What Is a Business?

The Goals of a Business

The primary purpose of a business is to maximize profits for its owners or stakeholders while maintaining corporate social responsibility.

Learning Objectives

Differentiate among potential goals of a business.

Key Takeaways

Key Points

  • Economic value added suggests that a principal challenge for a business is balancing the interests of new parties affected by the business, interests that are sometimes in conflict with one another.
  • Alternate definitions state that a business’ principal purpose is to serve the interests of a larger group of stakeholders, including employees, customers, and even society as a whole.
  • Many observers hold that concepts such as economic value added are useful in balancing profit -making objectives with other ends.
  • Social progress is an emerging theme for businesses. It is integral for businesses to maintain high levels of social responsibility.

Key Terms

  • corporation: A group of individuals, created by law or under authority of law, having a independent of the existences of its members, and powers and liabilities distinct from those of its members.
  • stakeholder: A person or organization with a legitimate interest in a given situation, action, or enterprise.
  • corporate social responsibility (CSR): A company’s sense of responsibility towards the community and environment (both ecological and social) in which it operates. Companies express this citizenship (1) through their waste and pollution reduction processes, (2) by contributing educational and social programs and (3) by earning adequate returns on the employed resources.

The Goals of a Business

Profit Maximization

According to economist Milton Friedman, the main purpose of a business is to maximize profits for its owners, and in the case of a publicly-traded company, the stockholders are its owners. Others contend that a business’s principal purpose is to serve the interests of a larger group of stakeholders, including employees, customers, and even society as a whole. Philosophers often assert that businesses should abide by some legal and social regulations. Anu Aga, ex-chairperson of Thermax Limited, once said, “We survive by breathing but we can’t say we live to breathe. Likewise, making money is very important for a business to survive, but money alone cannot be the reason for business to exist. ”

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Profit Maximization: This chart depicts profit maximization using the totals approach, where TR = Total Revenue and TC = Total Cost. The profit-maximizing output level is represented as the one at which total revenue is the height of C and total cost is the height of B; the maximal profit is measured as CB.

Social Benefit

Many observers would hold that concepts such as economic value added are useful in balancing profit-making objectives with other ends. They argue that sustainable financial returns are not possible without taking into account the aspirations and interests of other stakeholders such as customers, employees, society and the environment. This concept is called corporate social responsibility (CSR).

This conception suggests that a principal challenge for a business is to balance the interests of parties affected by the business, interests that are sometimes in conflict with one another. Former President Bill Clinton stated adamantly that major multinational companies must put their customers and employees’ interests before those of shareholders in order to promote economic development and growth, especially in emerging markets. For example, Alibaba, a Chinese Internet venture, strives to operate in the zone that Clinton calls “double-bottom line capitalism. ” The emerging new mantra is to create social progress as well as create profits. In a sense, corporate social responsibility highlights the fact that business, consumers and society are part of a shared ecosystem, and that the long-term health of this ecosystem must be maintained above all else.

Innovation as a Goal

Rohit Kishore persuades that business can also be viewed to exist for the purpose of creative expansion. Successful firms like Google manage to align their activities towards the purpose of creative expansion from the perspective of all stakeholders, especially employees. This also validates the growing importance of innovation as a core principle for corporation survival and success.

Contract Theory

Advocates of business contract theory believe that a business is a community of participants organized around a common purpose. These participants have legitimate interests in how the business is conducted and, therefore, they have legitimate rights over its affairs. Most contract theorists see the enterprise being run by employees and managers as a kind of representative democracy.

Stakeholder Theory

Stakeholder theorists believe that people who have legitimate interests in a business also ought to have voice in how the business is run. However, stakeholder theorists take contract theory a step further, maintaining that people outside of the business enterprise ought to have a say in how the business operates. Thus, for example, consumers, even community members who could be affected by what the business does (for example, by the pollutants of a factory) ought to have some control over the business.

Business as Property

Some people believe that a business is essentially someone’s property, and, as such, that its owners have the right to dispose of it as they see fit (within the confines of the law and morality). They do not believe that workers or consumers have special rights over the property, other than the right not to be harmed by its use without their consent. In this conception, workers voluntarily exchange their labor for wages from the business owner; they have no more right to tell the owner how he will dispose of his property than the owner has to tell them how to spend their wages. Similarly, assuming the business has purveyed its goods honestly and with full disclosure, consumers have no inherent rights to govern the business, which belongs to someone else.

People who subscribe to this view generally point out that a property owner’s rights are constrained by morality. Thus, a homeowner cannot burn down his home and thereby jeopardize the entire neighborhood. Similarly, a business does not have an unlimited right to pollute the air in the manufacturing process.

Benefits of Organization

Organization helps businesses achieve focus and success in reaching their goals.

Learning Objectives

Explain the role of specialization, delegation, efficiency and departmentalization in effective organization.

Key Takeaways

Key Points

  • Organization is the composition of individuals and groups directed towards coordinated goals.
  • Division of labor is the assigning of responsibility for each organizational component to specific workers or group of workers.
  • Specialization is division of labor with the added stipulation that the responsibility for a specific task lies with a designated expert in that field.
  • Good organization structure is essential for expanding business activity. Organization structure determines the input resources needed for the expansion of a business activity.

Key Terms

  • resource: Something that one uses to achieve an objective. An examples of a resource could be a raw material or an employee.
  • efficiency: The extent to which time is well used for the intended task.

Organization and Goal Orientation

Organizations have their own purposes and objectives. An organization employs the function of organizing to achieve its overall goals. It can serve to harmonize the individual goals of the employees with the overall objectives of the firm. Individuals form a group, and the groups form an organization. Organization, therefore, is the composition of individuals and groups. Individuals are grouped into departments, and their work is coordinated and directed towards organizational goals. Effective organization allows a firm to achieve continuity, effective management, and growth and diversification, and optimize the use of resources and provide proper treatment to employees.

Specialization and Division of Work

The philosophy of organization is centered on the concepts of specialization and division of work. Division of work refers to assigning responsibility for each organizational component to a specific individual or group. Specialization occurs when the responsibility for a specific task lies with a designated expert in that field. Certain operatives occupy positions of management at various points in the process to ensure coordination.

Efficiency

To make optimum use of resources such as labor, material, money, machine, and method, it is necessary to design an organization properly. Work should be divided and specific people should be given specific jobs to reduce the wastage of resources in an organization. In other words, effective organization promotes a high level of efficiency.

Delegation

Delegation is the process managers use to transfer authority and responsibility to positions below them. Today, organizations tend to encourage delegation from the highest to lowest possible levels. Delegation can improve an organizations flexibility to meet customers’ needs and help organizations adapt to competitive environments.

Departmentalization

Departmentalization is the basis on which individuals are grouped into departments, and departments into total organizations. Departmentalization allows organizations to simultaneously work on various projects and tasks. Approach options include:

  • Functional – by common skills and work tasks
  • Divisional – common product, program, or geographical location
  • Matrix – combination of functional and divisional
  • Team – to accomplish specific tasks
  • Network – departments are independent, providing functions for a central core breaker
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Organization: Any organization — in this case, a professional society — employs the function of organizing to achieve its overall goals.

Addressing Market Needs

In today’s business environment, ascertaining market needs is vital for a firm’s future viability, and even existence, as a going concern.

Learning Objectives

Recognize the needs for markets

Key Takeaways

Key Points

  • A market is one of many varieties of systems, institutions, procedures, social relations, and infrastructures whereby parties engage in exchange.
  • Many companies today have a customer focus (or market orientation). This implies that the company focuses its activities and products on consumer demands.
  • Market research is for discovering what people want, need, and believe; and how they behave.
  • Market segmentation is the division of the market or population into subgroups with similar motivations.

Key Terms

  • Market: Markets vary in form, scale, location, and types of participants, as well as the types of goods and services traded.
  • demand: The desire to purchase goods or services, coupled with the power to do so, at a particular price.

What is a Market?

In mainstream economics, the concept of a market is any structure that allows buyers and sellers to exchange any type of goods, services, and information. The exchange of goods or services for money is called a transaction. Market participants consist of all the buyers and sellers of a certain good, thus influencing its price.

This influence is a major study of economics and has given rise to several theories and models concerning the basic market forces of supply and demand. There are two roles in markets, that of a buyer and that of a seller. The market facilitates trade and enables the distribution and allocation of resources in a society.

This graph shows quantity as the x-axis and price as the y-axis. Lines representing demand and supply cross each other in the graph.

Supply and Demand: This graph depicts where a supply, such as a business, intersects with demand, such as the market need.

Markets allow any tradeable item to be evaluated and priced. It emerges more or less spontaneously or is constructed deliberately by human interaction in order to enable the exchange of services and goods. Historically, markets originated in physical marketplaces which would often develop into—or from— small communities, towns and cities.

A firm in the market economy survives by producing goods that persons are willing and able to buy. Consequently, ascertaining market needs is vital for a firm’s future viability, and even existence, as a going concern.

Many companies today have a customer focus (or market orientation). This implies that the company focuses its activities and products on consumer demands. In the consumer-driven approach, consumer wants are the drivers of all strategic marketing decisions. No strategy is pursued until it passes the test of consumer research.

Every aspect of a market offering, including the nature of the product itself, is driven by the needs of potential consumers. The starting point is always the consumer.

Market Research

Market research is a key factor in obtaining an advantage over competitors and is necessary in order to determine market needs that can and should be met.

It is the systematic gathering and interpretation of information about individuals or organizations through the use of statistical and analytic methods in order to gain insight or support decision making, and includes both social and opinion research. Market research provides important information that identifies and analyzes the market’s need, size, and competition; thus making it possible to determine how to market a product.

Market segmentation is the division of the market or population into subgroups with similar motivations. It is widely used for segmenting the various differences within the market: geographic, personality, demographic, technographic, use of product, psychographic, and gender. This allows firms to further distinguish market needs by subdividing and focusing on various groups within markets.

Market Trends

Market trends are the upward or downward movement of a market during a period of time. Analyzing these trends is another method that allows firms to decipher the needs of markets and strive to meet them.

The market size is more difficult to estimate if one is starting with something completely new. In this case, one would have to derive the figures from the number of potential customers, or customer segments. Besides information about the target market, one also needs information about one’s competitors, customers, and products. Lastly, one needs to measure marketing effectiveness.

As an example of a process of addressing market needs, imagine the release of a new film. When performing marketing research on it, here are several practices that a studio may use:

  • Concept testing, which evaluates reactions to a film idea and is fairly rare,
  • Positioning studios, which analyze a script for marketing opportunities,
  • Focus groups, which probe viewers’ opinions about a film in small groups prior to release,
  • Test screenings, which involve the previewing of films prior to theatrical release,
  • Tracking studies, which gauge (often by telephone polling) an audience’s awareness of a film on a weekly basis prior to and during theatrical release,
  • Advertising testing, which measures responses to marketing materials such as trailers and television advertisements,
  • Exit surveys, which measure audience reactions after seeing the film in the cinema.

Profit and Value

Profit is equal to a firm’s revenue minus its expenses, while value is the present value of the firm’s current and future profits.

Learning Objectives

Differentiate between profit and value

Key Takeaways

Key Points

  • Normal profit represents the total opportunity costs (both explicit and implicit) of a venture to an investor, whereas economic profit is the difference between a firm’s total revenue and all costs (including normal profit).
  • Given that profit is defined as the difference in total revenue and total cost, a firm achieves a maximum profit by operating at the point where the difference between the two is at its greatest.
  • The value of a firm is linked to profit maximization. A firm looking to maximize its profits is actually concerned with maximizing its value.

Key Terms

  • game theory: A branch of applied mathematics that studies strategic situations in which individuals or organisations choose various actions in an attempt to maximize their returns.

Profit

In accounting, profit refers to the difference between the purchase and the component costs of delivered goods and/or services, and any operating or other expenses. In neoclassical microeconomic theory, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs (both explicit and implicit) of a venture to an investor, whereas economic profit is the difference between a firm’s total revenue and all costs (including normal profit). In both classical economics and Marxian economics, profit refers to the return of capital stock (means of production or land) to an owner in any productive pursuit involving labor, or a return on bonds and money invested in capital markets. By extension, in Marxian economic theory, the maximization of profit corresponds to the accumulation of capital, which is the driving force behind economic activity within capitalist economic systems. Some common-use definitions of profit include the following:

  • Gross profit equals sales revenue minus cost of goods sold (COGS), thus removing only the part of expenses that can be traced directly to the production or purchase of the goods.
  • Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) equals sales revenue minus cost of goods sold and all expenses, except for interest, amortization, depreciation and taxes.
  • Earnings Before Interest and Taxes (EBIT), or operating profit, equals sales revenue minus cost of goods sold and all expenses except for interest and taxes. This is the surplus generated by operations.
  • Earnings Before Tax (EBT), or net profit before tax, equals sales revenue minus cost of goods sold and all expenses except for taxes. It is also known as pre-tax book income (PTBI), net operating income before taxes, or simply pre-tax income.
  • Earnings After Tax, or net profit after tax, equals sales revenue after deducting all expenses, including taxes (unless some distinction about the treatment of extraordinary expenses is made). In the U.S., the term net income is commonly used.

Profit Maximization

It is a standard economic assumption (though not necessarily a perfect one in the real world) that other things being equal, a firm will attempt to maximize its profits. Given that profit is defined as the difference in total revenue and total cost, a firm achieves a maximum by operating at the point where the difference between the two is at its greatest. In markets that do not show interdependence, this point can either be found by looking at graphical representations of revenue and cost directly, or by finding and selecting the best of the points where the gradients of the two curves (marginal revenue and marginal cost respectively) are equal. In interdependent markets, game theory must be used to derive a profit maximizing solution.

Value

Economic value is a measure of the benefit that an economic actor can gain from either a good or service. It is generally measured relative to units of currency. The interpretation, therefore, is “what is the maximum amount of money a specific actor is willing and able to pay for the good or service? ” Note that economic value is not the same as market price. If a consumer is willing to buy a good, this willingness implies that the customer places a higher value on the good than the market price. The difference between the value to the consumer and the market price is called “consumer surplus. ” It is easy to see situations where the actual value is considerably larger than the market price; the purchase of drinking water is one example. Value is linked to price through the mechanism of exchange. When an economist observes an exchange, two important value functions are revealed: those of the buyer and those of the seller. Just as the buyer reveals what he is willing to pay for a certain amount of a good, so, too, does the seller reveal what it costs him to give up the good. Said another way, value is how much a desired object or condition is worth relative to other objects or conditions.

In terms of a business, value is the present value of the firm’s current and future profits. The value of a firm is linked to profit maximization. A firm looking to maximize its profits is actually concerned with maximizing its value. As such, it is important for a firm to be able to accurately determine its present value.

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Profit and Value: Profit is equal to a firm’s revenue minus its expenses, while value is the present value of the firm’s current and future profits.

Profit and Stakeholders

A stakeholder is any group or individual who can affect or who is affected by achievement of a group’s objectives.

Learning Objectives

Compare and contrast stakeholders and shareholders

Key Takeaways

Key Points

  • The stockholders are the owners of the company, and the firm has a binding fiduciary duty to put their needs first to increase value for them.
  • Stakeholder theory argues that there are other parties involved, including governmental bodies, political groups, trade associations, trade unions, communities, associated corporations, prospective employees, prospective customers, and the public at large.
  • In some scenarios, even competitors are included as stakeholders.
  • Stakeholders believe that an organization should strive to achieve satisfaction among all parties involved, as opposed to solely pursuing the highest profit.
  • In some scenarios, even competitors are included as stakeholders.

Key Terms

  • fiduciary duty: A legal or ethical relationship of confidence or trust between two or more parties. Typically, a fiduciary prudently takes care of money for another person.
  • stockholder: One who owns stock.
  • stakeholder: A person or organization with a legitimate interest in a given situation, action, or enterprise.

What is a Stakeholder?

A stakeholder is an individual or group with an interest in an entity’s or organization’s ability to deliver intended results while maintaining viability of the product and/or service. The stakeholder concept was first used in a 1963 internal memorandum at the Stanford Research Institute. It defined stakeholders as “those groups without whose support the organization would cease to exist”.

In the center is the company with arrows pointing out to internal stakeholders (employees, manager, owners) and external stakeholders (suppliers, society, government, creditors, shareholders, customers).

Stakeholders: This diagram shows the typical stakeholders of a company.

In the traditional view of the firm, the stockholders are the owners of the company, and the firm has a binding fiduciary duty to put their needs first and to increase value. In older input – output models of the corporation, the firm converts the inputs of investors, employees, and suppliers into salable outputs which customers buy, thereby returning some capital benefit to the firm. By this model, firms only address the needs and wishes of those four parties: Investors, employees, suppliers, and customers. However, stakeholder theory argues that there are other parties involved, including governmental bodies, political groups, trade associations, trade unions, communities, associated corporations, prospective employees, prospective customers, and the public at large. Sometimes even competitors are counted as stakeholders.

Types of Stakeholders

Market stakeholders (sometimes called “primary stakeholders”) are those that engage in economic transactions with the business. Examples of primary stakeholders could be customers, suppliers, creditors or employees. Non-market stakeholders (sometimes called “secondary stakeholders”) are those who generally do not engage in direct economic exchange with the business, but are affected by or can affect its actions. Examples of non-market stakeholders include the general public, communities, activist groups, business support groups, or the media.

Stakeholders, Profit and Corporate Responsibility

Stakeholders, as opposed to shareholders, tend to focus on corporate responsibility over corporate profitability. Stakeholders believe that an organization should strive to achieve satisfaction among all parties involved, as opposed to solely pursuing the highest profit. An organization is a coalition between all stakeholders and exists to increase the common wealth of all parties.

In the field of corporate governance and corporate responsibility, a major debate is ongoing about whether the firm or company should be managed for stakeholders, stockholders (called “shareholders”), or customers. Proponents in favor of stakeholders may base their arguments on the following four key assertions:

  1. Value can best be created by trying to maximize joint outcomes. For instance, by simultaneously addressing customer wishes in addition to employee and stockholder interests, both of the latter two groups also benefit from increased sales.
  2. Supporters also take issue with the preeminent role given to stockholders by many business thinkers, especially in the past. The argument is that debt holders, employees, and suppliers also make contributions and take risks in creating a successful firm.
  3. These normative arguments would matter little if stockholders had complete control in guiding the firm. However, many believe that due to certain kinds of board of directors ‘ structures, top managers like CEOs are mostly in control of the firm.
  4. The greatest value of a company is its image and brand. By attempting to fulfill the needs and wants of many different people ranging from the local population and customers to their own employees and owners, companies can prevent damage to their image and brand, prevent losing large amounts of sales, avoid having disgruntled customers, and prevent costly legal expenses. While the stakeholder view has an increased cost, many firms have decided that the concept improves their image, increases sales, reduces the risks of liability for corporate negligence, and makes them less likely to be targeted by pressure groups, campaigning groups and NGOs (non-governmental organizations).

The Role of the Nonprofit

Nonprofits play a vital role in society by focusing resources and providing services to community needs without regard to profit.

Learning Objectives

Outline the characteristics of a nonprofit and their role in society

Key Takeaways

Key Points

  • While NPOs are permitted to generate surplus revenues, these revenues must be retained by the organization for its self-preservation, expansion, or plans.
  • Some NPOs may also be charity or service organizations. They may be organized as corporations, trusts, or cooperatives; or they may exist informally.
  • Both NPOs and for- profit corporate entities must have board members, steering committee members, or trustees who owe the organization a fiduciary duty of loyalty and trust.
  • NPOs have controlling members or boards. Many have paid staff including management, while others employ unpaid volunteers and even executives who work with or without compensation (occasionally nominal).

Key Terms

  • fiduciary: Related to trusts and trustees.
  • jurisdiction: The limits or territory within which authority may be exercised.
  • dividend: A pro rata payment of money by a company to its shareholders, usually made periodically (e.g., quarterly or annually).

Nonprofits Defined

A nonprofit organization (NPO) does not distribute profits or dividends. Instead it retains any earnings or surplus revenues to achieve its goals. An organization is deemed eligible for nonprofit status under US Internal Revenue Code Section 501(c).

While nonprofit organizations are permitted to generate surplus revenues, these revenues must be retained by the organization for its self-preservation, expansion, or plans. NPOs have controlling members or boards. Many have paid staff, including management, while others employ unpaid volunteers and even executives who work with or without compensation. Designation as a nonprofit and an intent to make money are not related in the United States. However, the extent to which an NPO can generate surplus revenues may be constrained, or the use of surplus revenues may be restricted.

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Nonprofit Organizations: U.S. Navy Sailors, assigned to the aircraft carrier USS Ronald Reagan, position a frame of a wall while helping the nonprofit group Habitat for Humanity build homes.

Some NPOs may also be charitable or service organizations; they may be organized as a corporation, a trust, a cooperative, or they may exist informally. A very similar type of organization, called a supporting organization, operates like a foundation, but is more complicated to administer, holds more favorable tax status, and is restricted in the public charities it can support. For legal classification, elements of importance include:

  • Economic activity
  • Supervision and management provisions
  • Representation
  • Accountability and auditing provisions
  • Provisions for the amendment of the statutes or articles of incorporation
  • Provisions for the dissolution of the entity
  • Tax status of corporate and private donors
  • Tax status of the foundation

In the United States, nonprofit organizations are formed by filing bylaws and articles of incorporation in the state in which they expect to operate. In most jurisdictions, some of the above elements must be expressed in the charter of establishment. The act of incorporating creates a legal entity, which enables the organization to be treated as a corporation by law and to enter into business dealings, form contracts, and own property as any other individual or for-profit corporation may do. Most countries have laws that regulate the establishment and management of NPOs, and that require compliance with corporate governance regimes. Most larger organizations are required to publish financial reports detailing their income and expenditures publicly.

The two major types of nonprofit organization are membership and board-only. A membership organization elects the board, meets regularly, and has the power to amend the bylaws. A board-only organization typically has a self-selected board and a membership whose powers are limited to those delegated to it by the board. A board-only organization’s bylaws may even state that the organization does not have any membership, although the organization’s literature may refer to its donors as “members. ”

In many countries, nonprofits may apply for tax exempt status, so the organization itself can be exempt from income tax and other taxes. In the United States, to be exempt from federal income taxes, the organization must meet the requirements set forth by the Internal Revenue Service. After reviewing the application to ensure the organization meets the conditions (such as the purpose, limitations on spending, and internal safeguards for a charity), the IRS may issue an authorization letter to the nonprofit granting it tax exempt status for income tax payment, filing, and deductibility purposes. The exemption does not apply to other federal taxes such as employment taxes. Federal tax-exempt status does not guarantee exemption from state and local taxes, and vice versa.

The Role of Nonprofits in Society

Nonprofit organizations play a vital role in society by focusing resources and providing services to community needs without regard to profit. Nonprofits aid in the development and upkeep of such sectors of society as the arts, economic development, cultural awareness, spirituality, veterans affairs, and health and wellness. In general, nonprofit organizations have strong ties to their local communities. Through these ties, nonprofits are able to accomplish local development and outreach.