■ ■ ■

new competitors legal changes, e.g. outlawing the product altogether economic changes that leave customers with much less money to spend technological changes that make the methods used by the new business old-fashioned and expensive.

ACTIVITY 1.3

This list of changes could be added to, but even these four factors indicate that the business environment is a dynamic one, and this makes owning and running a business enterprise very risky indeed.

Common types of entrepreneurial businesses New business start-ups can be found in nearly all industries, yet it is true to say that there are some industries and sectors of industry where there is a much greater likelihood of new entrepreneurs entering. These include: Primary sector

Farah branches out on her own

■

Farah was a well-qualified dressmaker. She had worked for two of the biggest dress shops in town. She was always arguing with her shop manager, who was very jealous about Farah’s superior dressmaking skills. Farah was now determined to set up her own business. She was lucky that her father was prepared to invest $5,000 in it, but she would have to find the rest of the capital needed – about $10,000, she guessed – from her own savings and a bank loan. Her first step was to investigate the prices of shop premises and she was disappointed when she found out how expensive the city-centre locations were. Her father suggested a cheaper but less busy out-of-town location. She contacted an accountant who offered to look after the financial side of the business, but he would charge at least $2,000 per year. Farah wondered if she could learn to keep the accounts herself if she attended classes at the local college in the evening. She wanted to make her shop very different from all of the competitors in the city and she had the idea of offering lessons in dress-making as well as selling finished dresses. She had been asked so many times by customers, ‘How did you do that?’ when they were pleased with her latest dress designs, that she was sure this was a great business opportunity. What she had not realised was the amount of paperwork she had to complete before her business could even start trading. [22 marks, 30 minutes] 1 Outline three problems that Farah had to deal with in setting up this new business. 2 Which of these problems do you think was the most important one for Farah to find a good solution to? Explain your answer. 3 Do you think Farah had some of the right qualities to be a successful entrepreneur? Justify your answer.

[6]

[10]

■

fishing – e.g. a small boat owned by an entrepreneur market gardening – producing cash crops to sell at local markets.

Secondary sector ■ ■ ■ ■

jewellery-making dress-making craft manufacture, e.g. batik cloth building trades.

Tertiary/service sector ■ ■

hairdressing car repairs cafés and restaurants

■

child-minding.

■

It would be most unusual for entrepreneurs to successfully establish themselves in, say, the steel-making industry or in car manufacturing, because of the vast amount of capital equipment and financial investment that would be required.

Impact of enterprise on a country’s economy All governments around the world are following policies that aim to encourage more people to become entrepreneurs. What are the claimed benefits to the economy of business enterprise? Employment creation: In setting up a new business, an entrepreneur is employing not only themselves (selfemployment), but also, very often, employing other people too. Very often these are members of the family or friends, but in creating such employment, the national level of unemployment will fall. If the business survives and expands, then there may be additional jobs created in the businesses that supply them. Economic growth: Any increase in output of goods or services from a start-up business will increase the gross domestic product of the country. This is called economic growth, and if enough small businesses are created, it will lead to increased living standards for the population. In addition, increased output and consumption will also lead to increased tax revenues for the government.

1: Enterprise

Firms’ survival and growth: Although a high proportion of new firms fail, some survive and a few expand to become really important businesses. These will employ large numbers of workers, add considerably to economic growth and will take the place of declining businesses that may be forced to close due to changing consumer tastes or technology. So, in Trinidad and Tobago, the relative decline of the sugar industry has been balanced out by the growth of the tourist industry, which has itself been boosted by small guesthouse businesses operating as sole traders.

In other words, a social enterprise is a proper business that makes its money in socially responsible ways and uses most of any surplus made to benefit society. Social entrepreneurs are not running a charity, however – they can and often do keep some of any profit they have made. Social enterprises compete with other businesses in the same market or industry. They use business principles to achieve social objectives. Most social enterprises have these common features:

Innovation and technological change: New businesses tend to be innovative and this creativity adds dynamism to an economy. This creativity can rub off on to other businesses and help to make the nation’s business sector more competitive. Many new business start-ups are in the technology sector, e.g. website design. The increased use of IT by these firms, and the IT services they provide to other businesses, can help a nation’s business sector become more advanced in its applications of IT, and therefore more competitive.

■

Exports: Most business start-ups tend to offer goods and services that meet the needs of local or regional markets. Some will expand their operations to the export market, however, and this will increase the value of a nation’s exports and improve its international competitiveness.

1 economic – make a profit to reinvest back into the business and provide some return to owners 2 social – provide jobs or support for local, often disadvantaged, communities 3 environmental – to protect the environment and to manage the business in an environmentally sustainable way.

Personal development: Starting and managing a successful business can aid in the development of useful skills and help an individual towards self-actualisation – a real sense of achievement. This can create an excellent example for others to follow and can lead to further successful new enterprises that will boost the economy still further. Increased social cohesion: Unemployment often leads to serious social problems and these can be much reduced if there is a successful and expanding small business sector. By creating jobs and career opportunities and by setting a good example for others to follow, entrepreneurship can help to achieve social cohesion in the country.

■ ■

They directly produce goods or provide services. They have social aims and use ethical ways of achieving them. They need to make a surplus or profit to survive as they cannot rely on donations as charities do.

Social enterprise – objectives Social enterprises often have three main aims. These are:

These aims are often referred to as the triple bottom line. This means that profit is not the sole objective of these enterprises. KEY TERM

Triple bottom line: the three objectives of social enterprises: economic, social and environmental.

ACTIVITY 1.4 TOP TIP Some questions may ask you to make references to businesses ‘in your own country’. You are advised to take a close interest during the Business course in the activities of businesses – new and well established ones – in your country.

Research a social enterprise business in your own country. Try to find out: ■ ■ ■

Social enterprise Social enterprises are not charities, but they do have objectives that are often different from those of an entrepreneur who is only profit motivated. KEY TERM

Social enterprise: a business with mainly social objectives that reinvests most of its profits into benefiting society rather than maximising returns to owners.

what its social and environmental objectives are how it is different from a charity how it is different from a traditional profit only business.

Write a report on your findings.

Example 1: SELCO in India. This social enterprise provides sustainable energy solutions to low-income households and small businesses. In one scheme, solar-powered lighting was provided by SELCO to a silkworm farmer who depended on dangerous and polluting kerosene lamps. The farmer could not afford the upfront cost, so SELCO helped with the finance, too.

Cambridge International AS and A Level Business

Example 2: The KASHF Foundation in Pakistan provides micro-finance (very small loans) and social-support services to women entrepreneurs who traditionally find it very difficult to receive help. This enables the women to set up their own

businesses in food production, cloth making and other industries. The loans have to be repaid with interest, but the interest rates are much lower than a profit-maximising international bank would charge.

ACTIVITY 1.5

Caribbean cook tastes success

A Jamaican reggae musician turned businessman has hit the headlines. Levi Roots appeared on a famous BBC TV programme called Dragons’ Den. On this programme, he persuaded wealthy businessmen to invest $100,000 in his new business idea. He plans to increase production of his Reggae Reggae Sauce, which uses an old family recipe. Levi realised this might be a good business opportunity when he started selling jerk chicken with this sauce on at local carnivals. Such was the demand from his street stall that he believed he could set up his own business making and selling the sauce. At first, his request for finance was turned down by many banks, but he was not dispirited. He applied to appear on Dragons’ Den and his business presentation was so effective that he had no problems in getting the $100,000 of start-up capital he asked for. In return, he agreed to give up 25% of his business profits to the businessman who agreed to offer the venture capital. Levi’s popularity after the programme and his great personality convinced one of the largest supermarket companies in Europe, Sainsbury’s, to buy enough of Levi’s sauce to stock all of its stores. His new financial backer said, ‘Levi is a great guy and he has created a great product which he is passionate about. I am sure that this deal with Sainsbury’s will be the first of many fantastic milestones on the way to business success and making his dreams a reality.’ Levi is now in discussion with an export company that wants to export the sauce back to the Caribbean.

Levi Roots had a bright idea for a new business – and he is now a successful entrepreneur.

[26 marks, 35 minutes] 1 Explain four possible benefits to the UK economy from Levi’s enterprise.

[8]

2 Analyse two reasons for the initial success of Levi Roots as an entrepreneur.

[8]

3 Do you think that Levi’s business will always be successful? Justify your answer.

[10]

1: Enterprise

SUMMARY POINTS Business activity uses resources to try to satisfy customers’ needs. Most businesses are always looking for ways to create value. Entrepreneurship is about taking risks to set up new business ventures. Successful entrepreneurs tend to have many characteristics in common. An economy can obtain many important benefits from entrepreneurship. Entrepreneurs face challenges such as a dynamic business environment. Social enterprises have three objectives, not just ‘to make a profit’.

RESEARCH TASK Use the internet to find out about three social enterprises in your own country. Write a brief report on: ■

what goods/services they provide

■

their main objectives

■

the main sources of finance.

AS Level exam practice questions Short answer questions [80 marks, 90 minutes] Knowledge and understanding 1 Explain what ‘creating value’ means. 2 What do you understand by the term ‘entrepreneur’? 3 List three characteristics of successful entrepreneurs and explain why they are important. 4 Identify three challenges faced by entrepreneurs. 5 Explain the concept of opportunity cost and give three examples of it. 6 Explain why a country is likely to benefit from expansion of its business enterprises. 7 What is meant by the term ‘social enterprise’? 8 Explain what is meant by the term ‘triple bottom line’. 9 Explain the difference between a charity and a social enterprise.

[3] [3] [9] [3] [9] [6] [3] [3] [3]

Application 10 List three factors of production that a new hairdressing business will require. 11 A new business selling computer soft ware has just opened in your town. Explain three needs that this business will have if it is to be successful. 12 Explain how a supermarket could create value added to the food and other goods it buys in. 13 Explain why there are so many new business enterprises in the tertiary sector of industry, such as hairdressing and car servicing. 14 Using an example of a small business/recently established new business, explain how its owners overcame the three challenges you identified in Q4. 15 List three benefits of entrepreneurship to your country’s economy and explain why they are important.

[3]

[6] [4]

[7]

[9]

Cambridge International AS and A Level Business

Data response 1

Rivelino – entrepreneur, innovator and strategic thinker

Wesley had been really pleased with himself six months ago. His business plan for a new laundry business had been well received by the bank manager. She had agreed to lend him $30,000 – half of the capital he needed for starting the business. Wesley planned to offer a premium laundry service for local hotels and guesthouses that did not have their own sheet and towel washing facilities. His promise was ‘returned next day, or nothing to pay’. The number of customers was small at first, but news of Wesley’s service standards and next-day promise soon spread. By the end of month three, the laundry was working to full capacity and Wesley needed more resources. He recruited four workers to help him. At the end of month four, the bank manager asked to see him again. He was shocked by what he was told: ‘You have reached your overdraft limit and cash coming in to the business is not enough to ensure survival. I want to see all of your accounting and sales records next week,’ she told him. Wesley knew that would be a problem. He had been so busy that his accounting records were three weeks out of date. Customers had not paid during this period – because he had not sent the bills out. Some customers were claiming that they should not pay anyway as their laundry had taken three days to be returned. Another problem concerned the workforce. They were always arguing because there were certain jobs that no one wanted to do, such as handling the chemicals used and cleaning the boiling tanks at the end of each day. Wesley had not allocated jobs clearly enough and the workers could not decide themselves. After his visit to the bank, he sat down with all of the company’s paperwork and wondered why he had not gained some experience in computer-controlled accounting. Wesley’s own business skills had mainly been gained in marketing – no wonder the sales of the laundry were doing so well.

‘We are a global business,’ states Rivelino Simmons, one of the three partners in Integrated Trade Solutions (ITS). This is a fast-growing business that responds to the changing needs of other businesses by developing cutting-edge software to facilitate e-commerce and e-trade transactions within the regional and global marketplace. This is not Rivelino’s first business venture. He has also set up businesses selling herbal teas and arranging boat tours for tourists. He has always been on the lookout for business opportunities. He started by using his hobby of video filming to offer his skills to film companies as a freelance cameraman, quickly developing a large number of important business contacts. He is now one of the best-known freelance cameramen in the Caribbean region. However, ITS is his biggest success by far. He discussed the opportunity to set up a software development company with an old school friend who was trained in software design and development. There have been opportunity costs. Rivelino not only gave his time to the new business venture but he also contributed his savings, marketing skills and business contacts. Rivelino and his friend were also joined by another partner who brought financial skills as well as software design experience. After much success selling software to the Caribbean market, Rivelino and his fellow entrepreneurs plan to provide advanced customised software on a global scale. Rivelino’s vision is fuelled by a drive to succeed and a love for the software development business. He recognises, however, the strength of competing businesses and the changes occurring in the business world, especially in e-commerce.

[30 marks, 45 minutes] 1 a Define the term ‘entrepreneurs’. b Briefly explain the term ‘opportunity costs’.

[30 marks, 45 minutes] [2] [3]

2 Explain the qualities Rivelino has that make him a successful entrepreneur.

[6]

3 Analyse two examples of opportunity cost experienced by Rivelino when setting up ITS.

[8]

4 Assess the likely importance of a dynamic business environment to the future success of ITS.

Returned next day, or nothing to pay

[11]

1 a Define the term ‘capital’. b Briefly explain the term ‘resources’.

[2] [3]

2 Explain three problems that Wesley now faces in managing his business.

[6]

3 Explain the skills that Wesley should have had from the start of the business that would have reduced the significance of these problems.

[8]

4 Recommend to Wesley what steps he should now take to overcome the diff iculties his business is experiencing.

[11]

AS Level essay questions [20 marks, 40 minutes each] 1 To what extent do you believe that a successful entrepreneur depends on luck rather than personal qualities and skills? 2 a Outline the main benefits to your country’s economy of an increase in the number of new business start-ups made by entrepreneurs. b Discuss the challenges that face new business entrepreneurs in your country.

[20] [8] [12]

Business structure

This chapter cover syllabus section AS Level 1.2.

On completing this chapter, you will be able to: ■

■

classify industries into levels of economic activity – primary, secondary and tertiary understand the differences between the private sector and public sector in your country

■

identify the different forms of legal organisation of business and evaluate the most appropriate one for different businesses.

Introducing the topic Introduction DULIP’S BUSINESS IS A SUCCESS Dulip’s business had been operating successfully for two years when he decided to expand. He wanted his business to grow so that he could eventually bring his two sons into the venture. ‘I need to start using the timber I cut to make furniture and other products. This will allow me to add value to the natural products that I produce,’ he explained to his family. Dulip realised that he would need much more capital to build a furniture-making factory. Although his business was profitable, it was not making enough of a surplus to pay for the extra costs involved. ‘Why don’t you ask one of your friends to invest in your business?’ asked Maria, his wife. ‘This would mean that you would not have to borrow so much.’ Dulip thought about this and replied, ‘I could do this and also ask them to help me manage the business. I am not sure that I could carry all of the management responsibilities. I may consider making my business a legally recognised business – called a company – because this would be easier to leave to our sons and offers some protection for our savings.’

Points to think about: ■ ■

■ ■

Why is it important to Dulip that he should expand his business? Do you think it is a good idea for this business, currently only producing timber for other businesses, to make and sell furniture? Would you advise Dulip to involve one of his friends in the business? What benefits does Dulip think being a ‘company’ will offer to him?

In the last chapter, we recognised the importance of business activity to an economy. The role of entrepreneurs and the main characteristics of successful entrepreneurs were also studied. Building on this knowledge, this chapter focuses on the different types of business structures that exist and the different ways of classifying business activity. The importance of the legal structure used by a business is examined and these different forms are examined and evaluated. The diminishing role of public-sector enterprises in many countries, through the process of privatisation, is also explained and discussed.

Classification of business activity Firms produce a vast range of different goods and services, but it is possible to classify these into three broad types of business activity. These broad categories, introduced in Chapter 1, are also the three stages involved in turning natural resources, such as oil and timber, into the finished goods and services demanded by consumers. The stages are the primary, secondary and tertiary sectors of industry. KEY TERMS

Primary sector business activity: firms engaged in farming, fishing, oil extraction and all other industries that extract natural resources so that they can be used and processed by other firms. Secondary sector business activity: firms that manufacture and process products from natural resources, including computers, brewing, baking, clothes-making and construction. Tertiary sector business activity: firms that provide services to consumers and other businesses, such as retailing, transport, insurance, banking, hotels, tourism and telecommunications.

Cambridge International AS and A Level Business

Country

Secondary

Tertiary

China

Ghana

United Kingdom

Primary

Table 2.1 Employment data 2013 – as percentage of total employment

Changes in business activity It is very important to recognise two features of this classification of business activity: Primary production – dairy farm in France

1 The importance of each sector in an economy changes over time. Industrialisation is the term used to describe the growing importance of the secondary-sector manufacturing industries in developing countries. The relative importance of each sector is measured in terms either of employment levels or of output levels as a proportion of the whole economy. In many countries in Africa and Asia, the relative importance of secondarysector activity is increasing. This brings many benefits as well as problems.

Benefits

■ ■

Secondary production – clothing factory in China

■ ■ ■

Total national output (gross domestic product) increases and this raises average standards of living. Increasing output of goods can result in lower imports and higher exports of such products. 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 countries’ output of raw materials, rather than just exporting these as basic, unprocessed products.

Problems ■

■ ■

Tertiary sector – the breath-taking Burj Al Arab hotel in Dubai

The balance of these sectors in the economies of different countries varies substantially. It depends on the level of industrialisation in each country. Table 2.1 shows the differences between three countries.

The chance of work in manufacturing can encourage a huge movement of people from the countryside to the towns, which leads to housing and social problems. Imports of raw materials and components are often needed, which can increase the country’s import costs. Much of the growth of manufacturing industry is due to the expansion of multinational companies. The consequences of this are covered later in this chapter.

2 In developed economies, the situation is reversed. There is a decline in the importance of secondary-sector activity and an increase in the tertiary sector. This process is termed deindustrialisation. In the UK, the proportion of total output accounted for by secondary industry has fallen by 15% to 23% in 25 years. Reasons for this include:

2: Business structure

■

Rising incomes associated with higher living standards have led consumers to spend much of their extra income on services rather than more goods. There has been substantial growth in tourism, hotels and restaurant services, financial services and so on – yet spending on physical goods is rising more slowly. As the rest of the world industrialises, so manufacturing businesses in developed countries face much more competition and these rivals tend to be more efficient and use cheaper labour. Therefore, rising imports of goods are taking the market away from the domestic secondarysector firms.

3 The importance of each sector varies significantly between different economies. Table 2.1 gives details of the differences that exist between three different countries’ economies and the share of total employment accounted for by each sector of industry.

Public and private sectors Industry may also be classified in other ways, for example by public or private sector and by type of legal organisation. As we shall see, these two types of classification are interlinked, as some types of legal structure are found only in the private sector. What is the difference between the private sector and public sector of the economy? KEY TERMS

Public sector: comprises organisations accountable to and controlled by central or local government (the state). Private sector: comprises businesses owned and controlled by individuals or groups of individuals.

In nearly every country with a mixed economy, most business activity is in the private sector. The relative importance of the private sector compared to the public sector is not the same in all countries. Those economies that are closest to a free-market system have very small public sectors. Those countries with central planning command economies will have very few businesses in the private sector. KEY TERMS

KEY TERM

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

The types and sizes of businesses in the private sector can vary considerably. The legal organisation of firms in the private sector is covered below. In most mixed-economy countries, certain important goods and services are provided by state-run organisations as it is argued that they are too significant to be left to private businesses. These usually include health and education services, defence and public law and order (police force). In some countries, important strategic industries are also owned and controlled by the state, such as energy, telecommunications and public transport. In recent years, there has been a trend towards selling these off to the private sector – privatisation – and the impact of this policy is analysed on page 67. Another reason for the state or public sector to provide goods or services rather than the private sector is the existence of what economists call ‘public goods’. These are goods and services that cannot be charged for, so it is impossible for a private-sector business to make a profit from producing them. A good example is street lighting. It is impossible to exclude people from obtaining the benefit of the streetlights if they have not contributed to paying for them – so why should anyone contribute directly towards paying for them? This means that taxes will have to be used to raise revenue to pay for a street-lighting system and this means that it can be provided only by the public sector.

The legal structure of business organisations – the private sector Figure 2.1 on the next page shows the main types of private sector business.

Sole trader Th is is the most common form of business organisation. Although there is a single owner in this business organisation, it is common for sole traders to employ others, but the fi rm is likely to remain very small. Because of this, although they are great in number, sole traders account for only a small proportion of total business turnover. All sole traders have unlimited

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

KEY TERM

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

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.

Cambridge International AS and A Level Business

Private-sector businesses

Sole trader

Partnerships

Private (Ltd)

Limited companies

Cooperatives

Public (plc)

Figure 2.1 The private sector – legal structure

liability. Th is means that the owner’s personal possessions and property can be taken to pay off the debts of the business, should it fail. Th is can discourage some potential entrepreneurs from starting a business. Another significant problem is fi nance for expansion. Many sole traders remain small because the owner wishes to remain in control of their own business, but another reason is the limitations that they have in raising additional capital. As soon as partners or shareholders are sought in order to raise fi nance, then the sole trader becomes another form of organisation altogether. In order to remain a sole trader, the owner is dependent on their own savings, profits and loans for injections of capital. This type of business organisation is most commonly established in the construction, retailing, hairdressing, car-servicing and catering trades. The advantages and disadvantages of this form of organisation are summarised in Table 2.2.

Partnership The partnership agreement does not create a separate legal unit; a partnership is just a grouping of individuals.

Partnerships are formed in order to overcome some of the drawbacks of being a sole trader. When planning to go into partnership, it is important to choose business partners carefully – the errors and poor decisions of any one partner are considered to be the responsibility of them all. Th is also applies to business debts incurred by one partner – in most countries there is unlimited liability for all partners should the business venture fail. In the UK, it is possible to set up limited liability partnerships. It is usual, although not a legal requirement, to draw up a formal Deed of Partnership between all partners. Th is would provide agreement on issues such as voting rights, the distribution of profits, the management role of each partner and who has authority to sign contracts. KEY TERM

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

ACTIVITY 2.1 Read the ‘Introducing the topic’ case study on page 15 again. [15 marks, 20 minutes] Would you advise Dulip to convert his business into a partnership? Explain all of the potential advantages and disadvantages before giving your recommendation.

Partnerships are the most common form of business organisation in some professions, such as law and

Advantages

Disadvantages

■

■ ■ ■ ■ ■

easy to set up – no legal formalities owner has complete control – not answerable to anybody else owner keeps all profits able to choose times and patterns of working able to establish close personal relationships with staff (if any are employed) and customers business can be based on the interests or skills of the owner – rather than working as an employee for a larger firm

[15]

■ ■

■ ■ ■

unlimited liability – all of owner’s assets are potentially at risk often faces intense competition from bigger firms, for example in food retailing owner is unable to specialise in areas of the business that are most interesting – is responsible for all aspects of management difficult to raise additional capital long hours often necessary to make business pay lack of continuity – as the business does not have separate legal status, when the owner dies the business ends too

Table 2.2 Advantages and disadvantages of sole-trader organisations

2: Business structure

Advantages

Disadvantages

■

■ ■ ■ ■

partners may specialise in different areas of business management shared decision-making additional capital injected by each partner business losses shared between the partners greater privacy and fewer legal formalities than corporate organisations (companies)

■ ■

■ ■ ■

unlimited liability for all partners (with some exceptions) profits are shared as with sole traders, no continuity and the partnership will have to be reformed in the event of the death of one of the partners all partners bound by the decisions of any one of them not possible to raise capital from selling shares a sole trader, taking on partners, will lose independence of decision-making

Table 2.3 Advantages and disadvantages of partnerships

accountancy. Small building firms are often partnerships, too. Many other owners of businesses prefer the company form of organisation and these are considered next. The advantages and disadvantages of partnerships are summarised in Table 2.3.

Limited companies There are three distinct and important differences between companies and the two forms of ‘unincorporated’ business organisation that we have just studied. These are:

1 Limited liability The ownership of companies is divided into small units called shares. People can buy these and become shareholders – part owners of the business. It is possible to buy just one share, but usually these are owned in blocks, and it is possible for one person or organisation to have complete control by owning more than 50% of the shares. Individuals with large blocks of shares often become directors of the business. All shareholders benefit from the advantage of limited liability. KEY TERM

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.

Nobody can make any further claim against shareholders, should the company fail. This has two important effects: ■ ■

People are prepared to provide finance to enable companies to expand. The greater risk of the company failing to pay its debts is now transferred from investors to creditors (those suppliers/lenders who have not been paid). Creditors, as a result, are very interested in both checking whether the word ‘limited’ appears in the business name and

scrutinising the company’s accounts for signs of potential future weakness.

2 Legal personality A company is recognised in law as having a legal identity separate from that of its owners. Th is means, for example, that if the foods sold by a company are found to be dangerous or contaminated, the company itself can be taken to court – not the owners, as would be the case with either a sole trader or a partnership. A company can be sued and can itself sue through the courts. This does not take all legal responsibilities away from the managers and owners. For example, directors can be legally responsible if they knowingly continue trading when their company is illiquid. They must still act responsibly and in accordance with the stated aims of the business and within the law. 3 Continuity In a company, the death of an owner or director does not lead to its break-up or dissolution. All that happens is that ownership continues through the inheritance of the shares, and there is no break in ownership at all.

Private limited companies The protection that comes from forming a company is, therefore, substantial. Small firms can gain this protection when the owner(s) create a private limited company. KEY TERM

Private limited company: a small to medium-sized business that is owned by shareholders who are often members of the same family; this company cannot sell shares to the general public.

Cambridge International AS and A Level Business

Advantages

Disadvantages

■

■ ■ ■ ■ ■

shareholders have limited liability separate legal personality continuity in the event of the death of a shareholder original owner is still often able to retain control able to raise capital from sale of shares to family, friends and employees greater status than an unincorporated business

■ ■ ■

legal formalities involved in establishing the business capital cannot be raised by sale of shares to the general public quite difficult for shareholders to sell shares end-of-year accounts must be sent to Companies House – available for public inspection there (less secrecy over financial affairs than sole trader or partnership)

Table 2.4 Advantages and disadvantages of private limited companies

The word ‘Limited’ or ‘Ltd’ (‘Pte’ in some countries) tells us that the business has this legal form. 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 and these are explained in the section after public limited companies. The advantages and disadvantages of private limited companies are summarised in Table 2.4. KEY TERMS

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.

Public limited companies These can be recognised by the use of ‘plc’ or ‘inc.’ after the company name. It is the most common form of legal organisation for really large businesses, for the very good reason that they have access to very substantial funds for expansion. A public limited company (plc) has all the advantages of private-company status, plus the right to advertise their shares for sale and have them quoted on the stock exchange. Th is not only means that public KEY TERM

Public limited company: a limited company, often a large business, with the legal right to sell shares to the general public – share prices are quoted on the national stock exchange.

limited companies can raise potentially very large sums from public issues of shares, but existing shareholders may also quickly sell their shares if they wish to. Th is flexibility of share buying and selling encourages the public to purchase the shares in the fi rst instance and thus invest in the business. The other main difference between private and public companies concerns the ‘divorce between ownership and control’. As was explained above, the original owners of the business are usually still able to retain a majority of shares and continue to exercise management control when it converts to private company status. Th is is most unlikely with public limited companies, due to the sheer volume of shares issued and number of people and institutions as investors. These shareholders own the company, but they appoint, at the annual general meeting, a board of directors who control the management and decisionmaking of the business. This clear distinction between ownership and control can lead to conflicts, for example over the objectives to be set and direction to be taken by the business. The shareholders might prefer measures that aim at shortterm profits, whereas the directors may decide to aim for long-term growth of the business, perhaps in order to increase their own power and status. Many private limited companies convert to plc status for the reasons given in Table 2.5 on page 22. It is possible for the directors or the original owners of a business to convert it back from a plc to private limited company status: Richard Branson and the Virgin group is one of the best-known examples. The reasons for doing this are largely to overcome the divorce between ownership and control – in a private limited company, it is normal for the senior executives to be the major, majority shareholders. In addition, the owner of a private limited company can take a long-term planning view of the business. It is often said that the major investors in a plc are only interested in short-term gains. ‘Short-termism’ can be damaging to the long-term investment plans of a business.

2: Business structure

A summary of the advantages and disadvantages of public limited companies is given in Table 2.5 on the next page.

ACTIVITY 2.2

Twitter ‘goes public’

Legal formalities in setting up a company

Twitter founders – Evan Williams and Jack Dorsey – became multimillionaires overnight when Twitter sold 70 million shares at US$26 each. The decision to convert the business into a public limited company was mainly to allow directors to spend capital on expanding the ‘micro-blogging’ business with expensive purchases of other Internet businesses.

All governments insist that certain legal stages are completed before a company may be established, in order to protect investors and creditors. In the UK, the following steps must be taken: 1 A Memorandum of Association must be completed. KEY TERM

Memorandum of Association: this states the name of the company, the address of the head office through which it can be contacted, the maximum share capital for which the company seeks authorisation and the declared aims of the business.

[16 marks, 20 minutes] 1 Explain what ‘going public’ means.

[4]

2 Analyse two potential benefits to the founders of the company from the decision to sell so many shares to the public.

[6]

3 Analyse two potential drawbacks to Twitter of becoming a public limited company.

[6]

The last two points in this definition – the maximum share capital for which the company seeks authorisation and the declared aims of the business – are of great interest

ACTIVITY 2.3

Footie Ltd to stay private after ruling out float Footie Ltd, the shoemaker and retailer that in 2013 was planning to ballot the owning family on a possible public flotation, is to stay private. The chairman said yesterday that the board had received overwhelming advice against trying to float the company and convert it into a plc. The company has no need of further capital to fund further expansion. The board and the shareholder council, which represents 72% of the shares, had agreed that a ballot would be ‘effectively a waste of time’. The company was formed over 100 years ago and has grown into one of the world’s largest private limited companies. Recently, it came within five votes of opting for a takeover by Shoeworks plc after a decade of declining fortunes. However, in April it announced annual profits up from £42.7 million to £50.8 million on sales of £825 million. That was its third year of record profits, reflecting its strategy of reducing [30 marks, 35 minutes]

its reliance on own manufacture and investing in its brands and shops. Footie Ltd is now more of a retailer and wholesaler than manufacturer, owning or franchising 650 shops and importing shoes from abroad. Five years ago, 75% of its shoes were manufactured in Footie’s European factories. Now it is just 25%, with 40% of the business based in Asia. Jim Parker, chief executive, has claimed that Footie is the largest conventional shoe brand in the world, having sold 48 million pairs last year. Yesterday he said the business was expanding rapidly in nearly all markets. ‘I am confident that we can continue to build the business as the benefits of moving to lower-cost countries come through, along with investment in our brand and retailing operations.’ Despite ruling out a float for now, the company said it would continue periodically to examine ‘the most appropriate legal structure to meet shareholders’ interests in the light of its strategy for future growth and the conditions in the footwear market’.

1 Explain two differences between a private limited company and a public limited company.

[4]

4 Examine possible reasons for the directors deciding to keep Footie Ltd a private limited company.

2 Is Footie Ltd in the private or public sector? Explain your answer.

[3]

5 Analyse the main benefits to the business and to existing shareholders if the company did ‘go public’. [6]

3 Which industrial sector(s) does Footie Ltd operate in? Explain your answer.

[5]

6 Explain what appear to be the main reasons for the recent growth in profits at Footie Ltd.

[6]

Cambridge International AS and A Level Business

Advantages

Disadvantages

■

■ ■ ■

■

limited liability separate legal identity continuity ease of buying and selling of shares for shareholders – this encourages investment in plcs access to substantial capital sources due to the ability to issue a prospectus to the public and to offer shares for sale (called a flotation)

■ ■ ■ ■ ■

legal formalities in formation cost of business consultants and financial advisers when creating such a company share prices subject to fluctuation – sometimes for reasons beyond business control, for example state of the economy legal requirements concerning disclosure of information to shareholders and the public, for example annual publication of detailed report and accounts risk of takeover due to the availability of the shares on the stock exchange directors influenced by short-term objectives of major investors

Table 2.5 Advantages and disadvantages of public limited companies

to shareholders. Knowing the maximum share capital means that the relative importance of any one share can be determined. Being aware of the company’s aims means that shareholders can avoid businesses that may operate in markets and products – such as weapons – that they may not want to be associated with. 2 The other main document is called the Articles of Association. KEY TERM 22

Articles of Association: this document covers the internal workings and control of the business – for example, the names of directors and the procedures to be followed at meetings will be detailed.

■

■ ■

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 often buys the produce of the members and then sells it collectively in order to obtain a better price. The advantages of such business units are: ■ ■ ■

When these documents have been completed satisfactorily, the registrar of companies will issue a certificate of incorporation. Private limited companies may now begin trading. In addition, to gain a listing on the stock exchange, which as explained above will greatly increase the marketability of shares, the accounts and trading record of the business will be carefully scrutinised by the stock exchange.

Other forms of business organisation Cooperatives These are a very common form of organisation in some countries, especially in agriculture and retailing. It is common to differentiate between producer or worker cooperatives that are involved with making goods and consumer or retail cooperatives that sell goods and services. Certain features are common to all cooperatives:

All members can contribute to the running of the business, sharing the workload, responsibilities and decision-making, although in larger cooperatives some delegation to professional managers takes place. All members have one vote at important meetings. Profits are shared equally among members.

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.

The potential drawbacks can include: ■ ■ ■

poor management skills, unless professional managers are employed capital shortages because no sale of shares to the nonmember general public is 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 two firms. KEY TERM

Franchise: a business that uses the name, logo and trading systems of an existing successful business.

KEY TERM

Cooperative: a jointly owned business that produces or distributes goods or services operated by members for their mutual benefit – as in consumers’ cooperatives or farmers’ cooperatives.

This contract allows one of them, the franchisee, to use the name, logo and marketing methods of the other, the franchiser. The franchisee can then, separately, decide which form of legal structure to adopt. Franchises are a rapidly expanding form of business operation. They have

2: Business structure

allowed certain multinational businesses, which are now household names, to expand much more rapidly than they could otherwise have done, McDonald’s and Ben and Jerry’s being just two examples. Why would a business entrepreneur want to use the name, style and products of another firm? Consider the case study activity ‘Harry goes it alone’ on page 25, which includes all of the main features of a typical franchise contract. Table 2.6 below outlines the advantages and disadvantages of franchises.

KEY CONCEPT LINK

If buying a franchise only adds the cost of a business and does not lead to the potential to increase revenue or sell products at a higher prices, then the value created by a franchise operation could be lower than a nonfranchised one.

Benefits of opening a franchised business

Possible limitations

■

■ ■ ■ ■

fewer chances of new business failing as an established brand and product are being used advice and training offered by the franchiser national advertising paid for by franchiser supplies obtained from established and quality-checked suppliers franchiser agrees not to open another branch in the local area

■ ■ ■ ■

share of profits or revenue has to be paid to franchiser each year initial franchise licence fee can be expensive local promotions may still have to be paid for by franchisee no choice of supplies or suppliers to be used strict rules over pricing and layout of the outlet reduce owner’s control over their own business

Table 2.6 Advantages and disadvantages of franchises

ACTIVITY 2.4 23

Shah’s garage Salman Shah has been in business as a sole trader for many years, owning a small garage and petrol station. He has two sons and a daughter and they want to be involved in his business. Each of them is married and has a family. The garage supplies petrol and oil to local customers and some passing motorists. However, there is little profit in petrol retailing. The car-repair side of the garage is facing increasing competition from the large franchised operations of the major car manufacturers. Salman wants to expand the business so that his children can become involved – at present, the profits could not support more than one family. He is thinking of three possible ways to expand the business: ■

Ayman, one of his sons, has bus- and taxi-driving licences. There could be the chance of providing a taxi service with a new five-seater taxi.

■

The local bus services are being withdrawn. There is a possibility of running a bus service to local factories and schools. The bus would therefore not be used all day and every day. Local shops have been closing because of competition from supermarkets. Salman could build a small extension to the petrol-station shop and stock it with groceries and everyday household items. His daughter Stella would be keen to manage this shop.

Salman knows that unless he takes some quick decisions his business will not survive. He also wants to keep control of it and to pass it on, as a profitable firm, to his children. He has very little money saved and all of the expansion options will require capital. He is very keen to avoid business risks and he has always been opposed to borrowing money for his firm.

[25 marks, 35 minutes] 1 Assume that Salman’s garage is located in the area where you live. He can only afford to choose one of the possible ways of expanding. Which would you suggest and why? 2 For the option you have suggested in Q1, make and justify an assumption about how much capital you think the business will need.

[6]

[4]

3 Advise Salman on ways in which capital might be obtained, making clear the options open to him if he changed the form of business organisation.

[6]

4 Which form of business organisation would you suggest for Salman’s business, and why?

[9]

Cambridge International AS and A Level Business

KEY TERM

Holding company: a business organisation that owns and controls a number of separate businesses, but does not unite them into one unified company.

Often, the separate businesses are in completely different markets, and this would mean that the holding company had diversified interests. Keeping the businesses separate means that they are independent of each other for major decisions or policy changes, yet there will always be the possibility of centralised control from the directors of the holding company over really crucial issues, such as major new investments. Many McDonald’s restaurants are franchised outlets – like this one in Malaysia

Joint ventures These are not the same as a merger, but they can lead to mergers of the businesses if their joint interests coincide and if the joint venture is successful. The reasons for joint ventures are: ■

■ ■

Costs and risks of a new business venture are shared – this is a major consideration when the cost of developing new products is rising rapidly. Different companies might have different strengths and experiences and they therefore fit well together. They might have their major markets in different countries and they could exploit these with the new product more effectively than if they both decided to ‘go it alone’.

Public-sector enterprises – public corporations The use of the term ‘public’ in two ways often causes confusion. We have already identified public limited companies as being owned by shareholders in the private sector of the economy. Thus, public limited companies are in the private sector. However, in every country there will be some enterprises that are owned by the state – usually central or local government. These organisations are therefore in the public sector and they are referred to as public corporations. KEY TERM

Public corporation: a business enterprise owned and controlled by the state – also known as nationalised industry.

KEY TERM

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

TOP TIP Public limited companies are in the private sector of industry – but public corporations are not.

Such agreements are not without their risks: ■ ■ ■

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 blaming the other for mistakes. The business failure of one of the partners would put the whole project at risk.

Holding companies Holding companies are not a different legal form of business organisation, but they are an increasingly common way for businesses to be owned.

Public-sector organisations do not often have profit as a major objective. In many countries, the publicly owned TV channels have the quality of public-service programmes as their main priority. State-owned airlines have safety as a priority. In the section on privatisation, the issues involved in selling off public corporations to the private sector, and the resulting change in objectives that often follows, are considered. A summary of the potential advantages and disadvantages of public corporations is given in Table 2.7.

2: Business structure

Advantages

Disadvantages

■

■ ■

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 raised mainly from the government

■ ■

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, for example by opening a new branch in a certain area to gain popularity

Table 2.7 Advantages and disadvantages of public corporations

ACTIVITY 2.5

Harry goes it alone Harry was really bored with his job as second chef in a top-of-the-market hotel. He was also tired of being ordered around by the manager and the head chef. He never liked taking orders and had always hoped to use his talents preparing food for customers in his own restaurant. The main problem was his lack of business experience. Harry had just been to a business conference with a friend of his and had been interested in the franchising exhibition there. One of the businesses offering to sell franchises was Pizza Delight. This firm sold a new type of pizza recipe to franchisees and provided all ingredients, marketing support and help with staff training. They had already opened 100 restaurants in other countries and offered to sell new franchises for a one-off payment of $100,000. If Harry signed one of these franchising contracts, then he would have to agree to: ■ ■ ■

problems that small firms often experience and Pizza Delight would pay for national advertising campaigns. They assured Harry that no other Pizza Delight restaurant could open within five kilometres of one already operating. Harry was almost convinced that this was the business for him. He had inherited money from a relative. However, several things still bothered him, for example, would it give him the independence he wanted so much? 25

buying materials only from Pizza Delight fitting out the restaurant in exactly the way the franchiser wanted making an annual payment to Pizza Delight of a percentage of total turnover.

In addition, he would have to find and pay for suitable premises and recruit and motivate staff. Pizza Delight claimed that their brand and products were so well known that ‘success was guaranteed’. As the product had been tested already, there would be none of the initial

One important function of the franchisee is motivating staff

[25 marks, 35 minutes] 1 Explain three potential benefits to Harry of opening a franchised Pizza Delight restaurant.

[6]

2 Explain three potential drawbacks to Harry of agreeing to the terms of the franchise contract.

[6]

3 If he decided to open his own restaurant, but under his own name, why might the risks of failure be greater than for a Pizza Delight franchise?

[4]

4 Using all of the evidence, would you advise Harry to take out a franchise with Pizza Delight? Justify your answer.

[9]

Cambridge International AS and A Level Business

ACTIVITY 2.6

Ford teams up with Chinese auto maker A joint-venture agreement has been signed between the American auto giant Ford and China’s Chang’an Automobile Group. According to the agreement, the construction of a newly launched Chang’an-Ford Motor Company will be completed in two years. Each party holds 50% of the joint venture’s shares. The initial investment of the joint venture amounts to $98 million. Sources said that Chang’an-Ford will manufacture and sell Ford-designed cars as well as car parts and components. Ford started cooperation with its Chinese counterparts in manufacturing auto parts and components in 1978. The auto giant considers its latest move a necessary strategy to be a part of China’s fastdeveloping auto market. The market is expected to reach 22 million cars in 2014. Chang’an Automobile Group was established some 45 years ago and produced some 2.7 million automobiles in 2012. It ranked first in China’s mini-car production last year.

Nestlé and Fronterra in dairy joint venture in Trinidad A new joint venture has been announced by Nestlé and Fronterra. It creates a business that will concentrate on milk processing and the marketing of dairy products. This joint venture should strengthen the position of both companies in the Caribbean market. Nestlé concentrates mainly on marketing branded dairy products, but Fronterra is much better known as a milk-product processor. By combining forces in Trinidad and Tobago, the joint venture will gain from Fronterra’s production and processing facilities and experience and Nestlé’s marketing expertise. The potential for success of the new joint venture, which will make and sell dairy products in Trinidad and Tobago, appears high. Much will depend, however, on milk prices and the ability of the new management team, made up of employees from both companies, to work well together.

[25 marks, 35 minutes] 26

1 What seem to be the main reasons for the joint venture between Ford and Chang’an?

[4]

2 Which business, in your opinion, seems to gain most from this venture? Explain your answer.

[5]

3 What problems might these two businesses have in dealing with each other in this venture?

[4]

4 Evaluate the likely advantages to both Nestlé and Fronterra of their new joint venture in Trinidad and Tobago.

[12]

2: Business structure

SUMMARY POINTS Different methods of classifying business activity exist; the method used will depend on the nature and purpose of the study being conducted. Classification can be based on the level of activity: primary, secondary or tertiary. Classification can be based on the legal structure of the organisation. Classification can be based on whether the business is in the public or private sector. Businesses in the private sector can have different legal structures – the selection of the most appropriate one is an important factor in determining success.

RESEARCH TASK ■

Make a list of up to ten businesses that operate in your region or country. Try to select both small and large businesses.

■

Research the legal structure of these businesses, e.g. sole trader, public limited company etc.

■

Explain for any four of these businesses whether you think their legal structure is appropriate.

AS Level exam practice questions Short answer questions [48 marks, 1 hour] Knowledge and understanding 1 What is the difference between private-sector and public-sector organisations? [3] 2 State three differences between a sole trader and a private limited company. [3] 3 Who (a) owns and (b) controls a public limited company? Explain why this distinction might lead to conflict. [6] 4 State two benefits and two risks for a business of engaging in a joint venture. [4] 5 Why might the directors of a public limited company decide to convert the business back into a private limited company by buying a majority of the shares? [3] 6 Explain how legal identity and continuity help businesses and companies to operate effectively. [4] 7 How does limited liability make it easier for companies to raise finance? [3] 8 Using the examples of a sole trader business and a public limited company, explain how the relationship between ownership and control differs in these two types of organisations. [6] 9 Using the examples of a partnership and a public limited company, explain how the legal structure of a business affects its ability to raise finance. [4] 10 Why might an entrepreneur decide not to take out a franchise agreement, but to establish an independent business? [4] Application 11 List two organisations in your own country that are in the public sector. 12 Explain three advantages to your own country from increased industrialisation. 13 Why might an entrepreneur opening a hairdressing business stand a greater chance of success if they bought a franchise licence than if they attempted to establish an independent business?

[2] [3]

[3]

Cambridge International AS and A Level Business

Data response [AS Level – 30 marks, 45 minutes]

Joe to expand his business Joe Sharma owns a small tea and coffee blending and packaging business. He buys in coffee beans and tea leaves and processes them. He sells the finished product to chains of retail stores. His business is facing increasing competition from large processors of tea and coffee based in other countries. Sales of his product to retail stores are falling for another reason. The rapid increase in consumer income is leading to many more people eating and drinking in hotels and restaurants and buying less tea and coffee to consume at home. The situation with his business is becoming so serious that he is thinking of selling his factory and using the capital to purchase some cafés and tea shops. He would then be able to benefit from the changes in consumer spending habits. Joe realises that he will need more capital than the sale of his factory would raise. Therefore, he is considering converting his sole-trader business into either a partnership or a private limited company.

1 a Define the term ‘sole trader’. b Briefly explain the term ‘partnership’. 2 a In which sector of industry is Joe’s business currently operating? Explain your answer.

[2] [3] [3]

b In which sector of industry is Joe planning to set up his new business? Explain your answer.

[3]

3 Analyse the problems Joe might face in switching from making tea and coffee products to entering the café and tea shop market.

[8]

4 Advise Joe, giving your reasons, on the most suitable form of legal structure for the business, given that extra capital will be required. [11]

AS Level essay questions [20 marks, 40 minutes each] 1 a Explain the key features of limited companies. 28

b Evaluate the factors that the owners of a rapidly expanding private limited company should consider before deciding whether to apply for conversion to a public limited company. 2 a Analyse the potential benefits to an entrepreneur of setting up a franchised business. b Evaluate the use of joint ventures by a food manufacturing business planning to expand sales into other countries.

[8] [12] [8] [12]

Size of business

This chapter covers syllabus section AS Level 1.3.

On completing this chapter, you will be able to: ■

■

identify several ways of measuring the size of businesses and evaluate each of them analyse the beneficial impact that small firms can have on a country’s economy

■

analyse advantages and disadvantages of small and large businesses explain the difference between internal and external growth.

Introducing the topic TALE OF TWO INDUSTRIES The size of the average Indian steel plant compared to the size of the average Indian retail shop could not be more different. Steel plants employ thousands of workers, have millions of dollars of capital invested in advanced equipment and produce annual output valued in the millions too. Tata, one of the largest steel makers in the world, has recently grown by taking over European steel giant Corus. The contrast with typical Indian retail outlets could not be greater. The small shopkeepers and street hawkers that presently account for more than 95% of Indian retail sales often employ just a few workers with Tata steel plant, India little investment in modern technology. However, all this could be about to change. Points to think about: There is a growing trend of mergers and takeovers in ■ Why do you think the average steel plant is much larger the retail sector. Large retail groups, such as Reliance than the average shop? and Walmart, are becoming established. It is claimed ■ How could you compare the sizes of different businesses? that the market share of this organised sector will be ■ Do you think consumers of steel, such as car makers, will 28% by 2017. A pressure group of small retailers, the benefit from a takeover of Corus by Tata? National Movement for Retail Democracy, is organising ■ Do you think Indian consumers will benefit from demonstrations to demand that big corporations leave increasing numbers of large retail shops owned by just a few large corporations? the retail industry.

Introduction Businesses vary in size from sole traders with no additional workers to huge multinational corporations employing hundreds of thousands of employees. Measuring the size of businesses is a rather inexact science, but efforts are still made so that comparisons can be made between them, and so that growth or contraction can be assessed over time. This information is of interest

not only to the managers of a business, but to investors and governments too. Small firms offer many benefits for the dynamism of an economy and often receive special assistance from governments. Even the world’s greatest companies started off as very small firms and the ways in which firms can expand and the impact of these forms of growth on stakeholders are the focus of the last section of this chapter.

Cambridge International AS and A Level Business

Measuring business size It is common to compare businesses by their size. Who wants to know how large a particular business is? The government might wish to give assistance to ‘small’ firms, so will need a measure of size. Investors in a firm may wish to compare the size of the business with close competitors – particularly in order to compare the rate of growth. Customers may prefer to deal only with large firms, assuming, perhaps, that they are more stable and less likely to cease production than smaller ones. There are two problems with these and other requirements for a way of measuring business size: 1 There are several different ways of measuring and comparing business size and they often give different comparative results. A firm might appear large by one measure but quite small by another. 2 There is no internationally agreed definition of what a small, medium or large business is, but the number of employees is often used to make this distinction.

Different measures of size

1 Number of employees This is the simplest measure. It is easy to understand – for example, it is obvious to everyone that a shop run by just the owner or their family is small. It is also clear that a firm employing many staff is likely to be large. However, there are problems. How about a business that needs to employ only a few people – such as a highly automated computer-chip maker with expensive capital equipment? Example: There are two soft drink firms in the same town. One uses traditional methods of production, using 108 people to make 300,000 litres of drink a week. The other is totally automated and produces one million litres a week with just ten staff.

2 Revenue Revenue is often used as a measure of size – especially when comparing firms in the same industry. It is less effective when comparing firms in different industries because some might be engaged in ‘high-value’ production, such as precious jewels, and another might be in ‘low-value’ production, such as cleaning services. This measure is needed to calculate market share.

3 Capital employed Generally, the larger the business enterprise, the greater the value of capital needed for long-term investment, or the greater the amount of capital employed. Again, comparisons between firms in different industries may give a rather misleading picture. Two firms employing the same number of staff may have very different capital equipment needs, such as a hairdresser and an optician. The latter will need expensive diagnostic and eyesightmeasuring machines. KEY TERM

Capital employed: the total value of all long-term finance invested in the business.

4 Market capitalisation Market capitalisation can be used only for businesses that have shares quoted on the stock exchange (public limited companies). It is calculated by this formula: Market capitalisation = current share price × total number of shares issued KEY TERM

Market capitalisation: the total value of a company’s issued shares.

As share prices tend to change every day, this form of comparison is not a very stable one. For example, a temporary but sharp drop in the share price of a company could appear to make it much ‘smaller’ than this measure would normally suggest.

5 Market share Market share is a relative measure. If a firm has a high market share, it must be among the leaders in the industry and comparatively large. However, when the size of the total market is small, a high market share will not indicate a very large firm. This is calculated using the following formula: total sales of business ×100 total sales of industry

KEY TERM

Revenue: total value of sales made by a business in a given time period.

Market share: sales of the business as a proportion of total market sales.

3: Size of business

Other measures that can be used These will depend very much on the industry. The number of guest beds or guest rooms could be used to compare hotel businesses. The number of shops could be used for retailers. Total floor sales space could also be used to compare retail businesses.

TOP TIP

Small firms (including micro-enterprises) are very important to all economies and to the industry in which they operate. Encouraging the development of small business units can have the following benefits: ■

■

Profit is not a good measure of business size – but it can be used to assess business performance.

Which form of measurement is best? There is no ‘best’ measure. The one used depends on what needs to be established about the firms being compared. This could depend on whether we are interested in absolute size or comparative size within one industry. If an absolute measure of size is required, then it is almost certainly advisable to test a firm on at least two of the above criteria and to make comparisons on the basis of these.

■

TOP TIP If asked to comment on data showing the sizes of different businesses, do remember that if another measure were used, the conclusions about relative size might be very different.

■

The significance of small and micro-businesses Even though we have not established a universally agreed definition of small firms, it will be easy to identify them within your own economy. They will employ few people and will have a low turnover compared to other firms. The official definition within your own country could be discovered from the trade and industry department. It is now common to make a further distinction for very small businesses known as ‘micro-enterprises’. The European Union definitions are shown in Table 3.1.

■

Many jobs are created by small firms and, even though each one may not employ many staff, collectively the smallbusiness sector employs a very significant proportion of the working population in most countries. Small businesses are often run by dynamic entrepreneurs, with new ideas for consumer goods and services. This helps to create variety in the market and consumers will benefit from greater choice. Small firms can create competition for larger businesses. Without this competition, larger firms could exploit consumers with high prices and poor service. The cost of air travel has been reduced in recent years due to the establishment of many small airlines competing with the large, established companies. Small firms often supply specialist goods and services to important industries in a country. For example, the global car industry is dominated by major manufacturers such as Toyota, BMW and Ford. All of these large businesses depend on small specialist suppliers of on-board computers, high-quality audio equipment and headlights. Very often, by being able to adapt quickly to the changing needs of large firms, small businesses actually increase the competitiveness of the larger organisations. All great businesses were small at one time. The Body Shop began in one small rented store in 1976. Hewlett-Packard started assembling electrical equipment in Packard’s garage! The large firms of the future are the small firms of today – and the more small firms are encouraged to become established and expand, the greater the chances that an economy will benefit from large-scale organisations in the future. Small firms may enjoy lower average costs than larger ones and this benefit could be passed on to the consumer too. Costs could be lower because wage rates paid to staff may be less than the salaries paid in large organisations, or the sheer cost of the administration and management structure of bigger enterprises may increase their costs dramatically.

Business category

Employees

Revenue

Capital employed

Medium

51–250

over €10m to €50m

over €10m to €34m

Small

11–50

over €2m to €10m

Micro

10 or fewer

up to €2m

Table 3.1 EU classifications of business size

Cambridge International AS and A Level Business

ACTIVITY 3.1

Problem of defining size Supermarket

Employees

Capital employed (£m)

300

150

800

Y Z

Selling space (Sq. metres)

No. of outlets

250

55,000

500

1,200

300,000

1,200

700

1,000

400,000

1,500

400

150,000

1 Which business is largest, using the following measures of size: ■ employees ■ capital employed ■ revenue ■ selling space ■ number of outlets? [5]

3 Explain which would be the preferred measure of size in the following circumstances: ■ the government wishes to identify the supermarket with the greatest degree of monopoly power ■ a bank wishes to lend money to the business with the largest capital base ■ a shareholder wishes to invest in the business with the greatest sales potential.

[9]

2 What do your results tell you about your attempt to measure business size?

4 What can you conclude about the levels of eff iciency of these four businesses?

[6]

[25 marks, 35 minutes]

Revenue (£m)

[5]

Even huge corporations started out small! The founders of Hewlett-Packard started the business in this garage.

These factors demonstrate the key benefits to a country’s economy of a thriving small-business sector. They explain why nearly all governments are keen to encourage and assist business start-ups and existing small businesses.

Government assistance for small businesses Most governments provide special assistance for small businesses (see also Table 3.2). These include:

1 Reduced rate of profits tax (corporation tax) – this will allow a small company the chance to retain more profits in the business for expansion. 2 Loan guarantee scheme – this is a government-funded scheme that guarantees the repayment of a certain percentage of a bank loan should the business fail. This makes banks much more likely to lend to newly formed businesses. However, the rates of interest are often higher than market rates and the firm must pay an insurance premium to the government. 3 Information, advice and support will be provided through the Small Firms agency of the Department for Business, Innovation and Skills. 4 In very economically deprived areas, such as cities with high unemployment, governments finance the establishment of small workshops, which are rented to small firms at reasonable rents. Other aid is designed to help small firms overcome the particular problems that they frequently experience. These include: ■ Lack of specialist management expertise – often the owner has to undertake all management functions, such as marketing, operations management, keeping accounts and dealing with staff matters, because the business cannot afford to employ specialists in each of these areas. ■ Problems in raising both short- and long-term finance – small firms have little security to offer banks in exchange