1.1.1 The nature of business activity
Every business, from a street food stall to a car maker, does the same basic job. It takes resources, turns them into something customers want, and tries to sell it for more than the materials cost. Along the way, it has to make choices about how to use what it has.
Factors of production
Factors of production: the resources a business needs to produce goods or services.
There are four of them:
- Land: natural resources, e.g. the site a shop stands on, farmland, water, oil, timber.
- Labour: the people who work in the business and the physical and mental effort they put in.
- Capital: man-made items used in production, e.g. machinery, tools, vehicles, buildings, and the money used to pay for them.
- Enterprise: the skill and risk-taking of the person who brings the other three together to start and run a business. This person is called the entrepreneur.
Example: Bean There Café
- Land: the plot the café is built on; coffee beans grown on farms.
- Labour: three baristas and a cleaner.
- Capital: espresso machine, tables and chairs, and the bank loan used to fit out the café.
- Enterprise: Amira, the owner, who put in her savings and organises everything.
If Amira’s café fails, she loses her savings. That risk is what makes her role “enterprise” rather than just labour.
Added value
Added value: Difference between the selling price of a product and the cost of bought-in materials and/or components.
Don’t confuse it with profit. Wages, rent and bills all come out of added value, and only what’s left over is profit.
Worked example: Kente & Co. shirts
Kente & Co. buys fabric, thread and buttons for $12 per shirt. It sells each shirt for $40.
Added value = $40 − $12 = $28 per shirt
How added value can be increased
There are two routes: get customers to pay a higher price, or cut the cost of bought-in materials.
Raise the price customers will pay:
- Build a brand people recognise and link with quality
- Use attractive packaging
- Improve quality or add extra features
- Offer better customer service, e.g. free delivery, after-sales support
- Make it more convenient, e.g. a better location or longer opening hours
Reduce the cost of bought-in materials:
- Find cheaper suppliers
- Buy in bulk to get discounts
- Cut waste in production
Problems with increasing added value:
- Raising the price only works if customers think the product is worth it. If not, they buy elsewhere.
- Extras like packaging cost money too. Added value only rises if the price goes up by more than the extra cost.
- Swapping to cheaper materials saves money now, but a drop in quality can cost sales later.
Example: Kente & Co. adds a gift box
Kente & Co. starts selling each shirt in a gift box that costs $2, and raises the price to $48.
- Before: $40 − $12 = $28 added value
- After: $48 − $14 = $34 added value
Added value rises by $6, but only if customers are happy to pay $48. If sales fall sharply, the change may not be worth it.
Opportunity cost
Opportunity cost: The next best alternative given up by choosing another item.
A business only has so much money, time and staff. Choosing one option means missing out on another.
- Only the next best alternative counts, not every option that was rejected.
- Thinking about opportunity cost helps a business see what it is really giving up before it decides.
Example: Ravi’s taxi firm
Ravi runs a taxi firm with three cars and has $20 000 to spend. His options, in order of preference:
- A fourth car, so he can take more bookings at busy times
- A booking app, so customers can order rides from their phones
- A radio advertising campaign
Ravi buys the fourth car. The opportunity cost is the booking app, and the extra bookings it could have brought in. The radio campaign is not part of the opportunity cost because it was not the next best choice.
