Unit 1: Business and its environment

Lesson 2 Business structure

Cambridge International AS Level AS9609

Business
structure
Learning objectives

 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
Classification of business activity
Key terms
Employment in different
sectors
Changes in business activity
 It is very important to recognise two features of this classification of
business activity:
 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
secondary sector activity is increasing.
 This brings many benefits as well as problems
Consequences of industrialisation:
benefits
 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 country’s output of raw materials, rather than
just exporting these as basic, unprocessed products.
Consequences of industrialisation: problems
 The chance of work in manufacturing can encourage a huge movement of people from the
countryside to 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.
 These can have a negative impact on the economy too.
 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 from 38% to 20% in 25 years.
 Causes of this change include:
 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 other services. However, spending
on physical goods has risen more slowly.
 Manufacturing businesses in developed countries face much more competition as a result of
increasing global industrialisation. These rivals tend to be more efficient and use cheaper labour.
 Therefore, rising imports of goods are taking the market away from the domestic secondary
sector firms.
Consequences of deindustrialisation

 The consequences of the decline in the relative importance of the

primary and secondary sectors and the
 increase in relative importance of the tertiary and quaternary sectors
include:
 job losses in agriculture, mining and manufacturing industries
 movement of people towards towns and cities
 job opportunities in service industries – tertiary and quaternary
sectors
 increased need for retraining programmes to allow workers to find
employment in service industries.
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.
 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
 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.
Key terms

 Mixed economy: economic resources are owned and controlled by both

private
and public sectors.

 Free-market economy: economic resources are owned largely by the

private
sector with very little state intervention

 Command economy: economic resources are owned, planned and

controlled by
the state
Public-sector enterprises: public
corporations
Business ownership- The legal
structure of business organisations –
the private sector
 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
This 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 firm 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 liability. This means that the owner’s
personal possessions and property can be taken to pay of the debts of
the business, should it fail.
 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
Sole trader – Advantages &
disadvantages
Partnership- a business formed by two or more
people to carry on a business together, with shared
capital investment and, usually, shared
responsibilities.
 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.
 Partnerships are the most common form of business organisation in
some professions, such as law and accountancy.
 Small building firms are often partnerships, too.
Partnership- advantages &
disadvantages
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
 2 Legal personality
 3 Continuity
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.

 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
Legal personality

 A company is recognised in law as having a legal identity separate

from that of its owners.
 This 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
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 substantial.

 Small firms can gain this protection when the owner(s) create a private
limited company

 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
Advantages & disadvantages of
private limited companies
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
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- 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
 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.
 This not only means that public 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.
Advantages &disadvantages of
public limited companies
Legal formalities in setting up a
company
 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:
 Memorandum of Association: this states the name of the
company, the address of the head of ice through which it can be
contacted, the maximum share capital for which the company seeks
authorisation and the declared aims of the business.
 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.
 When these documents have been completed satisfactorily, the
registrar of companies will issue a certificate of incorporation.
 Private limited companies may now begin trading.
Other forms of business
organisation
 Cooperatives- These are a very common form of organisation in
some countries, especially in agriculture and retailing.
 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
Advantages &disadvantages of
Cooperatives
The advantages of such business units are:
 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 non-member general
public is allowed
 slow decision-making if all members are to be consulted on important
issues.
Franchises- a business that uses the name,
logo and trading systems of an existing
successful business.

 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 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.
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 non-
franchised one
Advantages &disadvantages of a
franchise
Joint ventures- two or more businesses agree to work
closely together on a particular project and create a
separate business division to do so
 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’
 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- a business organisation that
owns and controls a number of separate businesses,
but does not unite them into one unified company.
 Holding companies are not a different legal form of business
organisation, but they are an increasingly common way for
businesses to be owned.
 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.
Public-sector enterprises – public
corporations- a business enterprise owned and
controlled by the state – also known as
nationalised industry
 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
Advantages & disadvantages of public
corporations
Social enterprise
 Social enterprises are businesses that aim to make profit in socially
responsible ways. Much of any profit is used to benefit society. However,
social entrepreneurs do not operate businesses as charities. They can
and often do keep some of any profit they have made.
 Social enterprises do have objectives that are often different from those
of an entrepreneur who is only profit motivated. However, they 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:
 They directly produce goods or provide services.
 They have social aims and use ethical ways of achieving them.
 They need to make a profit to survive as they cannot rely on donations
as charities do.
Changing the form of business
ownership
Homework