Lesson 02: Overview of Business Organizations PDF

Lesson 02 Overview of Business Organizations 2.0. Introduction As explained in the previous/introductory lesson, business is an organized activity and thus this lesson explains the term ‗Business Organization‘ and it‘s various forms. Business activity is a fundamental and univers...

Lesson 02 Overview of Business Organizations 2.0. Introduction As explained in the previous/introductory lesson, business is an organized activity and thus this lesson explains the term ‗Business Organization‘ and it‘s various forms. Business activity is a fundamental and universal feature of human existence and yet the concept of ‗business‘ is difficult to define with any degree of precision. Dictionary definitions tend to describe it as being concerned with buying and selling or with trade and commerce, or the concern of profit-making organizations, and clearly all of these would come within the accepted view of the business. This lesson is designed to discuss different components of business organizations. 2.1. Creating a Flexible Organization 2.1.1. What is an organization? Defining an organization is difficult as there are many types of organizations set up to meet a variety of needs, such as clubs, schools, companies, charities and hospitals. What they have in common is summarized in the definition produced by Buchanan and Hczynski.―Organizations are social arrangements for the controlled performance of collective goals‖.Accordingly, there are mainly three features in an organization. BBA1103 CDCE, University of Peradeniya Page 1  a. Collective Goals An organization is conscious and purposive creation. It is a means towards the achievement of common enterprise objectives. The organizational structure should build around common and clear cut objectives. This will help in the proper accomplishment of objectives. For instances, a school will be organized differently to a company that aims to make profits. The corporate purpose is being continuously upgraded mainly in the emergence of sustainability initiatives and even during the COVID-19. b. Social Arrangements The organization is a social entity where two or more persons working together with an objective, which is deliberately constructed or reconstructed. This feature differentiates the organization from the other social units. Unlike other social units, members enter the organization through a contract and thus, the relationship is purely contractual nature. An organization creates co-operative relationships among various members of the group. The relationship should be both vertical and horizontal among members of various departments. The structure should be designed that it motivates people to perform their part of work together. c. Controlled Performance An organization will have systems and procedures in place to ensure group goals are achieved. Usually, an organization includes breaking up the entire work into different segments. The organization‘s main aim is to achieve the goals and objectives through effective performance which is possible with human resource development. BBA1103 CDCE, University of Peradeniya Page 2 The term, ‗Business Organization‘ is defined differently by different scholars;among them, Peter F. Drucker, one of the great scholars in the field of management, defines a Business organization as; ―Any organization that fulfills itself through making a product or service is business‖. Moreover, according to B.O. Wheeler,―It is an institution organized and operated to provide goods and services to society under the incentive of private gain‖. According to both definitions, the most business activity takes place within an organizational context and even a cursory investigation of the business world reveals the wide variety of organizations involved, ranging from the small local supplier of a single good or service to the multibillion-dollar international or multinational corporation producing and trading on a global scale. Given this rich organizational diversity, most observers of the business scene tend to differentiate between organizations in terms of their size, type of product and/or market, methods of finance, the scale of operations, legal status and so on. Activity 01 Define business organization in your words and list out the names of business organizations that you are familiar with. 2.1.2. Factors that Influence an Organization Any business organization is influenced by the elements of its environment. This environment comprises a wide range of influences – economic, demographic, social, political, legal, technological, etc. – which affect business activity in a variety of ways and which can impinge not only on the transformation process itself but also on the process of resource acquisition and on the creation and consumption of output. This idea of the firm in its environment is illustrated in the following Figure 2.1. BBA1103 CDCE, University of Peradeniya Page 3 Figure 2.1: Factors influence on the organization In examining the business environment, a distinction can be made between those external factors which tend to have a more immediate effect on the day-to-day operations of a firm and those which tend to have a more general influence. The immediate or task environment for most firms includes suppliers, competitors, labor markets, financial institutions and customers, and may also include trading organizations, trade unions and possibly a parent company. In contrast, the general environment comprises those macro-environmental factors such as economic, political, socio-cultural, technological and legal influences on business which affect a wide variety of businesses and which can emanate not only from local and national sources but also from international and supranational developments. 2.2. Forms of Business Organizations Businesses are organized in different ways. These different types of business organizations can be classified as follows depending on various criteria.  Based on the ownership  Based on the mission  Based on the scale of Operations  Based on the nature of Operations BBA1103 CDCE, University of Peradeniya Page 4 2.2.1. Business Organizations Based on the Ownership The owners are the individuals who provide funds for the business and assume risks by involving in it. The owners enjoy the profits earned by the business and bear the losses of the business as well. Accordingly, business organizations can be categorized as follows based on their ownership.  Private sector business organizations Businesses owned by an individual or a group of individuals are known as private sector businesses. Private sector businesses can be further classified as a sole proprietorship, partnerships, incorporated companies, cooperative societies and other associations. o Sole Proprietorship - Businesses owned by an individual are known as a sole proprietorship where a business owned and run by someone for their own benefit. The business‘ existence is entirely dependent on the owner‘s decisions, so when the owner dies, so does the business. o Partnerships- The relationship among individuals conducting business in common with an objective to earn a profit is known as a partnership. These come in two types: general and limited. In general partnerships, both owners invest their money, property, labor, etc. to the business and are both 100% liable for business debts. In other words, even if you invest a little into a general partnership, you are still potentially responsible for all its debt. General partnerships do not require a formal agreement—partnerships can be verbal or even implied between the two business owners. Limited partnerships require a formal agreement between the partners. They must also file a certificate of partnership with the state. Limited partnerships allow BBA1103 CDCE, University of Peradeniya Page 5  partners to limit their own liability for business debts according to their portion of ownership or investment. o Incorporated Companies - A firm that is required to be registered under the Companies Act No. 07 of 2007, with a legal personality, can raise capital by issuing shares and the liability of the shareholders is limited, is an incorporated company. Incorporated companies are, for tax purposes, separate entities and are considered a legal person. This means, among other things, that the profits generated by a company are taxed as the ―personal income‖ of the company. Then, any income distributed to the shareholders as dividends or profits are taxed again as the personal income of the owners. o Cooperative Societies - A cooperative society is a democratically controlled independent organization. Further, it aims to achieve the common needs of a group of individuals voluntarily gathered and enjoy collective ownership. A cooperative society can be started with at least ten members and the capital is mainly provided by the membership subscriptions. The following table 2.1 shows the relative advantages and disadvantages of the above category of organizations. Advantages Disadvantages Sole a) All profits are subject to the a)Owner is 100% liable for Proprietorship owner business debts, b) there is very little regulation b)Equity is limited to the for proprietorships owner‘s personal resources c)owners have total flexibility c)Ownership of proprietorship when running the business is difficult to transfer d) Very few requirements for d) No distinction between starting—often only a business personal and business license income BBA1103 CDCE, University of Peradeniya Page 6 Partnerships a)Shared resources provide more a)Each partner is 100% capital for the business responsible for debts and b)Each partner shares the total losses profits of the company b)Selling the business is c)Similar flexibility and simple difficult—requires finding new design of a proprietorship partner d)Inexpensive to establish a c)The partnership ends when business partnership, formal or any partner decides to end it informal Incorporated a)Limits liability of the owner to a)Corporate operations are Companies debts or losses costly b)Profits and losses belong to the b)Establishing a corporation corporation is costly c)Can be transferred to new c)Start a corporate business owners fairly easily requires complex paperwork d)Personal assets cannot be d)With some exceptions, seized to pay for business debts corporate income is taxed twice Cooperatives a)Easy to Form a) Limited Capital b) Open Membership b) Inefficient Management c). Democratic Management c) Absence of Motivation d) Limited Liability d) Differences and e) Government Patronage Factionalism among Members f) Mutual Co-Operation e) Rigid Rules and g) Internal Financing h) Income Regulations Tax Exemption Durability f) Lack of Competition I) Elimination of Middleman g) Lack of Incentive and j) Equality Initiative Table 2.1: Advantages and disadvantages of private sector business organizations BBA1103 CDCE, University of Peradeniya Page 7   Public sector business organizations Public sector business organizations funded and owned by the government is a public sector business organization. State departments, state corporations, state companies, businesses registered and owned under Provincial Councils and Local Government Institutions are the different types of business organizations in the public sector. Following illustration in Figure 2.2 shows you a clear summary of the business organization classifications based in the ownership. Figure 2.2: Business organization classifications based in the ownership Activity 02 Explain the different forms of organizations and their relative advantages and disadvantages. Let’s try Self Assessment 01 BBA1103 CDCE, University of Peradeniya Page 8 2.2.2. Business Organizations Based on the mission Different organizations are established to achieve different objectives. Depending on the mission and the outcome of organizations, organizations can be categorized for-profit, nonprofit or social enterprises. In figure 2.9 below, the mission is defined as - the purpose for which an organization exists; the foundation that guides strategy, policies and approaches of the organizations (Schein, 1992; Andrews, 1971). The outcome of an organization is defined as how well an organization accomplishes its objectives; impact on the community and other stakeholders: financial performance of an organization (Dees, 2001). Based on the above typology, the following organizations' forms are identified as stated in Figure 2.9. Businesses can be classified as follows based on their objective and their outcome. Table 2.2: Typology of ventures based on mission and outcome All companies have a distinct purpose, but this is where the difference between a nonprofit and a for-profit is the starkest. While for-profit organizations may have a variety of goals, their primary mission is to generate profit and develop effective products and services that are valuable to consumers. A nonprofit, by contrast, doesn‘t prioritize profits and is instead dedicated to promoting a social cause or advocating for a particular standpoint. Examples of nonprofit services often include assisting with basic human and environmental needs such as food, water, education, endangered species, forests and wildlife. These services strive to solve BBA1103 CDCE, University of Peradeniya Page 9 important, potentially life-threatening problems and issues. Therefore, success for nonprofits is measured based on an organization accomplishing its philanthropic mission. Corporate social responsibility of commercial companies is defined as how a for- profit business with a profit orientation works with a social mission when a social and/or environmental mission embedded with a business model. These companies measure themselves by a double (financial and social) or triple (financial, social, and environmental) bottom line. Therefore, hybrid structures emerge when a for- profit business and a related non-profit organization are directly linked. This model is sometimes referred to as ‗social enterprises‘. Activity 03 Explain the meaning of hybrid organizations Recommended reading The meaning of social entrepreneurship by J. Gregory Dees https://centers.fuqua.duke.edu/case/wp- content/uploads/sites/7/2015/03/Article_Dees_MeaningofSocialE ntrepreneurship_2001.pdf BBA1103 CDCE, University of Peradeniya Page 10 2.2.3. Business Organizations Based on the Scale The scale of a business organization depends on different criteria. Some of the criteria used as follow.  Amount of capital invested in a business  Number of employees  Amount of the energy used  Market share of the business Based on the scale, business organizations can be categorized into two parts in general.  Small and medium scale businesses Different institutions have identified different criteria in classifying small and medium scale businesses. Accordingly, businesses with a small amount of capital invested, with a small number of employees and having a small market share relative to large scale businesses are known as small and medium scale businesses. For instance; businesses employing less than 25 employees according to the Census and Statistics Department are considered small scale businesses in Sri Lanka. In the UK, a small and medium scale business satisfies a minimum of two of the following criteria (Stokes, 2002) as stated in table 2.3. Medium-scale business small business Sales turnover up to £ 11.2 M £ 2.8M Balance Sheet Value up to £ 5.6M £ 1.4M Employees up to 250 employees 50 employees Table 2.3: small and medium scale business classification criteria BBA1103 CDCE, University of Peradeniya Page 11 In Sri Lanka, various organizations define small business differently as follows in (Gamage 2019) Table 2.1: Industrial Capital investment in plant and machinery does not exceed Development Board Rs. 4 million and the total number of regular employees do not exceed 50 people (Central Bank of Sri Lanka) Department of Capital investment less than Rs 5 m and few than 50 Small Industry employees World Bank Numbers of employees fewer than 50 and investment in a fixed asset at original book value, excluding land and building, do not exceed Rs8m. Sri Lanka Export Capital investment excluding land and building, of less than Development Board Rs. 8m Table 2.4: Small business definitions  Large scale businesses Businesses that have invested a large amount of capital, have employed a large number of employees, have a large market share and have the ability to influence the respective industry are known as large scale businesses. Following table 2.5 shows the difference between large and small organizations. Large Small Economies of scale Responsive Global reach Flexible Vertical hierarchy Regional reach Mechanistic Flat structure Complex Organic Stable market Simple ―Organization men‖ Niche finding Entrepreneurs Table 2.5Source: Based on John A. Byrne, ―Is Your Company Too Big?‖Business Week, 27 March 2010, 84-94 BBA1103 CDCE, University of Peradeniya Page 12 2.2.3. Business Organizations based on the nature of Operations Business organizations also are classified as service organizations, merchandising organizations, manufacturing and hybrid businesses based on the nature of Operations. Service Business: A service type of business provides intangible products (products with no physical form). Service type firms offer professional skills, expertise, advice, and other similar products. Examples of service businesses are Bank of Ceylon, KPMG. Merchandising Business: This type of business buys products at wholesale prices and sells the same at retail prices. They are known as "buy and sell" businesses. They make a profit by selling the products at prices higher than their purchase costs. A merchandising business sells a product without changing its form. Examples are grocery stores, convenience stores, distributors, and other resellers. Manufacturing Business: Unlike a merchandising business, a manufacturing business buys products with the intention of using them as materials in making a new product. Thus, there is a transformation of the products purchased. A manufacturing business combines raw materials, labor, and overhead costs in its production process. The manufactured goods will then be sold to customers. Hybrid Business: Hybrid businesses are companies that may be classified in more than one type of business. A restaurant, for example, combines ingredients in making a fine meal (manufacturing), sells a cold bottle of wine (merchandising), and fills customer orders (service). 2.3. Franchising as a Special form of Business Organization To complete this review of the legal structure of business organizations, it is useful to consider three developments that have a legal aspect: franchising, licensing and BBA1103 CDCE, University of Peradeniya Page 13 joint ventures. All three may be seen as a means of carrying out a business venture in a way that reduces some of the risks normally faced by the entrepreneur. However, in this section, we will discuss only franchising. 2.3.1. What is Franchising Franchising, which has grown significantly in recent years is an arrangement where one party (the franchiser) sells the right to another party (the franchisee) to market its product or service. In terms of their legal status the parties involved could be any of the forms described above, but in practice, it is usually the case that the franchiser is a company while the franchisee tends to be a sole trader or partnership. Both parties in law has a separate legal identity, but the nature of the contract between them makes their relationship interdependent and this has important implications for the operation of the franchise. Let’s try Self Assessment 02 2.3.2. The Growth of Franchising Most business historians date the beginning of franchising as a concept to the middle ages when feudal lords initiated the practice of selling to others the rights to collect taxes and operate markets on their behalf. However, this makes the earliest examples of franchising a political activity rather than a business activity. The first BBA1103 CDCE, University of Peradeniya Page 14 examples of franchising as a way of doing business are found in mid-nineteenth century Germany, where brewers set up contracts with tavern owners to sell their beer exclusively in the taverns. Although the Singer Sewing Machine Company was the earliest American product name franchisor, it was relatively quickly outpaced by an even more important product name franchisor: Coca-Cola. In the early 1890s, Coca-Cola chose to franchise the rights to bottle its carbonated beverage to a large number of independent businessmen who received exclusive territories in which to distribute the product in return for paying for and assuming the risk of, distributing the product. Franchising really took off as a form of business in the 1950s and 1960s, when many of the current large franchise chains, businesses such as Tastee-Freez®, KFC®, McDonald's, and Burger King®, were established. The acceleration of franchising in the 1950s and 1960s can be attributed largely to two factors: the rise of television advertising and the establishment of the national highway system. Perhaps because of the growth of franchising in the 1960s, that decade witnessed the formation of a flurry of fly-by-night franchise operations that established their systems, sold them to franchisees, took the franchisees' money, and quickly shut down. The loss of many people's investment in these franchises led to the beginning of franchise regulation in the 1970s. The Federal Trade Commission (FTC) initiated its first franchise fraud investigations in 1975. In that same year, the North American Securities Administration drew up draft guidelines for Uniform Franchise Offering Circulars (UFOCs), which have become the standard form for disclosing franchise opportunities to franchisees. This growing federal effort in the 1970s also culminated in the establishment of disclosure requirements and business rules for selling franchises by the FTC in 1979 and the start of the regulated era of franchising. As a result of this effort, franchising is now a regulated form of BBA1103 CDCE, University of Peradeniya Page 15 business, making an understanding of the legal environment in which it operates important to you as a franchisor. 2.3.3. Pros and Cons of Franchising According to the IFA (International Franchise Association); franchisor is the one who establishes the brand‘s trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor's name and system. The following table 2.6 and 2.7 show the advantages and disadvantages of franchising. Table 2.6: Advantages of Franchising BBA1103 CDCE, University of Peradeniya Page 16 Table 2.7: Disadvantages of Franchising 2.3.4. Franchising Agreement Franchise arrangements come in a variety of forms. Probably the best known is the ‗business format franchise‘ (or ‗trade name franchise‘) under which the franchiser agrees to allow the franchisee to sell the product or service with the help of a franchise package which contains all the elements needed to set up and run a business at a profit. These would typically include the brand name, any associated supplies, promotional material and other forms of support and assistance. In return the franchisee usually pays an initial sum or fee for the use of the service and its various elements, remits royalties based on sales and/or profits agrees to make a contribution for consultancy, training and promotion, and undertakes to maintain standards. Wimpy, Kentucky Fried Chicken, Burger King, Prontaprint and Dynarod are examples of this type of franchise. Other forms include manufacturer/retailer franchises (e.g. car dealers), manufacturer/wholesaler franchises (e.g. Coca-Cola, Pepsi) and wholesaler/retailer franchises (e.g. Spar and Mace) and it is estimated by the industry‘s trade body – the British Franchise Association – that in retailing alone franchising accounts for BBA1103 CDCE, University of Peradeniya Page 17 over 20 percent of sales in the United Kingdom. One indication of its growing significance is the spread of franchising into further and higher education, with universities and other colleges of higher education franchising some of their courses to local further education colleges, which in turn may franchise some of their courses to schools and/or sixth-form colleges. Another indicator is the decision by many clearing banks and firms of accountants to establish franchise sections to help and advice individuals who want to open a franchise or who have already done so and are seeking further guidance. 2.4. Let’s try Self Assessment 03 Summary Business organizations differ in many ways, but they also have a common feature: the transformation of inputs into output. This transformation process takes place against a background of external influences that affect the firm and its activities. Throughout this lesson, we have discussed many important aspects of business organizations. Now you could be able to define what a business organization is, identify the main aspects of a business organization, classify the business organizations and identify the main features of a franchising organization. The following lessons explore the business environment and its categories. BBA1103 CDCE, University of Peradeniya Page 18