Foundation of Business Studies

Introduction

• Business as a profession originated from the necessity to deal with the economic problem of scarcity.
• The 4 most basic concepts used to describe this economic problem are:
  • Need – This is any good or service that is essential for sustaining life, or allowing one to enjoy a decent living. This includes food, housing, clothes, education, and decent healthcare services.
  • Want – This is any desired good or service that can make life more comfortable, but is not essential for sustaining life. This includes a fancy smartphone, curved Smart television (TV), and a high-end car. Wants usually improve the standards of living of a person.
  • Scarcity – This is the state that exists when the available resources and means of production of goods and services cannot deliver enough goods and services to meet the needs and wants of the population.
  • Economic Problem – A state where available resources are limited, and the available supply of goods and services cannot meet the demands of the market or community, hence causing scarcity. Evidently, the economic problem is scarcity.
• Wants can be infinite (that is [i.e], unlimited), while needs can be finite.
• The ability to meet one’s needs and wants can be used to designate the relative wealth status of a person. A person who fails to meet his/her needs is considered poor, while one who can meet most of his/her wants is considered rich.
• Scarcity is caused by limited factors of production.
• Factors of Production is the collective designation of the resources required to create goods and services. If these factors of production are limited, then it follows that the production of goods and services is limited.
• The factors of production are:
  • Natural Resources – This is the land and all resources availed by nature including natural forests, wildlife, water bodies, and minerals such as oil, gas, and metals, as well as domesticated animals. It usually provides the raw material that needs to be converted to a product that can be sold.
  • Labor – This is the collective term that describes the pool of people ready to expend/use their energy, skills, and knowledge to transform raw material into a final product.
  • Capital – This term describes the resources needed to convert the raw material into goods that can be traded, i.e tradable goods. It includes finance, machinery (including heavy machines needed for extracting the raw material), and other manufacturing equipment needed for processing the raw material into tradable goods.
  • Enterprise – This is the quality of a person or entity to take a risk and use skills to bring together the 3 aforementioned factors of production so as to produce tradable goods. The enterprise can be a mining company, a manufacturing company, bank, retail business, or wholesale business.
• The person who engages in an enterprise is called an entrepreneur. The action of engaging in enterprise is described as entreprenuership.
• Limited resources compel a person to satisfy one want and forego another want, i.e one is forced to choose to fulfill one want and not the other. This choice of meeting a specific want over another want creates an opportunity cost, which is the value of the unmet want. For example (e.g), if a company has a fixed amount of money that can be used to buy either a lathe machine or a stamping machine, and the business decides to purchase the lathe machine, then the opportunity cost is equal to the value of the stamping machine because the business will not have this machine nor benefit from its services.
• Unlimited wants and limited resources to fulfill them creates a choice of which want to fulfill. This choice creates a priority of wants with high-priority wants being fulfilled first while low-priority wants are fulfilled later.
• To efficiently use the available limited resources, specialization is necessary. Specialization simply means that each business, person, or entrepreneur focuses on what (s)he/it is best at. Specialization creates a division of labor during production.
• The production process can be divided into its constituent tasks, and a worker is assigned to complete only one task. This is division of labor.
• Business is related to enterprise, and it serves to combine the factors of production in a way that they can produce products that can meet the wants of a population.
• A product is any good or service that can be sold in the market. A good is any tangible product such as food, car, or house; while a service is any intangible product such as banking and insurance.
• Business activity can be summarized as the process that combines scarce resources to produce products that the population wants while employing workers who are paid wages and salaries that allow them to purchase products in the market. Therefore, business activity is associated with the production of products, and the generation of payments for labor.
• An efficient business adds value to its products or raw materials. A product is usually sold at a higher price than the cost of purchasing or making it, and this difference between the selling price and production cost (which includes the buying price for finished products) is called the added value. For instance, a rancher buys a bull for US$1000, then goes to feed and vaccinate it before selling it off for US$2500. The added value is US$1500, and it covers the cost of feeding, vaccinating, housing, and deworming the bull among other miscellaneous costs (including transporting it to and from the ranch), as well as the profit the rancher made. Thus, added value includes the profit but it is not the profit. If the added value does not cover all the expenses used by the business before the product is sold, then the product is said to be sold at a loss.
• There are 2 main ways to increase the added value:
  • Raise the selling price.
  • Reduce the manufacturing cost or buying price (of the product/material).

Sectors of the Economy

• There are 3 levels of economic activity, also called stages of production:
  1. Primary (Stage 1) Level of Production – This involves working with natural resources, and it involves activities such as farming, mining, fishing, agro-forestry, and animal husbandry. Basically, it involves producing the raw materials for the stage 2 level of production. These raw materials are produced from natural resources. It is also called the primary sector of the economy or industry.
  2. Secondary (Stage 2) Level of Production – This involves converting the raw materials from the primary sector into processed goods. Its primary activities include manufacturing, construction, and food processing. It is also called the secondary sector of the economy or industry.
  3. Tertiary (Stage 3) Level of Production – This is the service sector of the economy that provides services to both businesses and consumers. Its principal activities include retail or wholesale trade, insurance, banking, tourism, and transport. As expected, it is described as the tertiary sector of the economy or industry. There are also two unique levels of economic activity that fall under this sector, and they are:
     • Knowledge Economy – This is the intellectual activities associated with technological innovation, education, scientific research, and cultural progress. Basically, it involves all intellectual activities that are associated with knowledge production. Alternatively, it is described as the quaternary sector.
     • Quinary Sector – This is the sector involved in ultimate decision-making that decides which economic activities are to be pursued, and how they are to be pursued, as well as how their output or progress are to be appraised or monitored. Key actors in this sector are the top executives in businesses, companies, and state corporations; as well as top officials in governments and universities. It is sometimes considered a sub-entity of the quaternary sector.
• The 3 sectors of the economy make up the national economy of a nation. The relative importance of each sector to the national economy is determined by the:
  • Proportion of its output to the total national output i.e proportional contribution to the total national output.
  • Percentage of the labor force employed in the sector.
• In developing nations, the primary sector employs most of the workforce – usually in agriculture and mining – and contributes the largest percentage of revenues to the national economy, usually larger than the secondary and tertiary sectors combined. On the other hand, in developed nations, the secondary and tertiary sectors of the economy form the largest share of the economy. In nations considered the most developed nations, the tertiary sector contributes the largest percentage of revenues to the national economy, usually larger than the primary and secondary sectors combined.
• During the transition from a developed nation into a most developed nation, de-industrialization occurs.
• Deindustrialization describes the phenomenon of a decline in the output of the manufacturing sector, which results in a decline in the relative importance of the secondary sector to the national economy. In a nation that is transitioning into a most developed nation, deindustrialization occurs as the service sector gains prominence. Sometimes, deindustrialization occurs as a nation experiences economic decline which results in the primary sector dominating the national economy. This form of deindustrialization is marked by material simplification, and it is one of the hallmarks of collapse of a complex society. This collapse known as societal collapse is characterized by loss of the secondary sector of the economy which results in loss of socioeconomic complexity, with an attendant loss of strong government instutions and rule of law which results in an upsurge of violence and devaluation of civilized societal norms and morals that results in a hostile business environment.
• In a country, there are 2 sectors of economic ownership. They are:
  • Public Sector – This is made up of businesses that are owned or controlled by the government e.g parastatals and state corporations. Decisions are made by the government or state bodies, which also set the prices of its goods and services. The main businesses that are included in the public sector are utility companies that supply water and electricity to residents, public transport, defense, education, and health-care services.
  • Private Sector – This is made up of businesses and enterprises not owned nor controlled by the government. In this sector, business owners and executives make decisions regarding how to increase their output, how to do it, what products to prioritize, and most importantly, how their products are to be priced. Sometimes, product pricing in this sector is subjected to government regulations.
• In a mixed economy, the public and private sectors co-exist together.
• At times, the government sells a public sector business to a private sector business, and this is called privatization. Privatization usually increases product quality and improves service delivery, but at the cost of laying off workers as part of cost-cutting measures, along with non-prioritization of social objectives.
• The money invested in any business is called capital. Privatization allows private businesses to invest capital in privatized businesses. A privatized business is a public business that has been bought by a private business.

Entrepreneurship

• The person who chooses to take a risk to start a new business venture is generically described as an entrepreneur. Apart from risking his/her capital and finances from investors, there is also the opportunity cost of foregoing salaried employment for self-employment.
• The key qualities of an entrepreneur are that (s)he is:
  • Hardworking.
  • Creative – (S)he has the ability to come up with new ideas.
  • Innovative – (S)he has the ability to put new ideas into practice, and monetize them.
  • Self-confident.
  • Amenable to taking risks.
  • Optimistic.
  • Effective communicator.
  • Independent.
• A government supports a business start-up because it can:
  • Create employment.
  • Increase competition in the market, which enhances market competitiveness.
  • Increase the total economic output of the market.
  • Support social objectives such as helping disadvantaged groups.
  • Grow into a large business.
• Government support can take the form of:
  • Provision of low-interest loans to start-ups.
  • Creation of enterprise zones where start-ups are provided with low-rent business premises.
  • Organizing sessions where entrepreneurs can engage with business experts and receive business advice.
  • Grants to start-ups that employ a set number of people from an economically-distressed area plagued with high unemployment.
  • Provision of research facilities and funding to support market research, and allow entrepreneurs to access this research.
• The size of the start-up business is determined by the:
  • Capital Employed: This is the amount of capital raised that is actually injected into the business.
  • Number of Employees: This is principally influenced by the production method used by the business to create the product that it sells. For instance, a factory with an automated production line can achieve high product output using a few workers.
  • Sales Value: This is the number of items sold by a business. It is useful for determining the size of a retail business, as well as comparing 2 retail businesses that sell the same products.
  • Output Value: This is influenced by the number of products produced by the business and the cost per unit of product. For instance, a low output of high-value products can create a larger output value than a high output of low-cost items.
• A business that requires a high amount of capital in order to become operational, e.g a highly-automated factory, is called a capital-intensive business.

Business Plan

• Before starting a business, the entrepreneur must create a business plan that indicates how the business is to be run, its future projections, anticipated challenges, and how to manage these challenges.
• The business plan is usually printed on a document where the entrepreneur states the business objectives (including products to be sold and targeted consumer base) and location of the business, as well as detail of its (business) operations, resources required, operating costs, projected cash flow, anticipated challenges, and how capital is to be raised. Additionally, it considers the prospects for growth. It can also include a list of business owners if the start-up is to be owned by a partnership.
• The business plan document is required to have the following:
  • Name of business.
  • Type of business – Is it a sole proprietorship, a partnership, or a corporation?
  • Business owner(s).
  • Business location.
  • Business aim.
  • Products to be sold. This is usually provided as a list.
  • The average price of each product.
  • Targeted market.
  • Market research that was done prior to drawing up this plan, and the research findings and analysis. Research results are usually included as part of the appendix.
  • Labor plan – that is described as the human resource plan – if the business plans to employ workers.
  • Capital.
  • Mandatory business resources such as equipment, furniture, and sale tools.
  • Business operation costs. This includes costs of input or stock, fixed business costs, and variable business costs.
  • Anticipated cash flow.
  • Profit forecast.
  • Anticipated challenges.
  • How to manage challenges.

• The entrepreneur may need to provide a business plan so as to access an overdraft facility or credit or loan.

Business Growth, Mergers, Acquisition, and Conglomerate Integration

• The benefits that business growth brings to its owners and shareholders are:
  • Increase in total profit.
  • High status and market prestige.
  • Decrease in operating costs per capita due to economies of scale.
  • Increase in proportion of market share which can create market dominance or monopoly that gives the business great leverage when dealing with suppliers. It can even set the price of products it purchases from these suppliers as is the case with Walmart Incorporated.
• There are two main ways in which a business can grow: internal growth and external growth.
• Internal growth basically means that the business expands its operations, e.g a retail store opening new branches in different cities. This form of growth is usually slow but easily manageable. In most cases, profits made in existing business operations are used to fund internal growth. It is also called organic growth.
• External growth means that the business acquires another existing business, either through a direct acquisition or a merger.
• Merger means that the owners of the businesses agree to have their businesses joined into one business, while acquisition means that one business buys another business and thus the owner of the bought business cedes ownership of the business once (s)he has been paid the agreed amount of money. Acquisition is also called takeover.
• A merger or acquisition is considered an integration because the operations of two or more businesses are synchronized and merged together to fit the business operations of a single business, i.e operations of two or more businesses are integrated together so as to create a unified and streamlined business flow.
• The main types of external growth are:
  • Horizontal Merger: This occurs when the business acquires an existing business in its stage of production in the same industry or market sector e.g a shoe retail store acquires another shoe retail store. It is also called horizontal integration. Horizontal integration increases the market share of the (new) integrated business, while decreasing the number of competitors in a market. It can also create economies of scale.
  • Vertical Merger: This occurs when the business acquires an existing business in a different stage of production in the same industry or market sector e.g a furniture company acquiring a lumbar company. It is also called vertical integration. This vertical integration can be:
    • Forward Integration – The business acquires an existing business whose stage of production is closer to the end consumer, e.g a furniture company acquiring a furniture retail store. Forward integration gives a business better access to the consumer, as well as access to information about consumer preferences and needs.
    • Backward Integration – The business acquires an existing business whose stage of production is closer to the primary sector e.g a furniture company acquiring a lumber yard. This assures the business a steady supply of raw materials for producing its products, as well as denying competitors access to the supplier, besides allowing the business to influence the cost of raw materials (or components) in the market so as to increase production costs for rival businesses. For example, buying timber from agroforesters decreases the supply of timber in the market for other lumbar yards, which forces these lumber yards to increase the price of processed wood that they sell to rival furniture companies, and in turn these furniture compnaies increase the prices of their furniture which makes their products less competitive in the consumer market.
  • Conglomerate Merger: This occurs when the business acquires an existing business in a different industry or market sector. This is also called diversification or conglomerate integration. For instance, a furniture company acquiring a real estate company. It allows for risk to be spread across different industries, in addition to enabling the sharing of ideas across different industries.
• Business growth can also present problems such as:
  • Inability to effectively control the integrated business.
  • Incompatibility of business operations such as management styles and work ethics in the 2 or more businesses being merged together.
  • Poor communication with staff acquired from merged businesses.
  • High cost of mergers and acquisitions can make business expansion quite costly.
• Decentralization of business operations by allowing the separate units of the combined business to run their affairs with relatively high degree of autonomy in the domains of business decisions and execution of business strategies can help alleviate the problem posed by poor communication, challenges in control, and difficult integration of business operations.

Why Some Businesses Remain Small and Others Fail

• Some businesses are forced by circumstances to stay small, and the 3 main causes of this are:
  • Type of Business: If the business offers personalized services to its consumers, e.g hairdressing, then it is difficult to grow as growth increases the customer pool which causes the business to lose its close personal touch with its individual customers.
  • Market Size: A small market size with a limited pool of target consumer base compels a business to stay small. This explains why a specialist business that caters to niche luxury markets remains small and avoids mergers or acquisitions.
  • Preference of Owner: Some business owners want to keep their businesses small, principally because it allows them to easily control them.
• Not all businesses are successful, and some fail. The main reasons why businesses fail are:
  • Poor management that is usually caused by a lack of experience in running a business.
  • Over-expansion or poor thought-out expansion that leads to dysregulated cash flows and budgets.
  • Poor financial management can lead to a shortage of liquid cash and the piling of debts which can result in insolvency. Insolvency simply means the inability of a business to pay debts.
  • Poor change management or inability to plan for change in a highly fluid business environment. Usually, this change is caused by new competitors entering the market, new technology, or sudden changes in local economies e.g lockdown to limit the spread of SARS-CoV-2 has caused nightclubs and bars to close down.

Business Organization

• A business that is not considered (as) a separate legal entity from its business owner(s) is called an unincorporated business.
• An incorporated business is a legal trading entity whose identity is separate from its individual owner(s), and continues to exist if one of its owners dies or is incapacitated; and the business can legally enter into binding (legal) contracts and agreements. As expected, the business account is separate from the personal accounts of its owners.
• There are 6 types of business organizations in the private sector:
  • Sole Proprietorship: This business is run and managed by the owner who is described as the sole proprietor. In the legal sense, it is the easiest business to set up, hence its popularity. It is also called a sole trader organization. The demerit of sole proprietorship is its unlimited liability. Liability is the debt and obligations that the business entity owes to its creditors, suppliers, consumers, and service providers (e.g insurance providers). Unlimited liability means that the business entity and the owner are not two separate legal entities, and thus debts incurred by the business can be repaid by selling both the business stock and the private property of the owner.
  • Partnership: This business is owned and managed by 2 or more entrepreneurs who have agreed to start and run it. Each entrepreneur is considered a partner in this partnership. Normally, the partners raise the capital, make joint decisions, and share the profits. This partnership can be formed informally through a verbal agreement where the entrepreneurs agree to be partners in the business, or formally through a legally-bidding written deed of partnership, also called a partnership agreement. In some jurisdictions, entrepreneurs can form a limited liability partnership. The limited liability partnership (LLP) is a unique partnership that creates allows the liability of each partner to be determined by his/her capital contribution to the business, thus introducing limited liability while allowing the business to be recognized legally as a distinct (separate) legal entity. Therefore, the LLP is an incorporated limited liability business that continues to exist after the demise of one of the partners. Even so, none of the partners is allowed to sell shares.
  • Private Limited Company (PLC): This is an incorporated business that is jointly owned by 2 or more people who are given shares as proof of ownership. Because each owner has shares, (s)he is called a shareholder, and the shares are the amount of capital that (s)he has invested in the business. The shareholders appoint a board of directors to run and manage the business. Because this type of business is owned by shareholders and is run by appointed directors, it is described as a company. In most PLCs, the directors are usually the majority shareholders. The majority shareholder is the investor who owns the largest proportion of shares issued by the company. Unlike the LLP, the PLC allows its shareholders to sell their shares or buy the shares of other investors, but this must be done with the consent of the other shareholders. As a legally incorporated business entity with limited liability, the trading name of a PLC is required to end with Limited (or its abbreviation Ltd) or proprietary limited [or (Pty) Ltd]. To form the PLC, the shareholders must send the following 2 documents to the registrar of companies:
    • The Articles of Association – This has the rules of management of the PLC, including how the directors are chosen/elected, when and how they will hold official meetings, and the duties and rights of each director; as well as procedures and rules governing the issuance of shares.
    • The Memorandum of Association – This has the name, address, and objectives of the PLC, as well as its directors. It also states the number of shares owned by each director.
    • These 2 documents allow the registrar of companies to issue a certificate of incorporation to the PLC so that it can start trading.
  • Public Limited Company: This is an incorporated limited company in the private sector that is allowed to sell its shares to the general public. In the United Kingdom (UK), the company name must end with plc. In the United States of America, PLC is called a Publicly Traded Company (PTC), Public Company, Public Limited Company, Publicly Listed Company, or Publicly Held Company. Unlike the PLC, a public limited company must be managed by professional managers who serve as the company directors, even if they do not own shares in the company. It is legally mandatory for this company to hold an annual general meeting (AGM), which allows shareholders to vote for the directors who are tasked with the management and ultimate decision-making responsibilities in the company. Therefore, unlike the PLC, majority shareholders do not necessarily have control over the running of operations or decision-making in the company. The elected directors make up the Board of Directors (BoD) which is tasked with employing managers to run daily operations in the company. The public limited company is said to exercise divorce between ownership and control as it is the shareholders who own the company, but it is the BoD and its managerial staff who control the company. Once per year, this company pays dividends to its shareholders. Dividends are the after-tax profit paid to shareholders as annual returns to investors.
  • Joint Venture: This occurs when 2 or more existing businesses come together to pursue a for-profit project, and they share the risks, profits, and losses; as well as contribute capital for the project. This for-profit project is described as a venture.
  • Franchising: This is a method of doing business where a business, called the franchisor, leases out rights to other businesses to use its patented business idea in its operations, or sell its proprietary products. This means that the franchisor does not sell its products directly to the end consumer, instead licensing another business called the franchisee to sell the products to these end consumers. This business model whereby a franchisee is licensed to use the brand name, logo, and trading method of the franchisor is called a franchise. Normally, the franchisor supplies the products sold by the franchisee, and at times trains the staff of the franchisee, besides managing advertisements for all its franchises.
• The main type of business organization in the public sector is the public corporation.
• A public corporation is a government-owned company that is managed by a BoD appointed by governmental authorities, and the BoD is expected to conform to guidelines and objectives set by the government. This makes it analogous to the public limited company, but with a far limited divorce between ownership and control. Public corporations usually exist to prevent private-held monopolies from exploiting consumers or adversely impacting government planning, as well as ensure that government owns providers of critical public services such as electricity providers, water suppliers, and public transport.
• A nationalized business is a business that once belonged to the private sector but was acquired by the government. It is the contrapositive of a privatized business.