Chapter 1: Meaning, Features and Objectives of Business
A shopkeeper opens his shutter every morning, arranges his stock, sells through the day and settles his accounts at night. He buys goods, employs a helper, pays rent and hopes that what he earns exceeds what he spends. Repeat this routine across factories, transport fleets, banks, insurance offices and warehouses, and the whole of business activity comes into view. Business is not a single act of selling. It is a continuing occupation carried on regularly, involving goods or services, exchange for value, and the expectation of profit. This chapter begins by fixing what the word ‘business’ means and which activities fall inside it. It then sets out the features that mark an activity as business, and explains why business is treated as an economic activity rather than a social or personal one. Finally, it examines what a business aims at. Profit is essential, but a business that pursues profit alone soon loses the customers, workers and public goodwill on which it depends. The chapter therefore closes by weighing the economic and social objectives against each other.
Figure
Fig. 1.0-1 — A Neighbourhood Retail Shop In Business Hours Photograph of a small retail shop with stocked shelves and a shopkeeper attending to a customer at the counter.
1.1 Meaning And Concept Of Business
Every society needs someone to produce goods, move them to where they are wanted, store them until they are demanded and finance the whole chain. Business is the name given to this occupation. In ordinary English the word carries the sense of ‘being busy’, but in the subject it has a narrower and stricter meaning: an occupation in which a person is regularly engaged in producing, buying, selling or exchanging goods and services with the object of earning profit.
The word covers far more than a shop. Manufacturing, trading, transport, warehousing, banking, insurance and finance are all business, because each of them either produces goods and services or helps the production and exchange of goods along. A firm that only stores wheat for six months is as much in business as the mill that grinds it.
Business And Economic Activity
An economic activity is any human activity undertaken to earn money or a livelihood. A doctor charging a fee, a teacher drawing a salary and a trader selling cloth are all engaged in economic activity, because each earns an income from it. Activities done out of affection, duty or personal pleasure — a mother cooking for her family, a person gardening on a Sunday — earn no income and are therefore non-economic.
Business is one kind of economic activity, not the whole of it. Every business activity is economic, but every economic activity is not business, because a salaried employee and a professional also earn income without carrying on a business of their own. What separates business from the rest is the combination of regular dealings, exchange for value and the profit motive.
The Modern Concept Of Business
The older view described business simply as buying and selling for profit. The modern view is wider, because a firm that thinks only of the next sale does not survive long in a competitive market. Business today is understood as an activity that creates and keeps a customer.
On this view, a business does four things: it converts scarce economic resources into goods and services, it shapes those goods to the preferences of customers, it innovates so that its offering does not become outdated, and it markets what it makes so that the goods actually reach the buyer. Profit follows from doing these well. It is the result of the activity rather than its starting point, and this distinction runs through the rest of the chapter.
1.2 Features Of Business
Not every activity that involves money is business. A person who sells his old scooter has made a sale, but he has not entered the business of selling scooters. A firm therefore needs a test, and the features listed below are that test: an activity is business only when it possesses them together. Each feature also explains something about how a business must be run, which is why they are worth learning as reasons and not as labels.
- Dealings in goods and services — business must deal in something that can be supplied to others. Goods may be consumer goods, bought for personal use, or producer goods such as machines and tools, bought to make other goods. Services such as transport, banking, electricity supply and communication are intangible and cannot be stored, yet they are dealt in exactly as goods are.
- Profit motive — the activity must be undertaken with the object of earning profit. Without profit a firm cannot cover its costs, reward its owner or finance its growth, so the profit motive is what gives business its continuity. An activity carried on out of charity or affection is not business, however large it may be.
- Economic activity — business is undertaken to earn a livelihood, not for pleasure, duty or social service. This is why non-economic activities are excluded from it even when they involve effort, skill and expense.
- Regularity of dealings — the dealings must be repeated and continuous. An isolated transaction is not business, because a single sale creates neither an occupation nor a source of livelihood. A person who sells his watch once at a gain is not a watch dealer; a person who buys and sells watches through the year is.
- Element of risk and uncertainty — business risk arises because a firm commits money today for a return that is expected tomorrow. Consumer tastes change, demand shifts, trade cycles turn and government policy is altered, and none of these can be foreseen with certainty. Risk cannot be removed from business; it can only be managed, and it is borne in the expectation of profit.
- Sale, transfer or exchange — goods or services must be transferred to another party for value. A manufacturer who produces for his own consumption, or gives the output away as a gift, has not carried on a business activity, because nothing has been exchanged for a consideration.
- Creation of utility — business adds to the usefulness of resources rather than merely handling them. Raw cotton is of little use until it is spun and woven, and cloth is of no use lying in a mill when the buyer is in another city.
- Business is both an art and a science — it is an art because it depends on the personal ability, judgement and experience of the person carrying it on, and a science because it rests on a body of principles and established practice that can be studied and applied.
- Wide scope — business covers the whole chain from production to distribution, together with the services such as banking, insurance, transport and warehousing that support that chain.
The Three Utilities
The utilities a business creates are usually classified by how they are created, and the classification is summarised in FC 1.1.
Flowchart
FC 1.1 — Types Of Utility Created By Business Utility → Form utility (created by industry, by converting raw material into finished goods), Place utility (created by transport, by moving goods to where they are wanted), Time utility (created by warehousing, by holding goods until they are demanded)
1.3 Business As An Economic Activity
Human activities are of two kinds. Those undertaken to earn money or a livelihood are economic; those undertaken out of love, duty, religious feeling or personal satisfaction are non-economic. A worker in a factory, a doctor in a clinic and a teacher in a school are all engaged in economic activity, because each earns an income from what he does. The same doctor treating his own child free of charge is not.
The distinction matters because business is studied as a branch of economics, not of social service. The two kinds of activity are compared in Table 1.1.
Why Business Is An Economic Activity
Business qualifies as an economic activity on each of the tests that economic activity is put to. The reasons below explain how.
- Efficient use of scarce resources — land, labour, capital and machinery are limited and costly. A business must procure them at a price and combine them so that as little as possible is wasted, because any waste comes straight out of its own earnings. This is exactly the problem economics is concerned with.
- Exchange of goods and services — a business earns only when it sells, distributes or exchanges what it has produced. Income arises from the exchange itself, which is what marks the activity as economic rather than personal.
- Creation of utilities — by converting, transporting and storing goods, a business raises their capacity to satisfy wants, as set out in FC 1.1. Utilities are created in order to earn, and this is why utility creation is treated as an economic function.
- Profit motive — business is pursued as an occupation and a means of livelihood. It yields a regular income to the person carrying it on, in the same way that a salary does to an employee.
- Satisfaction of human needs — the goods and services a business supplies meet the needs of the society, while the profit it earns meets the needs of the businessman. Both sides of the transaction gain, which is the essential character of an economic exchange.
Business, then, is an economic activity in a double sense. It is a means of generating income for the person who carries it on, and a means of satisfying the wants of the society that buys from him. Neither purpose can be pursued for long without the other.
1.4 Aims And Objectives Of Business
An objective is the end a business sets out to achieve. Objectives matter because they decide what activities the firm may carry on and what it must refuse: a firm that has fixed quality as an objective cannot adulterate its product to save cost, however tempting the saving. Objectives therefore give direction to business activity and provide a standard against which performance is later judged.
To an ordinary observer the only objective of a business is to earn profit, and profit is undeniably essential. A firm that does not earn cannot pay its suppliers, replace its machinery or survive a bad year. But profit alone cannot be the whole aim, because a business depends on customers who must keep buying, workers who must keep working and a society that must keep tolerating its presence. Urwick put the point sharply: earning profit can no more be the objective of a business than eating is the objective of living. Eating sustains life; it is not what life is for.
Peter Drucker took the argument further and held that a business has only one valid purpose, which is to create a customer. It is the customer who decides what the business is, since it is his willingness to buy that keeps the firm in existence and justifies society entrusting resources to it. On this reasoning the objectives of a business fall into the groups shown in FC 1.2.
Flowchart
FC 1.2 — Objectives Of Business Objectives of business → Economic objectives, Social objectives, Human objectives, National objectives
Human objectives concern the people inside the firm: a business is not merely land, raw material and machines, and its success rests on the cooperation and morale of the managers and workers it employs, whose dignity must be respected. National objectives concern the firm’s contribution to the country, through honest payment of taxes, generation of employment and use of national resources. The two principal groups, economic and social, are examined below.
1.4.1 Economic Objectives
Economic objectives are the ends a business must achieve to remain financially sound. They come first in order of necessity, because a firm that fails at them cannot pursue any other objective at all.
- Earning profit — profit is the reward for bearing risk and the measure by which the success of the firm is judged. It is also an internal source of finance for growth, since profit that is retained saves the firm from borrowing. What is objectionable is not profit but profiteering, that is, earning excessively by exploiting a shortage or a customer’s helplessness.
- Creating customers — a business survives only so long as there is demand for what it offers, so it must both attract new buyers and retain existing ones. Customers are created through advertisement, promotion and, above all, through satisfying the needs they came with, which is why customer satisfaction and profit are not opposed ends.
- Maximum utilisation of resources — men, machines and materials are scarce and costly, so every business is expected to make the fullest use of them. This is achieved by employing efficient staff, keeping machinery working near capacity and reducing wastage of raw material.
- Innovation — markets do not stand still, and a firm that offers the same product in the same way indefinitely is overtaken by rivals. Innovation, through research and development and through new methods of working, is therefore an objective rather than a luxury.
- Satisfying human needs — when a business meets a genuine need, the standard of living of consumers improves, demand is created which keeps production going, and the firm earns the income it needs to continue and expand. The economic objective and the social result meet at this point.
1.5 Role Of Profit In Business
Profit is the surplus that remains with a business after all its costs have been met out of its revenue. Its role in business is easily misread. Profit is not simply the owner’s income; it is what allows the firm to exist at all, and it performs several distinct functions at once. Understanding these functions explains why no business, in any economic system, can be indifferent to profit.
What Profit Does For A Business
- It ensures survival — a firm meets its costs out of what it earns, and continuous losses exhaust its funds until it is forced to close. No enterprise can survive unless it earns at least a reasonable rate of return on the money invested in it.
- It is the reward for risk — the owner commits capital with no guarantee of a return, and profit is what compensates him for accepting that uncertainty. Where the risk is greater, a larger return is expected.
- It acts as an incentive — the prospect of profit is the strongest reason a person has for starting a business, working hard at it and staying in it. Remove the incentive and the effort weakens with it.
- It measures efficiency — profit is an index of how well a firm has combined its resources. Rising profit ordinarily indicates good management and cost control, while falling profit is an early signal that something in the working of the firm needs correction.
- It provides finance for growth — profit that is not distributed becomes retained profits, which are the cheapest source of finance available to a firm. Expansion, new machinery and modernisation can then be funded without borrowing and without paying interest.
- It improves creditworthiness and bargaining strength — a firm with a record of earnings can raise loans more easily and on better terms, and can negotiate with suppliers and buyers from a stronger position.
- It prevents stagnation — earnings allow a business to spend on research, better methods and better trained staff, which is how it keeps pace with competitors instead of standing still.
Profit As A Result, Not An Object
None of this makes profit the purpose of business. The distinction that runs through the subject is that profit should be the result of a business rather than its object. A firm that sets out to serve its customers well and manage its resources efficiently will earn profit as a consequence; a firm that sets out to maximise profit directly is tempted towards adulteration, overpricing and neglect of its workers, and loses in the long run the very customers and goodwill it depends on.
This is why profit and profiteering are treated so differently. The first is a legitimate return earned by supplying value; the second is an excessive gain extracted by exploiting a shortage or a buyer’s helplessness. The maxim that follows from the whole discussion is that service should come first and profit next.
1.6 Should Profit-Maximisation Be The Goal Of Business
The previous section established that profits are essential to a business. A further question follows from it, and it is one on which experts have long disagreed: should a business aim at the largest profit it can possibly earn, or at a profit that is merely sufficient? The two positions are set out below.
Arguments In Favour
Economists such as Joel Dean have defended profit maximisation, holding that in a competitive economy the pursuit of maximum profit is itself the chief social responsibility of management, since a firm that earns well serves society best. The arguments made in support are these.
- Profit is the reward of the businessperson — he alone bears the loss if the venture fails, so there is no ceiling on what he may fairly earn if it succeeds.
- Profit is the means of satisfying human needs — a firm earns more only by selling more, and it sells more only by supplying what people actually want.
- Profit measures business efficiency — the higher the profit, the better the firm has used its scarce resources, so maximising profit amounts to maximising efficiency.
- Profit is the base of protection, growth and stability — large earnings cushion a firm against bad years and finance its expansion.
- Profit enables a business to do more for society — welfare spending, employee benefits and community work all have to be paid for out of earnings.
- Profit is an incentive — the larger the reward in prospect, the greater the effort and enterprise it calls forth.
- Profit expands economic activity — profitable firms invest more, employ more and add more to national output.
Arguments Against
The opposite view holds that maximisation is the wrong test. Peter Drucker argued that the problem of a business is not to maximise profit but to earn profit sufficient to cover the risks of economic activity and so avoid loss, and Urwick made the same point in saying that profit can no more be the objective of a business than eating is the objective of living. The criticisms are as follows.
- It conflicts with social welfare — maximisation encourages hoarding, adulteration, overpricing and other exploitation, because these raise the surplus fastest.
- It develops selfishness and ignores the service motive — the firm begins to treat the customer as a source of gain rather than as the reason for its existence.
- It widens inequalities of income — the whole surplus is claimed by the owners of capital, while wages and prices are pressed in the opposite direction.
- It leads to conflict between owners and workers — profit maximised at the cost of the workforce produces resentment, disputes and loss of morale.
- It gives an incentive to corruption and unfair means — where the only test is the size of the surplus, the methods used to obtain it cease to be examined.
- It sacrifices the long term to the short term — cuts in quality, maintenance and research raise this year’s profit and weaken the firm’s position in every year after it.
There is a further objection of principle. A business uses four factors of production — land, labour, entrepreneurship and capital — and each of them is entitled to a fair return. Profit is the return to capital alone. To maximise it is to maximise the reward of one factor at the expense of the rest, which cannot be defended as a rule of business conduct.
The Balanced View
The conclusion generally accepted is that adequate profit, not maximum profit, is the proper goal. A business must earn enough to cover its risks, sustain itself and grow; beyond that, it must pursue its social objectives alongside its economic ones. Profit is the result of good business, not its object, and the motto that follows is service first and profit next.
1.7 Summary
- Business is that economic activity which is carried on regularly and which involves the production, purchase, sale or exchange of goods and services with the object of earning profit. It covers manufacturing and trading as well as the transport, warehousing, banking, insurance and finance that assist exchange.
- Every business activity is an economic activity, but every economic activity is not business, because employment and profession also yield an income without amounting to the carrying on of a business.
- The modern view of business is wider than buying and selling. A business creates and keeps a customer by converting resources into goods and services, shaping them to customer preferences, innovating and marketing what it makes.
- An activity is business only when it possesses the features of dealings in goods and services, profit motive, economic character, regularity of dealings, risk and uncertainty, sale or exchange for value, creation of utility, the character of both art and science, and wide scope.
- Business creates three utilities:
- Form utility — created by industry, by converting raw material into finished goods.
- Place utility — created by transport, by moving goods to where they are wanted.
- Time utility — created by warehousing, by holding goods until they are demanded.
- Business is treated as an economic activity because it uses scarce resources efficiently, earns through exchange, creates utilities, is pursued as a livelihood under the profit motive, and satisfies the needs of society as well as of the businessman.
- Objectives give direction to business activity and provide the standard against which its performance is judged. They fall into four groups: economic, social, human and national.
- The economic objectives of business are earning profit, creating customers, maximum utilisation of resources, innovation and satisfying human needs.
- The social objectives of business are the supply of quality goods at reasonable prices, fair trade practices, creation of employment opportunities, welfare of workers, healthy relations with workers and their unions, observing the restraints society imposes, and honest payment of taxes.
- Profit performs several distinct functions in a business: it ensures survival, rewards risk, acts as an incentive, measures efficiency, finances growth through retained profits, improves creditworthiness and bargaining strength, and prevents stagnation.
- Profit must be distinguished from profiteering. Profit is a reasonable surplus earned by supplying value; profiteering is an excessive gain extracted by exploiting scarcity or the buyer’s helplessness.
- Profit maximisation is defended on the ground that it rewards risk, measures efficiency, finances growth and expands economic activity. It is criticised because it conflicts with social welfare, encourages unfair means, widens inequalities, provokes conflict with workers and sacrifices long-term interest to short-term gain.
- The accepted position is that adequate profit rather than maximum profit is the proper goal. Profit should be the result of a business and not its object, and economic objectives must be pursued alongside social ones — service first and profit next.
1.8 Key Terms
- Business That economic activity which is carried on regularly and which involves the production, purchase, sale or exchange of goods and services with the object of earning profit.
- Business risk The possibility of loss arising because a business commits money today for a return expected in the future, under conditions it cannot fully foresee.
- Economic activity An activity concerned with the production, exchange or distribution of goods and the rendering of services, undertaken to earn money or a livelihood.
- Economic objectives The ends a business must achieve to remain financially sound, namely earning profit, creating customers, maximum utilisation of resources, innovation and satisfying human needs.
- Profit The excess of the revenue earned by a business over the costs incurred in earning it; the reward for bearing business risk.
- Profit maximisation The goal of earning the highest possible profit from business activity, treating the size of the surplus as the chief test of business success.
- Retained profits That part of the profit which is kept in the business instead of being withdrawn by the owners, and which serves as an internal source of finance.
- Social objectives The ends a business sets in discharge of its obligations to society, such as quality goods at fair prices, fair trade practices, employment, worker welfare and honest payment of taxes.
- Social responsibility The obligation a business owes to the groups it deals with — customers, workers, suppliers, government and the public — in return for the resources and protection society provides it.
- Utility The capacity of a good or service to satisfy a human want, created by business in the form of form utility, place utility and time utility.
1.9 Points To Ponder
- If regularity is what separates business from an isolated transaction, how would you classify a person who buys and sells land only once every few years but earns a substantial gain each time?
- A firm claims that by earning the largest possible profit it automatically serves society best, since it employs more people and pays more tax. What is the strongest objection to this reasoning, and what is the strongest defence of it?
- Profit is described both as a measure of efficiency and as a reward for risk. Can a business earn a large profit while being inefficient? What would that tell you about the limits of profit as a measure?
- Social objectives such as worker welfare and fair pricing usually reduce profit in the short run. On what grounds can a business justify them to its owners, and where should the line be drawn?
- If a business exists to create a customer, as Drucker held, does it follow that whatever customers are willing to buy is a legitimate line of business? Consider goods whose sale society restricts.
- Automation allows a firm to use its resources more fully while employing fewer workers. Two of the objectives studied in this chapter pull in opposite directions here — how should a business weigh them against each other?
1.10 Objective Questions
- Which of the following activities would NOT be classified as business? [1]
- A trader buying and selling grain through the year
- A person selling his own furniture once before shifting house
- A firm storing goods in a warehouse for traders for a fee
- A transport operator carrying goods for manufacturers
- Time utility is created by which of the following? [1]
- Industry
- Transport
- Warehousing
- Advertising
- Assertion (A): Every economic activity cannot be called a business activity. [1] Reason (R): Business is carried on regularly with the object of earning profit, while employment and profession also yield an income without amounting to business.
- Both (A) and (R) are true, and (R) is the correct explanation of (A).
- Both (A) and (R) are true, but (R) is not the correct explanation of (A).
- is true, but (R) is false.
- is false, but (R) is true.
- Fill in the blank: Profit that is kept in the business instead of being withdrawn by the owners is known as _____. [1]
- Retained profits
- Profiteering
- Trade credit
- Working capital
- Match Column A with Column B and choose the correct option. [1]
- Creating customers
- Fair trade practices
- Innovation
- Welfare of workers
- Social objective
- Economic objective
- Social objective
- Economic objective
- (i)–(B), (ii)–(A), (iii)–(D), (iv)–(C)
- (i)–(A), (ii)–(B), (iii)–(C), (iv)–(D)
- (i)–(D), (ii)–(C), (iii)–(B), (iv)–(A)
- (i)–(B), (ii)–(C), (iii)–(A), (iv)–(D)
1.11 Check Your Concepts
- Define business and state any one feature that distinguishes it from an isolated transaction. [2]
- Explain, with one example of each, the three utilities created by business. [3]
- Distinguish between profit and profiteering, and state why the difference matters to a business in the long run. [3]
- ‘Business is an economic activity.’ Give any four reasons in support of this statement. [4]
- Evaluate the claim that profit maximisation should be the goal of business, presenting the arguments on both sides and stating a reasoned conclusion. [6]
1.12 Case-Based Questions
- Anaya Foods packs and sells spices from a small unit. During a shortage last season the owner held back stock for three weeks and released it at a much higher price, earning a large surplus. This year she has decided instead to keep prices steady, pay her packers a higher wage and use part of last year’s earnings to buy a grinding machine that reduces wastage of raw material.
- Identify and explain the practice the owner followed during the shortage, and state one way it could damage the firm. [2]
- Name one economic objective and one social objective reflected in her decisions this year, giving a reason for each. [2]
1.4.2 Social Objectives
A business operates inside a society and deals constantly with owners, workers, customers, suppliers and the government. It uses the society’s resources and enjoys the protection of its laws, and it owes each of these groups an obligation in return. This obligation is what is meant by the social responsibility of a business, and the ends it sets under that head are its social objectives.
The two groups are set side by side in Table 1.2. They are not alternatives. Economic objectives make the firm strong enough to serve, and social objectives earn it the goodwill and the licence to keep operating.
Table 1.2 — Economic And Social Objectives Of Business | Basis | Economic objectives | Social objectives | |—|—|—| | Concern | The financial soundness of the firm | The firm’s obligation to society | | Beneficiary | Primarily the owner and the business itself | Customers, workers, government and the public | | Measurement | Measurable in money terms, such as profit earned | Largely judged by conduct and goodwill | | Consequence of neglect | The firm cannot survive or grow | The firm loses trust, goodwill and public support | | Examples | Earning profit, creating customers, innovation | Fair trade practices, worker welfare, honest taxes |
Pick any one shop or firm you deal with regularly and note down one economic objective and one social objective you can observe in the way it operates.