1.2 Business Structure

Economic Sectors

Primary, Secondary and Tertiary Sector Businesses

Firms produce a vast rage of different goods and services, but it is possible to classify these into three broad types of business activity

• Primary Sector Business Activity:
  • Firms engaged in industries that extract natural resources so that they can be used and processed by other firms
  • Examples: farming, fishing, oil extraction
• Secondary Sector Business Activity:
  • Firms that manufacture and process products from natural resources
  • Examples: computers, brewing, baking, clothes-making and construction
• Tertiary Sector Business Activity
  • Firms that provide services to consumers and other businesses
  • Examples: retailing, transport, insurance, banking, hotels, tourism and telecommunications

Changes in business activity:

• The importance of each sector in an economy changes over time
• 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
• Benefits and problems of the increasing importance of secondary sector activity (industrialisation is used to describe the growing importance of the secondary-sector manufacturing industries in developed countries):
  • 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 countries’ output of raw materials, rather than just exporting these as basic, unprocessed products
  • Problems:
    • 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 in manufacturing industry is due to the expansion of multinational companies
• Reasons for the decline in the importance of secondary-sector activity and an increase in the tertiary sector (deindustrialisation is used to describe the situation in developed economics):
  • Rising incomes associated with higher living standards have led consumers to spend much of their extra income on services rather than more goods
  • As the rest of the world industrialises, manufacturing businesses face more competition and these rivals tend to be more efficient and use cheaper labour
    • Rising imports of goods are taking the market away from the domestic secondary sector firms

The Public and Private Sectors

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

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

• 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
  • Example: health and education services, defence and public law and order (police force)
• The existence of ‘public good’: goods and services that cannot be charged for, so private-sector businesses cannot make a profit from producing them

Legal Structures

Main features of Different Types of Legal Structure, Including Ability to Raise Finance

Main Types of Private Sector Businesses:

• 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
  • Firm is likely to remain small
  • All sole traders have unlimited liability
    • The owner’s personal possessions and property can be taken to pay off the debts of the business, should it fail
  • Sole traders remain small because the owner wishes to remain in control of their own business and the limitations they have in raising capital

Advantages

Disadvantages

1. Easy to set up – no legal formalities 2. Owner has complete control – not answerable to anybody else 3. Owner keeps all profits 4. Able to choose times and patterns of working 5. Able to establish close and personal relationships with staff (if any are employed) and customers 6. Business can be based on the interests or skills of the owner – rather than working as an employee for a larger firm

1. Unlimited liability – all of owner’s assets are potentially at risk 2. Often faces intense competition from bigger firms 3. Owner is unable to specialise in areas of the business that are most interesting – is responsible for all aspects of management 4. Difficult to raise additional capital 5. Long hours often necessary to make business pay 6. Lack of continuity – as the business does not have separate legal status, when the owner dies, the business ends

• 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
  • Drawing up a formal Deed of Partnership between all partners
    • Provides agreement on issues such as voting rights, the distribution of profits, the management role of each partner and who has authority to sign contracts

Advantages	Disadvantages
1. Partners may specialise in different areas of business management 2. Shared decision-making 3. Additional capital injected by each partner 4. Business losses shared between the partners 5. Greater privacy and fewer legal formalities than corporate organisations (companies)	1. Unlimited liability for all partners 2. Profits are shared 3. No continuity and the partnership will have to be reformed in the event of the death of one of the partners 4. All partners bound by the decisions of any one of them 5. Not possible to raise capital from selling shares 6. A sole trader, taking on partners, will lose independence of decision-making

• Private limited company: a small to medium-sized business that is owned by shareholders who are often members of the same family
  • Shares will be owned by the original sole trade, relatives, friends and employees
  • 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

Advantages	Disadvantages
1. Shareholders have limited liability 2. Separate legal personality 3. Continuity in the event of the death of a shareholder 4. Original owner is still often able to retain control 5. Able to raise capital from sale of shares to family, friends and employees 6. Greater status than an unincorporated business	1. Legal formalities involved in establishing the business 2. Capital cannot be raised by sale of shares to the general public 3. Quite difficult for shareholders to sell shares 4. Less secrecy over financial affairs than sole trader or partnership (end-of-year accounts should be available for public inspection)

• Public Limited Company: a limited company, often a large business, with the legal right to sell shares to the general public
  • Can raise potentially very large sums from public issues of shares and existing shareholders may also quickly sell their shares if they wish to
    • This flexibility of share buying and selling encourages the public to purchase the shares in the first instance and thus invest in the business
  • Shareholders own the company – however, they appoint a board of directors who control the management and decision-making of the business
• Cooperatives: a business organisation that is owned and controlled by the people who use its products, supplies or services
  • All members can contribute to the running of the business, sharing the workload, responsibilities and decision-making
  • All members have one vote at important meetings
  • Profits are shared equally among members

Advantages	Disadvantages
1. Buying in bulk 2. Working together to solve problems and take decisions 3. Good motivation for all members to work hard as they will benefit from shared profits	1. Poor management skills 2. Capital shortages because no sale of shares to the non-member general public is allowed 3. Slow decision making if all members are to be consulted on important issues

• Franchise: a business that uses the name, logo and trading system of an existing successful business
  • The franchisee is allowed to use the name, logo and marketing methods of the franchiser
  • The franchisee can then, separately, decide which form of legal structure to adopt

Advantages	Disadvantages
1. Fewer chances of new business failing as an established brand and product are being used 2. Advice and training offered by the franchiser 3. National advertising paid for by franchiser 4. Supplies obtained from established and quality-checked suppliers 5. Franchiser agrees not to open another branch in the local area	1. Share of profits or revenue has to be paid to franchiser each yearInitial franchise licence fee can be expensive 2. Local promotions may still have to be paid for by franchisee 3. No choice of supplies or suppliers to be used 4. Strict rules over pricing and layout of the outlet reduces owner’s control over their own business

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

Advantages

Disadvantages

1. 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 2. Different companies might have different strengths and experiences and they therefore fit well together 3. They might have major markets in different countries and can be exploited with the new product more effectively than if they decided to ‘go it alone’

1. Styles of management and culture might be so different that the two teams do not blend well together 2. Errors and mistakes might lead to one blaming the other for mistakes 3. The business failure of one of the partners would put the whole project at risk

• Holding company: a business organisation that owns and controls a number of separate businesses, but does not unite them into one unified company
  • The separate businesses are in completely different markets and the holding company have diversified interests
  • Keeping the businesses separate means that they are independent of each other for major decisions or policy changes
    • However, there will always be the possibility of centralised control from the directors of the holding company over crucial issues
• Public corporations: a business enterprise owned and controlled by the state – usually central or local government
  • Do not often have profit as a major objective

Advantages	Disadvantages
1. Managed with social objectives rather than solely with profit objectives 2. Loss-making services might still be kept operating if the social benefit is great enough 3. Finance raised mainly from the government	1. Tendency towards inefficiency due to lack of strict profit targets 2. Subsidies from government can also encourage inefficiencies 3. Government may interfere in business decisions for political reasons

Concept of Limited Liability and its Importance

• Limited liability: the only liability – or potential loss – a shareholder has if the company fails is the amount investment in the company, not the total wealth of the shareholder
  • The ownership of companies is divided into small units called shares
    • Share: a certificate confirming part ownership of a company and entitling the shareholder owner to dividends and certain shareholder rights
  • People can buy these and become shareholders
    • Shareholder: a person or institution owning shares in a limited company
  • Individuals with large blocks of shares often become directors of the business
• Effects of Limited Liability:
  • 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)

Problems Resulting from Changing from One Legal Structure to Another

• Sole Trader to Partnership
  • 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
    • Example: business debts incurred by one partner – there is unlimited liability for all partners should the business venture fail
  • The loss of independence of decision making
  • Profits are shared
• Private Limited Companies to Public Limited Companies
  • The original owners of the business are usually still able to retain a majority of shares and continue to exercise management control when it is a private limited company
    • However, with public limited companies, due to the sheer volume of shares issued and number of people and institutions as investors, this is most unlikely
  • In a public limited company, shareholders own the company but they appoint a board of directors who control the management and decision-making of the business
    • This clear distinction between ownership and control can lead to conflicts, over the objectives to be set and direction to be taken by the business

Reference: Stimpson, P., Farquharson, A., & Stimpson, P. (2015). Cambridge international As and A level business coursebook. Cambridge: Cambridge University Press.