Unit 1.1 Introduction to Business Management

Unit 1.1 Introduction to Business Management

Unit 1.1 This chapter explains what a business is and what businesses do. It outlines the main business functions (or departments) and explains the differences between sectors. Primary Secondary Tertiary Quaternary

The Economic Problem: Needs & Wants
A need is something we have to have to live e.g. food, water, clothing A want is something we desire but don’t necessarily have to have e.g. jewelry, holidays abroad. Activity: Make a list of your personal needs and wants. Limit your wants to 10 items.

The Economic Problem Wants are unlimited, however, resources are limited. This creates scarcity. Because of scarcity, we have to make choices. When making a choice, the next best alternative we had to give up is called the opportunity cost.

Opportunity Cost Activity
What could be the opportunity cost of using some land to build a restaurant? What could be the opportunity cost of spending $ 200 on a pair of Nike sports shoes?

What is opportunity cost?
It is defined as the best alternative that is foregone when making a decision Differs from ACCOUNTING COST – in that accounting costs do not look at the cost (or value) of foregone choices e.g. student education accounting cost = tuition fees + books opportunity cost = foregone income if the person chose to study instead of working

Businesses exist to satisfy needs and wants of people, organization and governments

What is a business? Business is a decision-making organization involved in the process of using inputs to produce goods and/or to provide services. Are organizations involved in the production of goods and/or the provision of services.

Organization A social unit of people that is structured and managed to meet a need or to pursue collective goals. All organizations have a management structure that determines relationships between the different activities and the members, and subdivides and assigns roles, responsibilities, and authority to carry out different tasks. Organizations are open systems--they affect and are affected by their environment.

Stages in the production of finished goods

INPUTS PROCESSES OUTPUTS
Raw materials, components, machinery, equipment and labor PROCESSES Turning inputs into the provision of services or the manufacturing of goods Stages in the production of finished goods OUTPUTS The output or provision of final goods and services

Factors of Production In the production of any good or service, the following resources are needed: Land = all natural resources provided by nature e.g. forests, fisheries Labor = the efforts and skills of people Capital = the finance, machinery and equipment Enterprise = the skill and risk-taking ability of the person who brings together the resources to produce a good / service. The factors of production (land, labor, capital, and entrepreneurship) include two types of capital: working capital (current or liquid assets) and fixed capital (plant and equipment; other long-term assets). Money is a current asset that is the most fluid or fastest changing asset. It can be exchanged for any of the other factors of production.

Factors of Production

Factors of Production Land Labor Capital Enterprise (Entrepreneurship)
- natural resources available for production - renewable resources: those that replenish - non-renewable resources: cannot be replaced Labor - physical and mental effort of people used in production Capital - all non-natural (manufactured) resources that are used in the creation and production of other products Enterprise (Entrepreneurship) - refers to the management, organization and planning of the other three factors of production

Entrepreneurship vs. Intrapreneurship
Entrepreneurs are owners or operators of an organization who mange, organize and plan the other 3 factors of production. They are risk takers who exploit business opportunities in return for profits. Intrapreneurship is the act of behaving as an entrepreneur but as an employee within a large business organization. Intrapreneurs work in an entrepreneurial capacity, with authority to create innovative products or new processes for the organization.

Examples of Intrapreneur

Entrepreneurs Intrapreneurs
Owners of organization Takes substantial risks Visionary Rewarded with profit Responsibility for workforce (labor) Failure incurs personal costs Employees of organization Takes medium to high risks Innovative Rewarded with pay and remuneration Accountability to the owner Failure is absorbed by the organization Remuneration – money paid for work or service

Factors of Production Land Labor Capital Rent Wages Profit INCOME
Enterprise Rent Wages Interest Profit INCOME

Entrepreneurship: Profits
Resources Resource Payments (Incomes for households) In exchange for their land, labor, capital and entrepreneurship, households receive payments. The payments for the four productive resources (which are costs for firms). For Land: Rent Firms pay households RENT. Landowners have the option to use their land for their own use or to rent it to firms for their use. If the landowner uses his land for his own use, the opportunity cost of doing so is the rent she could have earned by providing it to a firm. For Labor: Wages Firms pay households WAGES. To employ workers, firms must pay workers money wages. If a worker is self employed, the opportunity cost of self-employment is the wages he could have earned working for another firm. For Capital: Interest Firms pay households INTEREST. Most firms will take out loans to acquire capital equipment. The money they borrow comes mostly from households' savings. Households put their money in banks because they earn interest on it. Banks pay interest on loans, which becomes the payment to households. If a household chooses to spend its extra income rather than save it, the opportunity cost of doing so is the interest it could earn in a bank. Entrepreneurship: Profits Households earn PROFIT for their entrepreneurial skills. An entrepreneur who takes a risk by putting his creative skills to the test in the market expects to earn a normal profit for his efforts.

What businesses need

The Marketplace What’s a MARKET?
A place or process whereby buyers (customers) and sellers (businesses) meet to trade. Important to NOTE: CUSTOMERS are the people or organizations that buy a product CONSUMERS are the ones that actually use the product e.g. Student’s education

Common Mistake The terms customer and consumer are often used interchangeably by candidates, although they have different meanings. Make sure you can distinguish between the two concepts and use them in the right context – customers are the people or organizations that buy a product whereas consumers are the ones who actually use the product. These may be the same entity (e.g. someone who buys and eats a meal), but not necessarily such as parents (customers) paying for their children’s (consumer) birthday presents.

The Circular Flow of Resources The Circular Flow Market economies are characterized by a circular flow of money, resources, and products between households and firms in resource and product markets. Notice: Money earned by households in the resource market is spent on goods and services in the product market Money earned by firms in the product market is spent on resources from households in the resource market. A resource market is a market where a business can go and purchaseresources to produce goods and services. Resource markets can be distinguished from product markets, where finished goods and services are sold to consumers, and financial markets, where financial assets are traded. The incentives of Households: Maximize Utility The incentive of Firms: Maximize Profits!

Types of Products Consumer goods – products sold to general public
- consumer durable goods: products that last a long time and can be used repeatedly - non-durable goods: products that need to be consumed very shortly after purchase

Capital goods or Producer goods –. products purchased by other
Capital goods or Producer goods – products purchased by other businesses to produce other goods and services e.g. computers, machinery, tools Services – intangible products provided by businesses e.g. teachers (education), doctors (health care)

Why is business activity needed?
The aim of all business is to combine the factors of production to make products (goods or services) which will satisfy people’s wants. Businesses add value to the factors of production. Businesses employ workers and pay them wages, this allows them to consume products made by other people.

Value Added The enhancement a company gives its product or service before offering the product to customers. Value added is used to describe instances where a firm takes a product that may be considered a homogeneous product, with few differences (if any) from that of a competitor, and provides potential customers with a feature or add-on that gives it a greater sense of value. (Investopedia)

Value Added Note that added value is NOT the same as profit.
A value add can either increase the product's price or value. For example, offering one year of free support on a new computer would be a value-added feature. Additionally, individuals can bring value add to services that they perform, such as bringing advanced financial modeling skills to a position in which the hiring manager may not have foreseen the need for such skills. (Investopedia)

Value added can come in the form of:
Speed and /or quality of service Prestige associated with the purchase Feel-good factor Perceived value for money Quality of the finished product Brand image and/or brand loyalty Taste or design Inability to obtain such products cheaper elsewhere

Value Added

Loss! Profit = Total Revenue - Total Costs
Inflows of money, usually from the sale of products Outflows of money, to finance production activities If business costs are greater than revenue? Loss!

to survive in the long run
Functions of profit: Acts as an incentive to produce Acts as a reward for risk takers It encourages invention and innovation Acts as an indicator of growth (or decline) A source of finance Must make a PROFIT to survive in the long run

Making the best use of limited resources: specialization
It is important to use the resources we have in the most efficient ways. Specialization is when each worker specializes in some part of the production process. This dividing up of the production process into different tasks is called division of labor. Specialization and the division of labor increase efficiency and output. TASK: List advantages and Disadvantages of Specialization

Specialization Advantages Disadvantages
Increased productivity Increased efficiency Standardization Higher profit margin Boredom Inflexibility Lack of autonomy Capital costs – extremely expensive More on specialization in Unit 2 HRM

Four functional areas of a business organization
Production Marketing Finance Human Resources (Personnel)

Business Functions Production (operations) – responsible for converting raw materials into finished goods. Tasks include: Deciding how the good will be manufactured Stock control Quality control Research and development

Business Functions 2. Marketing – responsible for identifying and satisfying consumer wants and needs. Responsible for: Product Price Place Promotion

Business Functions 3. Finance – in charge of managing the money of the organization. Responsible for: Recording financial transactions Cash flow Budgeting

Business Functions 4. Human Resources – manager, the personnel of the organization. Responsible for: Recruitment Training Pay and benefits Health and safety

Decision by Peugeot Citroen in 2010 to launch the world’s first hybrid diesel car required interaction between: Marketing – will consumers be prepared to buy this car and at what price? Finance – do we have the capital needed to develop and produce it? HR Management – do we need to recruit additional engineers before this project can be turned into a market-ready car? Operations Management – can we produce this product at a cost which allows the marketing department to set a profitable price level?

The Business of Education Page 3
Question 1.1.1 The Business of Education Page 3

Business Sectors PRIMARY Sector
- business involved with the extraction, harvesting and conversion of land (i.e. natural resources) as a factor of production - ex. agriculture, fishing, mining, forestry

- business involved with the extraction, harvesting and conversion of land (i.e. natural resources) as a factor of production - ex. agriculture, fishing, mining, forestry 2. SECONDARY Sector - business involved in using raw materials and other resources for the manufacturing or construction of finished and useable products - ex. aircraft manufacturer uses steel, rubber

- business involved with the extraction, harvesting and conversion of land (i.e. natural resources) as a factor of production - ex. agriculture, fishing, mining, forestry 2. SECONDARY Sector - business involved in using raw materials and other resources for the manufacturing or construction of finished and useable products - ex. aircraft manufacturer uses steel, rubber 3. TERTIARY Sector - business involved in providing services – QUATERNARY SECTOR

Tertiary sector – the breathtaking Burj Al Arab hotel in Dubai

Business Sectors 4. Quaternary Sector – services involving complex processing and handling of information: education & research, engineering, IT specialist, R&D etc. - Subcategory of the tertiary sector where businesses are involved in intellectual, knowledge-based activities that generate and share information. – QUATERNARY SECTOR

Business Sectors All four business sectors are interdependent because each sector relies on the others to remain in existence. Primary sector production tends to yield low added value. In order to develop economically, there must be a shift in business activity to manufacturing and service sectors which have higher added value. (This shift is referred to as ‘sectoral change’ and the process is known as ‘industrialization’)

Sector vs. Industry This difference pertains to their scope; a sector refers to a large segment of the economy, while the term industry describes a much more specific group of companies or businesses. A sector is one of a few general segments in the economy within which a large group of companies can be categorized.

Production Sectors Page 6
Question 1.1.2 Production Sectors Page 6

Chain of Production Primary – timber workers and miners extract materials such as wood, sand and metal ores Secondary – Engineers and builders use machinery and equipment to transform raw materials into usable items, such as doors, bricks, windows and paint Tertiary – sales agents, financiers and solicitors are needed to sell the finished house Primary production -> Manufacturing -> Tertiary Production -> Consumers

Exam Tip! During your IB Business and Management course it is a good idea to read the business section of newspapers regularly. This will help you to apply the work you have done in class to the world outside. What, for example, was the major business story in your country this week?

Reasons for setting up a business

Reasons for setting up a business (GET CASH)
Growth Earnings Transference and inheritance Challenge Autonomy Security Hobbies

Growth Assets such as property and land tend to increase in value over time. This is called capital growth It is quite common for the capital growth of a business to be worth more than the value of the owner’s salaries

Earnings Chinese saying “You can never get rich earning money from working for someone else” Potential returns from setting up your own business can easily outweigh the costs, even though the risks are high

Transference and inheritance Many self-employed people view their business as something that they can pass on (transference) to their children (inheritance). This helps to give them a sense of security that might not be possible if they chose to work for someone else.

Challenge Some people might view setting up and running a business as a challenge. It is this challenge that drives them to perform and gives them personal satisfaction. Being successful in business boosts self-esteem.

Autonomy Being self-employed means that there is autonomy (independence, freedom of choice and flexibility) in how things are done within the organization.

Security There is usually more job security for someone who is their own boss Although the risks are great, being self-employed makes it potentially easier to accumulate personal wealth (financial security) to provide higher funds for (early) retirement Redundant – no longer needed Employees can be dismissed, made redundant or even replaced by technology

Hobbies Successful entrepreneurs have a passion for what they do and this is made easier if the nature of the work is directly related to their interests Redundant – no longer needed Employees can be dismissed, made redundant or even replaced by technology

Steps in the process of starting a business
Write a business plan Obtain start-up capital Obtain business registration Open a business bank account Marketing

Business Plan This document include the goals and objectives for the new business with an outline plan of how these targets are to be accomplished.

Start-up capital Money that is needed to start a business.
Small business owners will use their own savings and/or obtain loans to finance their start-up. The loan process can take several months to complete, with the lender usually requesting a completed business plan before any funds are approved.

Business Registration
Before a business can trade or hire workers, it must satisfy registration and licensing requirements. The owner(s) must also register the legal status of the business (ie. partnership or limited liability – Unit 1.2)

Business Bank Account Setting up business bank account allows the business to pay for its costs of operation and to receive payments from customers.

Marketing Potential customers need to know about the business and its products. Marketing includes advertising and other promotional materials.

NOTE: Starting a new business is highly risky because the owners and investors are taking a step into the unknown, even if risks are calculated. Most new business ideas fail, mainly due to mismanagement. Careful consideration in the business plan can reduce the risks of setting up a new business.

Starting a Business Factors to consider:
Business idea Finance Human resource Entrepreneurial skills Fixed assets Suppliers Customers Marketing Legalities These considerations are set out in an official business plan (unit 1.6). This document sets out what a business proposes to do, how it intends to achieve this, the cost implications and the expected financial returns. Potential investors and financiers will scrutinize the contents of a business plan before parting with their money.

Business idea This might be done by setting up a business that does not currently exist, by identifying and filling the niche (unfilled gap) in a market or by providing products that have a unique selling point. Examples of successful business based on innovative ideas: Amazon.com (online book retailing) Dell (custom-made computers) Dyson (bag-less vacuum cleaners)

Finance Needed to fund business activities Is usually the key barrier to setting up a new business as most entrepreneurs need to borrow some money Need record keeping of financial accounts – need to hire accountants

Human resource Needed at all stages of business activity, from the design and development of a product to delivering it to the consumer Entrepreneurs will have to consider the need for hiring, training, retaining and motivating their staff

Entrepreneurial skills Industrial and interpersonal skills Effective leadership and negotiation skills are required to deal with different stakeholder groups such as employees, suppliers and the government Must have self confidence and a passion for what they do

Fixed assets Such as premises and capital equipment Location decision is crucial but problematic Popular location improves the chances of attracting customers, but the cost of land and property is much greater

Suppliers Needed to provide the business with its raw materials, finished stock of products and support services Negotiations over issues such as price and delivery times also need to be undertaken

Customers Business will fail without them Need market research to produce products that are desirable, available at the right prices and sold in the right places The size of the market also determines the amount of sales Example: Publishers are generally not interested in authors whose work only caters for a very small number of customers

Marketing Is ESSENTIAL, irrespective of how good a business idea might be It is needed to convince lenders and buyers that the product is a WINNER

Legalities Legal issues must be considered Example: consumer protection rights, copyright and patent legislation, employment laws Infringement of legal issues can present huge problems for a business Example if a restaurant breaks food hygiene laws, it might be required to cease all operations

Possible problems faced by start-ups
Lack of finance capital Cash flow problems Marketing problems Unestablished customer base People management problems Legalities Production problems High costs of production Poor location External influences

Lack of finance capital

Lack of finance capital Owners of new or small businesses might not have the credentials or experience to secure funding Funds borrowed might require high interest repayments which could affect the cash flow position of the firm Some business owners might have to remortgage their own homes to raise the funds needed

Cash flow problems

Cash flow problems Problem with working capital (money available for the daily running of a business) Lot of stock that cannot be easily turned into cash Customers might demand a lengthy credit period (buy now pay later schemes ranging from days) Ongoing costs – wages, rent, utility bills, taxes and interest payments on bank loans Businesses produce cash flow forecast in their business plan to identify likely periods of poor cash flow so that provisions can be taken to cover any shortfalls.

Marketing problems

Marketing problems Arise when businesses fail to meet customer needs which results in poor sales Key to success is to identify a niche (gap) in the market and then fill it

Unestablished customer base

Unestablished customer base Major problem facing new businesses is attracting customers Customer loyalty is built over a long period of time and may require marketing know-how and large amounts of money

People management problems

People management problems New businesses lack experience in hiring appropriate staff with all the necessary skills Lead to poor levels of customer service and the need to retrain staff or to rehire people

Legalities

Legalities The paperwork and legal requirements of setting up a new business can be tedius, confusing, time consuming and expensive. Any oversight could result in the business having to pay out large sums of money for compensation or penalty fees.

Production problems

Production problems Difficulty to forecast levels of demand, therefore more likely to either over produce or under produce Overproduction leads to stockpiling, wastage and increased costs Underproduction leads to dissatisfied customers and a loss of potential sales

High costs of production

High costs of production Huge amount of money needed for purchasing assets required for production Need to pay start-up costs such as rent, advertising and insurance Cannot benefit from economies of scale

Poor location

Poor location Busy areas will offer the highest potential number of customers, but the premises will also cost the most Fixed costs, such as rent or mortgage repayments, form a large percentage of total costs Aim for any new firm is to break-even by keeping down the fixed costs

External influences

External influences All businesses, irrespective of size are prone to exogenous shocks that create a difficult trading environment ie. oil crisis, economic recession More established firms tend to be better resourced to handle external influences; new businesses are more vulnerable so potentail for business failure is greater

Common Mistake Candidates often claim that businesses should not pursue a particular project because of the risks involved. However, all business decisions carry an element of risk. Mark Zuckerber, co-founder of Facebook, said that the biggest risk for entrepreneurs is not taking any risks, especially in a rapidly changing business world.

Elements of a business plan
The business The product The market The finance The personnel The marketing See Table 1.1.b (page 12)

Change, Culture, Ethics, Globalization, Innovation, Strategy
CUEGIS Change, Culture, Ethics, Globalization, Innovation, Strategy

Key TERMS Review

LABOR Refers to physical and mental human effort used in the production process.

CAPITAL Refers to all non-natural resources used in the production process. An example is money, but the term also includes resources such as machinery, tools, equipment and factories.

ENTREPRENEURS Are people who manage, organize and plan the other 3 factors of production. They are risk takers who exploit business opportunities in return for profits.

DIVISION OF LABOR Refers to the specialization of workers in the provision of goods and/or services by breaking a job down into particular roles or tasks that are repeated by the same workers.

FUNCTIONAL AREAS Is the term used to refer to the different sections of a business. These are usually named as the marketing, production, finance and human resources departments.

PRIMARY SECTOR Refers to businesses involved in the cultivation or extraction of natural resources, such as farming, mining, quarrying, fishing, oil exploration and forestry.

OPPORTUNITY COST Refers to cost measured in terms of the best alternative that is foregone when a choice is made.

SECONDARY SECTOR Is the section of the economy where business activity is concerned with the construction and manufacturing of products.

LAND Means natural resources that can be found on the planet. This includes renewable and non-renewable natural resources such as water, fish, wood and physical land itself.

TERTIARY SECTOR Refers to the section of the economy where business activity is concerned with the provision of services to customers.

Business Sectors Primary Sector – extracts and uses the natural resource. Secondary Sector – manufactures goods using the raw materials from primary sector. Tertiary Sector – provides services to consumers and other sectors of industry. Quaternary Sector – services involving complex processing and handling of information: education & research, engineering, IT specialist, etc.

Specialization Division of Labor
Means that a business concentrates on the production of a particular good or service or a small range of similar products Division of Labor Is the term used to refer to the specialization of people, rather than organizations

Business must add VALUE in the production process
VALUE ADDED is the difference between the value of inputs (costs of production) and the value of outputs (goods/services sold to customers) Profit is earned – business selling its products for more than its production costs PROFIT = REVENUE – COSTS

ADDED VALUE Is the difference between a product’s price and the total cost of the inputs that went into making it. It is the extra worth created in the production process.

The End of Unit 1.1

Unit 1.1 Introduction to Business Management

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