1 1/ The Fundamentals of Business

Introduction to Business by Lawrence J. Gitman, Carl McDaniel, Amit Shah, Monique Reece, Linda Koffel, Bethann Talsma, and James C. Hyatt is licensed under a Creative Commons Attribution 4.0 International License (CC BY 4.0).

SOURCE: Pxfuel.

Business Basics

This module provides the basic structures of business, its organization, outside forces influencing it, and where it is heading in North America. It also explores how the world’s economies and governments shape economic activity. Each day in the United States, thousands of new businesses are born. Only a rare few will become the next Apple, Google, or Amazon. Unfortunately, many others will never see their first anniversary. The survivors are those that understand that change is the one constant in the business environment. Those organizations pay attention to the business environment in which they operate and the trends that affect all businesses and then successfully adapt to those trends. In this module, we will meet many businesses, both large and small, profit and not-for-profit, that prosper because they track trends and use them to identify potential opportunities.

The Nature of Business

We begin our study of business by introducing you to the primary functions of a business, the relationship between risk and profits, and the importance of not-for-profit organizations. The address the following topics:

• Examine the major components of the business environment and how changing demographic, social, political, and legal, and competitive factors affect all business organizations.
• Explore how economies provide jobs for workers and compete with other businesses to create and deliver products to consumers.
• Understand how governments attempt to influence economic activity through policies such as lowering or raising taxes.
• Discuss how supply and demand determine prices for goods and services.
• Examine key trends in the business environment, economic systems, and the competitive environment.

How do businesses and not-for-profit organizations help create our standard of living?

Take a moment to think about the many businesses you encounter on a typical day. As you drive to class, you may stop at a gas station that is part of a major national oil company and grab lunch from a fast food chain such as Taco Bell or McDonald’s or the neighbourhood pizza place. Need more cash? You can do your banking on a smartphone or other device via mobile apps. You do not even have to visit the store anymore: online shopping brings the stores to you, offering everything from clothes to food, furniture, and concert tickets.

A business is an organization that strives for a profit by providing goods and services desired by its customers. Businesses meet the needs of consumers by providing medical care, autos, and countless other goods and services. Goods are tangible items manufactured by businesses (i.e. laptops). Services are intangible (no physical presence) offerings of businesses. Physicians, lawyers, hairstylists, car washes, and airlines all provide services. Businesses also serve other organizations like hospitals, retailers, and governments, by providing machinery, goods for resale, and other items.

SOURCE: Pxfuel.

Businesses create the goods and services that are the basis of our standard of living. The output of goods and services people can buy with the money they have measures the standard of living. The United States has one of the highest standards of living in the world. Countries like Switzerland and Germany have higher average wages than the United States, their standards of living are not higher, because prices are so much higher, meaning the same amount of money buys less in those countries. The Economist website (link) has a current ranking of standards of living by country.

Businesses play a key role in determining our quality of life by providing jobs and goods and services to society. Quality of life refers to the general level of human happiness based on such things as life expectancy, educational standards, health, sanitation, and leisure time. Building a high-quality of life is a combined effort of businesses, government, and not-for-profit organizations. In 2017, Vienna, Austria, ranked highest in quality of life, followed by Zurich, Switzerland; Auckland, New Zealand; and Munich, Germany. It may come as a surprise that not one of the world’s top cities is in the United States: seven of the top 10 locations are in western Europe, two are in Australia/New Zealand, and one is in Canada. At the other end of the scale, Baghdad, Iraq, is the city scoring the lowest on the annual survey.¹

SOURCE: Julius Silver.

Creating a quality of life is not without risks, however. Risk is the potential to lose time and money or otherwise not be able to accomplish an organization’s goals. Without enough blood donors, the American Red Cross faces the risk of not meeting the demand for blood by victims of disaster. Businesses such as Microsoft face the risk of falling short of their revenue and profit goals. Revenue is the money a company receives by providing services or selling goods to customers. Costs are expenses for rent, salaries, supplies, transportation, and many other items that a company incurs from creating and selling goods and services. Some costs incurred by Microsoft in developing its software include expenses for salaries, facilities, and advertising. If Microsoft has money left over after it pays all costs, it has a profit. A company whose costs are greater than revenues show a loss.

Microsoft uses its resources intelligently, often increasing sales, holding costs down, and earning a profit. Not all companies earn profits, but that is the risk of being in business. In North American businesses today, there is generally a relationship between risks and profit: the greater the risks, the greater the potential for revenue (or loss). Companies that take too conservative a stance may lose to more nimble competitors who react quickly to the environment.

SOURCE: Pexels.

Take Sony, the Japanese electronics giant, once a leader with its Walkman music player and Trinitron televisions, steadily lost ground (and profits) over the past two decades to other companies by not embracing new technologies such as the digital music format and flat-panel TV screens. Sony misjudged what the market wanted and stayed with proprietary technologies rather than create cross-platform options for consumers. Apple, at the time an upstart in personal music devices, quickly grabbed the lion’s share of the digital music market with its iPods and iTunes music streaming service. By 2016, Sony restructured its business portfolio and has experienced substantial success with its PlayStation 4 gaming console and original gaming content.²

Non-profit Organization

Not all organizations strive to make a profit. A not-for-profit organization is an organization that exists to achieve some goal other than the usual business goal of profit. Charities such as Habitat for Humanity, the United Way, the American Cancer Society, and the World Wildlife Fund are not-for-profit organizations, as are most hospitals, zoos, arts organizations, civic groups, and religious organizations. Over the last 20 years, the number of non-profit organizations, employees, and the volunteers who work for them has increased considerably. Government is our largest and most pervasive not-for-profit group. Over 1.5 million nongovernmental not-for-profit entities operate in the United States today and contribute more than $900 billion annually.³

SOURCE: Pxfuel.

Like their for-profit counterparts, these groups set goals and require resources to meet those goals (but not profit-driven). A not-for-profit organization’s goal might feed the poor, preserving the environment, increasing attendance at the ballet, or preventing drunk driving. These organizations do not compete directly with one another like Ford and Honda, but compete for talented employees, volunteer time, and donations.

Hurricane Irma affected the island of Puerto Rico, the Kentucky, and Hawaii National Guard assisted storm victims by donating to disaster relief efforts. Some not-for-profit charities focused aid toward the people of the region, but others delivered care to sufferers: animals and pets. Most animal hospitals are not normally a refuge for displaced animals, many facilities opened their doors to pet owners affected by the torrential rains.

The boundaries that formerly separated not-for-profit and for-profit organizations have blurred, leading to a greater exchange of ideas between the sectors. For-profit businesses are now addressing social issues. Successful not-for-profits apply business principles to operate effectively. Not-for-profit managers concern themselves with the same concepts as their colleagues in for-profit companies: developing strategy, budgeting carefully, measuring performance, encouraging innovation, improving productivity, demonstrating accountability, and fostering an ethical workplace environment.

Top executives manage the administrative and business side of the organization: human resources, finance, and legal concerns. Ticket revenues cover a fraction of the museum’s operating costs, so the director spends a great deal of time seeking major donations and memberships. Today’s museum boards of directors include both art patrons and business executives who want to see sound fiscal decision-making in a not-for-profit setting. A museum director must walk a fine line between the institution’s artistic mission and financial policies. According to a survey by The Economist, over the next several years, major art museums will look for new directors, as more than a third of the current ones are approaching retirement.⁴

Table 1. Charity versus Non-Profit Organization

SOURCE: Government of Canada, 2016.

In Prince Edward Island, non-profit organizations can be incorporated by letters patent under Part II of the Companies Act. Non-profit companies have members but do not share capital. The provincial government has dedicated resources to support non-profit organizations on their website (link), including affordable housing, green space initiatives, and hardware like computers for co-operatives and non-profits alike. In Canada, non-profit organizations are clubs, societies, or associations that operate solely for social welfare, civic improvement, pleasure/recreation, or any other purpose except for-profit.⁵

Unlike non-profits, Canadian charities must use their resources for charitable activities and purposes that fall into one or more of the following categories:

• relief of poverty
• advancement of education
• advancement of religion
• other purposes that benefit the community

Examples of charities include:

• relief of poverty (food banks, soup kitchens, and low-cost housing units).
• advancement of education (colleges, universities, and research institutes).
• advancement of religion (places of worship and missionary organizations).
• purposes beneficial to the community (animal shelters, libraries, and volunteer fire departments).⁶

Factors of Production: Foundation of Business

To provide goods and services, organizations require factors of production (resources). Four traditional factors of production are common to all productive activity: natural resources, labour (human resources), capital, and entrepreneurship. Many experts now include knowledge as a fifth factor, acknowledging its key role in business success. By using the factors of production efficiently, a company can produce more goods and services with the same resources.

Natural resources are useful input commodities in their natural state, including farmland, forests, mineral and oil deposits, and water. Sometimes natural resources are “land,” although the term means more than just land. Companies use natural resources in different ways like the International Paper Company using wood pulp to make paper or Pacific Gas Electric Company using water, oil, or coal to produce electricity. Today urban sprawl, pollution, and limited resources have raised questions about resource use. Conservationists, environmentalists, and government bodies are proposing laws to require land-use planning and resource conservation.

Labour, or human resources, refers to the economic contributions of people working with their minds and muscles. This input includes the talents of everyone (from a restaurant cook to a nuclear physicist) who performs the many tasks of manufacturing and selling goods and services. Capital is the tools, machinery, equipment, and buildings used to produce goods and services and get them to the consumer. Sometimes the term capital is also used to mean the money that buys machinery, factories, and other production and distribution facilities. Money itself produces nothing, it is not one of the basic inputs as it is a means of acquiring the inputs and not money.

Entrepreneurs are the people who combine the inputs of natural resources, labour, and capital to produce goods or services to make a profit or accomplishing a not-for-profit goal. These people make the decisions that set the course for their businesses; they create products and production processes or develop services. There is no guarantee their time and effort are profitable, but if successful, can create great wealth.

Today, many individuals want to start their own businesses as media often prop entrepreneurship, wealth, and personal prestige. Many start their first business from their dorm rooms (i.e. Mark Zuckerberg of Facebook), or while living at home, so their cost is almost zero. Entrepreneurs include people such as Microsoft cofounder Bill Gates (the richest person in the world in 2017), and Google founders Sergey Brin and Larry Page. Micro-, small-, and medium-sized business account for most businesses operating globally, making significant contributions (local through to global markets).

Several outstanding managers and noted academics are emphasizing a fifth factor of production, knowledge. Knowledge refers to the combined talents and skills of the workforce and has become a primary driver of economic growth. Today’s competitive environment places a premium on knowledge and learning over physical resources. Recent statistics suggest that the number of U.S. knowledge workers has doubled over the last 30 years, with about 2 million knowledge job openings annually. Automation has replaced many “routine” jobs over the last decade or outsourced to other countries, technology has actually created more jobs that require knowledge and cognitive skills.

Footnotes