The Wealth of the People:
The Wealth of the Business Enterprise
An Inquiry into the Relationship between
Wealth, Freedom, and Life
By
Fernando Urias
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SMASHWORDS EDITION
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PUBLISHED BY:
Fernando Urias on Smashwords
Copyright © 2011 by Fernando Urias
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Disclaimer
This book is designed to provide information and entertainment. It is published with the understanding that the publisher and author are not engaged in rendering legal, economic, accounting, political, financial, or any other type of professional service. If legal or other expert assistance is required, the services of a competent professional should be sought.
It is not the purpose of this book to reprint all the information that is otherwise available to authors and publishers but instead to complement, amplify, and supplement other texts. You are urged to read all the available material and learn as much as possible about economics and human organizations and tailor the information to your individual needs.
Every effort has been made to make this book as complete and as accurate as possible. However, there may be mistakes, both typographical and in content. Therefore, this text should be used only as a general guide and not as the ultimate source on economic or social organizations. Furthermore, this manual contains information on economics and social sciences that is current only up to the publishing date.
The purpose of this book is to educate and entertain. The author and publisher shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to have been caused, directly or indirectly, by the information contained in this book.
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Introduction
This is the fourth book of the "Wealth of the People" series, an inquiry about the requirements for the production of wealth in society.
The first book looked at the economics of one person living alone in an island. The book concludes that to produce wealth you have to work using your tools. The time and intelligence invested in your tools determines the income that you can make with your work. Your tools are your physical capital and your skills are your human capital. Your physical and human capital constitutes your capital structure.
The second book looked at the requirements for the wealth production process to continue when a neighbor appears in the island. An agreement to respect life and property emerges as the first requirement. This and other agreements that are necessary for the production of wealth can be grouped under the concept of social capital. The work that you perform using your capital structure, including its social component, determines the income that you can make.
The third book looked at the wealth production possibilities in a free market. It assumes that there is sufficient social capital in a society to allow the existence of a free market. The conclusion of the book is that a free market has many advantages that contribute to the wealth production processes making it a necessary component of the social capital required in a society to increase the wealth of its people.
This is the fourth book of the series. It is a about the wealth of the business enterprise. The book assumes that there is sufficient social capital in a society to allow for the existence of business enterprises. The business enterprises become the suppliers of the market and the people working in them become the consumers. The business enterprises are shown to be an integral part of the survival and enrichment process of the people.
This fourth book assumes that you have read the first three. If you have not, please go to smashwords.com to read them in order.
A full list of the "Wealth of the People" titles can be found at the end of this book.
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The Mission of the Business Enterprise
If you were in an island alone producing the goods that you would need for your survival, you could think that you were running a small business enterprise of one worker with one customer. You would be the worker producing products and you would your own customer. Alone in an island, there would be no question in your mind that the mission of your one-person business enterprise would be to produce the goods that you would need for your survival. This is the first objective of a business enterprise.
If you would invest in a tool to improve one of your wealth production processes, you would be going after a second objective that goes beyond survival. You would be looking for a way to produce at a faster rate to increase your wealth production capabilities. You would be looking for a way to get out of poverty. This would be a second objective of your one-person business enterprise: to improve your wealth production capability by investing in tools that will make you wealthy and get you out of poverty.
When your neighbor appears in the island and you would hunt an extra turkey to exchange for a pound of vegetables, you would become a worker hunting a turkey and your neighbor would become the customer buying it. The worker and the customer would no longer be the same person. The separation of the production and consumption actions into two different people would not change the mission of your one-person business enterprise. You would still be producing to survive and investing to get out of poverty. The trade with your neighbor makes a profit that contributes to both objectives and becomes part of your survival and enrichment activities. In the trade you would be passing the advantage of your investment to your neighbor contributing to the same two objectives for your neighbor. The profit that you would make in the sales transaction is a necessary incentive for the transaction to occur and a requirement for the trade to happen. Making a profit in the sales transaction can be stated as a requirement for your business enterprise to ensure that the trade transaction is contributing to both objectives. The investments in your business enterprise have to yield sufficient savings to leave a profit in the sales transaction after passing some of the savings to your neighbor. The mission of the people to produce wealth and invest to get out of poverty is delegated from the people to the business enterprises.
The Business Enterprise Mission Principle of Wealth Production
It is the mission of a business enterprise to produce and sell the products and services needed by its customers and to invest in better methods of production yielding savings sufficient to make a profit in the sales transaction after passing some of the savings to its customers becoming in this way the vehicle for the people's survival and enrichment.
The Profit Incentive to Expand the Business Enterprise
The existence of profit in a wealth production process is an incentive for a person or a business enterprise to hire people to increase production. In the turkey hunting business, if it would be taking two hours to hunt a turkey using a spear giving a turkey a price slightly above two bundles and you are able to hunt one in half an hour using a bow and arrows, you would be motivated to invest in as many bows and arrows and to hire as many people as you could to run a hunting business enterprise. You could make one and a half bundles of profit in every turkey hunted and sold.
The origin of the profits is the more efficient production process that yields savings compared to the existing processes and market prices. The task to improve productivity by investing in physical capital and to expand production until the market needs are filled is delegated from the people to the business enterprises through the profit motive. The owner of a business enterprise is motivated by the incentive of profits to invest in the best processes and expand production as fast as possible. The profits of a business enterprise motivate the owner to exercise his entrepreneurial function to look for investments that will improve the wealth production process, to organize business enterprises that can operate at a profit, and to design and manufacture products that can make life easier for the people.
The existence of profit in a wealth production process is an indication that the market is willing to pay a price for a product that is higher than the resources that it takes to produce it. The business enterprise has to find these products and their wealth production processes to meet these market needs.
Profit is the incentive to make an investment. The motivation to improve a wealth production process is passed to the business enterprise through the profit possibilities. The business enterprise is motivated to find more efficient ways of producing to increase the wealth of its owner and in the process the wealth of every buyer. The objective to become rich by investing in better production method in a free country is passed from the people to the business enterprise.
Through the profit motive, a business enterprise becomes a group of people organized by its owner to produce and sell a product for a price that pays for all the expenses, including salaries and investments, and leaves a profit after the sales transaction.
The Business Enterprise Profit Principle of Wealth Production
The profits of the business are the motivation for the formation of business enterprises. The work and investment required for every citizen to survive and become wealthier is delegated from the people to the business enterprises which become responsible to produce the goods needed by the people and to look for investments that will make the wealth production process more efficient resulting in the enrichment of its customers, employees, and owners.
The Supply Curve for the Business Enterprise
The supply curve shows that suppliers are willing to supply a higher quantity of product at high prices. The reason is that higher prices bring higher profits. At high prices, the demand for the product would be less than the supply and the price has to drop to sell all the inventories. At a high price with a high profit, a single business enterprise would be motivated to increase production and one enterprise is be sufficient to increase production to the point where the prices would start dropping causing the effect of passing some of the savings to the buyers.
If you were working at full capacity in your hunting business hunting and selling twenty turkeys per day and the market maintains the price of two bundles per turkey, you could invest in another bow and arrow, hire a person for ten bundles per day, produce twenty more turkeys, sell them for forty bundles, and keep thirty bundles of profit. If the price does not drop, you could hire ten people, produce two hundred turkeys per day, make three hundred bundles of profit, and dedicate yourself to supervise the ten people. The price of the turkeys will eventually drop if you continue increasing production. Eventually, you would expand production until the price drops to a point where most of the profits are passed to the buyers. You would stop increasing production when the product is selling at a small percentage over its cost and increasing production and lowering prices any further would mean selling at a loss. The percentage of profit at which you would stop can be called a normal profit rate and it would be roughly equal to the profit opportunity of any other business.
The Business Enterprise Passing Profits to Customers Principle of Wealth Production
The business enterprise has the capability to increase production by hiring people and it will increase production until the price of the product drops to a point where the profit rate is a small percentage over the costs of the product and similar to the profit in other industries. This will result in most of the savings from the business enterprise investments to be passed to its customers.
The Profit Effect on the Wage Rate
Lowering prices when there is a high price to clear the inventories is an income increase to the turkey buyers. This income increase is equivalent to an increase in the real wage of the turkey buyers. If a turkey buyer is working ten hours per day earning ten bundles and buys a turkey for two bundles, he would have a turkey and eight bundles after the purchase. If the price of a turkey drops to one bundle, he will have nine bundles left after the turkey purchase or an equivalent income of eleven bundles. His real income would have increased from ten bundles to the equivalent of eleven bundles. This would be a ten percent increase.
The wage rate is also increased by business enterprises that are making high profits by bidding up the wages in the market. To increase production and increase the hiring of employees, the business enterprise has to pay a higher wage to attract labor. This is a real and a nominal increase in the wage rate. This would cause the effect of passing some of the investment savings to the employees instead of passing them to the customers. The wage rate of the turkey hunter will be higher than the bundle makers because of the higher profits of this industry will allow it to pay higher wages. If the skill required for hunting is higher than for bundle making, then the business enterprises hiring hunters will be able to hire the people that will have better skills since they are paying more. The portion of profits passed to the employees as increased wages would be recorded as an increased expenses.
The investments of the business enterprise increase the income of all the people in the supply chain but the income increase has different names as it goes through the processes from production to consumption. The single person in an island working ten hours can produce eight bundles and one turkey increases his income to the equivalent of eleven and a half bundles by investing in a bow and arrows. This is investment income but it is equivalent to an increase in the wage rate of this single person. When a turkey is exchanged for a pound of vegetables, these are buyer savings, that are equivalent to an increased income to the buyer and there are sales profits that is an increased income to the seller. When the business enterprise is formed, the income flows as salaries to employees, savings to buyers, and profits to the owner and they all come from working in more efficient wealth production process.
Higher wages result for positions that require higher human capital according to the supply and demand of each particular position. The business enterprise will pay higher wages for managers to manage the increased number of people, engineers to design the products and the processes, and entrepreneurs to make the right decisions in the market.
The Business Enterprise Passing Profit to Employees Principle of Wealth Production
When the business experiences high profits, it will bid high in the market to attract employees of the skills needed to run the business enterprise raising the wage rate of the employees and passing in this way a portion of the profits in the form of increased wages. Positions that require higher human capital might require higher wages according to the supply and demand of each position.
The Division of Labor
Once a business enterprise has several employees, they can produce many times more efficiently by dividing the tasks among them using specialized tools for each operation. A classic example of this is mentioned by Adam Smith in his Wealth of Nations where he describes how a group of people making pins can produce thousands of times more pins by dividing the labor amongst them and working with the appropriate tools in a way where they specialized in their tasks. People arranged this way are able to produce thousands of times more pins that the same number of people would be able to produce individually. The possibility of having a more efficient process using the division of labor comes as a result of the existence of a market that demands high quantities of product, the investment in the appropriate tools, and a business enterprise that can expand production pursuing higher profits.
The Division of Labor Principle of Wealth Production
A market with mass production demands great quantities of product that allows business enterprises to organize wealth production processes in a very efficient way by having people specialize and using specialized tools in each operation.
Competition
The expansion of one business enterprise is sufficient to cause the need to lower prices to sell all the production. If a business enterprise decides to keep high profits by not expanding production, it will lose the business to any competitor that will execute the expansion. A wealth production process that has high profits attracts several business enterprises that would try to fill the supply making the price drop until the product reaches a normal price. The normal price would be the price where the business enterprises would make a normal profit.
When several suppliers increase production, sometimes they go after the same market share and overproduce. The supply will exceed the demand at the current market price and the product will accumulate in unsold inventories. Suppliers will lower prices and cut production quantities until the inventories are sold. The price at which suppliers will be willing to continue production will be at least the normal price level. The accumulated inventories might have to be sold below the normal price and sometimes at a loss.
In a free market, competition brings the best products that can be produced. Any business enterprise that is not able to offer a competitive product at a competitive price will lose its customers. When this happens, there will be unemployment and a difficult time for many people. This is an undesirable effect of competition but a necessary condition for business enterprises and people to have the incentive of being the best wealth production processes survive and become wealthier. Most important to keep in mind is that although unemployment is an undesirable effect, it is the result of the voluntary choices of the customers. If you do not have a product that people want to buy, there is no reason why they should be forced to do so. Business enterprises that would become complacent and do not produce the best product possible will not receive the voluntary decision of the buyers to buy their product.
In a market of free competition, business enterprises have to use the best practices of the industry, even if they have to copy them, to stay in the business. A business enterprise has to be the innovator that everybody copies or copy the innovator to keep up with the market. Any business enterprise that does not progress with the industry will eventually have to close its doors. In a free market, a business enterprise has to invest in the best wealth production process available because the business enterprise that makes the right investments will be able to sell at a lower price while still making a profit.
Since the largest percentages of profit are available when the product or process is new, the business enterprises that are constantly innovating and investing correctly to make life easier for their customers are the one that will be the most profitable.
If a business enterprise is experiencing losses but a competitor is not, it means that the competitor has found a better wealth production process. The losing business enterprise has to improve its cost structure and methods to be able to stay in the industry.
If all the enterprises in the industry are experiencing losses, it means that the demand has shifted to other products in other industry and the production in this industry must be adjusted downward. The less efficient producers will be the ones experiencing the biggest losses and would be the ones that would exit the market first.
Competition in a free market will result in business enterprises reducing their prices until their profits are a small percentage over their cost. The business enterprise that does not reduce prices will have its market share reduced.
The competitive strength of a company is not a specific idea or an invention but the constant execution of the best wealth production processes that will meet the customer needs. The success of the company rests in the alignment between the work that needs to be performed and the requirements of the customers.
The existence of competition in a free market gives great power to the customers. It gives great power to the people. Any business enterprise that does not maintain its performance will not be preferred by the buyers in the market and will lose market share.
Competition protects the consumer in the purchasing decision. How would the otherwise know that the price that you are paying for a product is a fair price? Producers will not share their internal costs. A consumer can decide to purchase the best alternative by evaluating several products, suppliers, their quality, and their prices.
A business enterprise can get distracted in its wealth production process and neglect the market needs. The mistake is usually not realized until an alert competitor takes away the business. This happens sometimes when a business enterprise has a successful business formula and the market changes. Sometimes the business enterprise is not able to abandon the once successful formula and it will lose customers for not following the new needs of the market.
A business enterprise that aligns its mission and its actions to the natural mission of producing wealth for the people's survival and enrichment becomes a formidable competitor. This alignment should hold its employees from incurring in excessive costs and its owners from wanting excessive profits that would slow down the growth of the business enterprise. A company well aligned should design, produce, and sell the products that are wanted by the people at a reasonable price and capture a great portion of the market share.
The Competition Principle of Wealth Production
Competition in the market requires that the business enterprises invest in the best possible wealth production processes and sell the higher quantities of product resulting from these investments at prices that are slightly above the production costs having the effect of passing most of the savings to the buyers.
The Normal Profit Rate
If you could produce two turkeys in one hour with a bow and arrows and sell them for two bundles each, you would be making a profit of three bundles per hour. This is a three hundred percent profit over the one bundle per hour labor rate. At this profit rate, you would hire people to increase production. As you increase the quantity supplied, you would find out that you have to lower prices to sell the higher production quantities. At a price to one bundle per turkey, you would still be making a very high profit rate of one hundred percent. You would keep expanding. If the price drops to three quarters of a bundle, you would still make a high profit of fifty percent. How low would the profit rate have to be to stop expanding? If you follow this logic, you should agree that the expansion will continue until this business is no longer the best investment available. This would be the price where the profit in the sale of turkeys is a normal profit rate and the resulting price can be called the normal price. This price will be at the intersection of the demand and supply curves because it would be the price with a normal profit at which suppliers are willing to supply the quantity that is demanded.
The investment will result in a larger number of people using the product because they are able to afford it at the new lower normal price.
A business enterprise could try to continue operating at a high profit margin, but this situation can only be maintained for a short period of time and it is of very high risk for the enterprise because competitors will be able to take business away by being willing to work with a lower profit margin.
The Normal Profit Rate Principle of Wealth Production
Business enterprises adjust production to the level of the quantity demanded at the price that produces a normal profit rate, allocating the people to the quantity of product work that is desired by the market in every sector of production. In a free market, the business enterprises are motivated to expand production until the prices drop to a level that is a small percentage over the costs. This can be called a normal profit rate. This will cause the effect that most of the savings from the investments of better wealth production processes to be passed to the customers of the business enterprise.
The Limitation for Wealth Increase
If you were alone in an island with nothing but your hands, the first limitation to become wealthy would be the time that you have to work. You would have to work to meet your basic needs and this will consume most of your time. Once you would have achieved survival, you would have to make tools to make your life easier just like Robinson Crusoe had to do. Each tool would take a great deal of time. The amount of time that you would be investing in your tools would be slowly increasing your capital structure. For the business enterprise, you would think that the limitation to increase its wealth would be the resources available to invest but this is not so. As long as a business enterprise is making profits, it can borrow money if the interest rate is below the profit and still make money. The limitation for a business enterprise comes when the prices drop because the people do not want or cannot afford the production at high prices. The limitation for investment becomes the quantity demanded by the people at a given price. Production can be expanded only up to this point.
The price and the quantity demanded is determined by the people that can fit the goods in their budget. This in turn is determined by the wage rate. This relationship closes a circle of survival and enrichment where the business enterprises supply the products required at a normal price and a normal profit rate after hiring all the people that they could, and paying the people with the money that they will use to buy the goods.
The limitation for the investment resources comes when the profit rate comes down close to the interest rate of the market and it is no longer possible to borrow money to invest at rates that will yield a profit and the investment is no longer the best investment since the interest rate is so close and pays with less risk.
The Business Enterprise Wealth Improvement Limitation principle of Wealth Production
In the same token that you time and your work would be the limitation for the investment that you can make for your wealth improvement alone in the island. The business enterprise will find a limitation on the quantity demanded of the product at the cost of the resources plus the normal profit rate that reflects the budget of society for that product.
Unemployment
When a business enterprise experiences losses because the prices of the product have dropped too low, the business enterprise will have to reduce production and let employees go. If the business enterprise does not let go the employees, it would have to keep them in the payroll doing nothing and it would have to pay them with money from reserves. This would result in wasted resources due to the people that would be paid but would have no productive output. This adjustment to lower production levels will is cause unemployment.
The Business Enterprise Supply Adjustment Unemployment Principle of Wealth Production
When a business enterprise expands pursuing high profits it will reach a point of no gain or loss where production is too high and the business enterprise will have to reduce production and let some employees go.
The Income Statement
The income statement is a report of the business enterprise showing the sales minus the costs in a period of time. If the results are positive, the business had a profit. If they are negative, the business had a loss.
The first line of the income statement shows the total sales of the business enterprise. The total sales are a measure of the first mission of the business enterprise, which is to make a product or service and sell it.
The last line shows the profit or loss, which is the third objective of the business enterprise, which is to make a profit by selling products for prices that are higher than their cost or making products for less than their price.
The income statement does not show a measurement of the second objective. This is the reduction in prices that that the business enterprise achieves through time due to its investments. This could only be measured by looking at the product offerings through time and showing that a company has been selling them at lower prices as time goes by. These lower prices will only be evident if the graph is discounted for inflation.
Meeting all three objectives could be shown in a single graph with time in the horizontal axis and the objectives in the vertical axis. A business enterprise that is fulfilling its mission should show increasing sales, increasing profits, and a reduction of prices through time. The reduction of prices will only show if the graph is adjusted for inflation.
The expenses of a business enterprise have a degree of relationship to the volume of the business by which they can be classified as fixed or variable. All expenses increase with volume but some of the expenses are more directly and closely proportional to the volume while others increase in big steps. Raw material and direct labor are called variable expenses for this reason. Higher quantities of volume will require proportionally higher quantities of raw material and labor. A building does not change for a volume range. Its cost looks like a fixed expense until the capacity is filled up and more capacity has to be bought or rented.
When you produce a product, you need to sell the product for more than its variable cost. This way, each unit of the product will make a contribution to the fixed expenses. You have to sell enough units of a product so that the profit made in all the units is more than sufficient to pay for the fixed expenses and the business can declare a net profit. The profit made over the variable costs is called gross profit and the profit made over all costs is called net profit.
Most of the fixed expenses are the result of investments in the physical tools that are necessary for production. The accounting term to recognize the usage of a fixed tool in a period of time is called depreciation. The usage of the fixed costs is recognized in the income statement for the period that they are used up.
The variable costs are incurred while working and are composed mainly of raw material and labor. The physical capital structure of the business enterprise is what gives the ability to pay for the direct labor and salaries of everybody that works for the business enterprise as they work for the company.
The Balance Sheet
To perform the wealth production processes, the business enterprise needs physical capital and other assets. The assets and liabilities of the business enterprise are listed in its balance sheet. The assets are the tools and other assets that the firm controls. These assets can be owned and have been bought with borrowed money. The liabilities are the part that the firm borrowed to buy tools.
Some of the components of physical capital are the tools. The business enterprise needs to have a capital structure that is as good as any competitor's to make its sales while making a profit. The assets in the balance sheet represent the capacity of the business enterprise to produce.
Money is another one of the components of the assets. Money is needed to buy the physical assets of the company when an investment is made. Money is also needed to buy working capital. This is the raw materials and inventories that are in the process of being converted or sold. Money is equivalent to human time in storage. To make an investment that will improve productivity, many hours had to be saved and invested in building a tool. In a market, the tool can be made and sold for money. A business that has a successful business formula can purchase the tool with money and pay it with a portion of the sales by putting the depreciation charge in every period. The possibility to convert money into a tool makes money a factor of production. It is also part of the capital structure.
When you were alone, before making any tools, your main assets, your hands, your mind, and your time were not written in a balance sheet. The accounting in the balance sheet starts when you invest in the water pouch and the bow and arrows. A water pouch costs twenty hours of work so when you finish one, you would have an asset with the cost of twenty hours listed in the balance sheet. The water pouch lasts for twenty days so every day you would consume one hour of the twenty hours stored until the pouch is totally consumed and you would have to build another. The usage of the water pouch would be recorded in the income statement as a depreciation expense of one hour of depreciation per day and in the balance sheet as a water pouch with a decreased value as the days go by.
The liabilities in the balance sheet represent what the business enterprise owes. Some of the assets that are controlled by the business enterprise are purchased with borrowed money. The liabilities in the balance sheet show the part of the business that is owed.
The Human Capital of the Business Enterprise
The balance sheet of the business enterprise lists the physical capital but it does not lists the human capital. One reason for this is that the human capital of a company is not owned but it is hired. Any employee working in a company can decide to stop working at a given moment and take his human capital away.
Running a modern business enterprise requires a great amount of human capital. With the growth of the enterprise, specialization and division of labor, and the use of more complex tools, the business enterprise needs to have people with the ability and the knowledge to run the processes correctly and to communicate to each other. This knowledge is in the heads of the employees of the company and constitutes the human capital of the company.
There is an ingredient of the human capital that is hard to quantify. It is the drive and attention of its owner. It is the entrepreneurship of a business enterprise. This entrepreneurship includes the ability to know where the market is going and to organize and direct the resources of the business enterprise to serve the market accordingly.
The growing complexity of business enterprises require that they bid and pay for the element of intelligence and knowledge required to run its processes. The requirement for the direction of the enterprises and the supply of this intelligence creates a market of very high salaries for the people that can show that they can execute these tasks well.
The Owner
If you would be alone in an island, you would be the owner of your one-person business enterprise. As the owner, you would have to decide which products to build. This should be easy to do since you would be your own customer. Your decision would result in committing your time to the production of the goods that would be of the highest value to you or the tools to produce these goods. This would be your role of owner and entrepreneur.
For the owner of a larger business enterprise, the decisions become more difficult. You have to decide which products to design and build for people that you do not know. Making the correct decisions will keep the enterprise profitable and making mistakes can make the enterprise experience losses. To make the correct decisions, the owner has to be in close communication with its customers and watching his competitors. Making these decisions is called entrepreneurship.
The owner of a business enterprise is responsible that the wealth producing capability of the business enterprise is preserved and increased and that the wealth production process is equal or better than any competitor. The owner is responsible to fulfill the three objectives of the enterprise, which are: to supply products, to reduce their cost, and to make money while doing it.
For the employees of the business enterprise, the owner is a representative of the customer. The owner has to identify the products and the service that the customers will want and steer the enterprise in that direction. The value of entrepreneurship is to know the needs of the market and organize the resources to meet these needs in a profitable way.
One of the biggest challenges for an owner is to transmit the owner mentality to the management and employees of an enterprise. The probability of success of a business enterprise improves if all the employees think and act as if they owned the business. The employees should have the owner mentality of serving the customer, taking care of the assets of the company, executing the wealth production process correctly, and acting with the understanding that the business enterprise is the means of everybody's survival.
Another responsibility of the owner is the management of the business enterprise. The owner has to make sure that resources are used correctly and not wasted. The owner has the responsibility to directing an organization in which the livelihood of all the employees and the satisfaction of the customers depends. The success of the business enterprise depends on how well the owner understands the needs of the customers and how capable is the business enterprise to meet them.
The expense of a business enterprise includes the salaries of the employees that are hired. The owner is ultimately responsible to steer the business enterprise to provide the right products to its customers to achieve the success of the company and ensures the survival and enrichment of its employees.
The Customer
The consumption of a product by the customer is the last step of the wealth production process. If you were producing for yourself, the final step of your wealth production process would be the consumption of the product. In the island alone, the satisfaction of your need comes only after the product has been produced. In the island, the consumption of the product cannot be dissociated from the effort required to produce it. You could only consume what was previously produced.
With trade, the production person is different than the consumption person. For the trade process to occur, the customer has to agree to buy your product. The acceptance of the product by the customer becomes a necessary step for the process to continue. This gives great power to the customer and makes the business enterprise dependent of its customers. For the business enterprise, it is of the utmost importance and a necessary condition for survival that the enterprise understands the needs of its customers and that these needs be met better than any competitor. A business enterprise that forgets this is will be breaking the wealth production process and will lose its customers.
Money and the business enterprise provide the media by which you can enjoy the results of your work with products that you did not build. You serve a customer through a business enterprise, the customer pays the business enterprise, the business enterprise pays your wages, and you use your wages to buy products from other business enterprises.
Your survival and enrichment depends on your customer’s preference for your business enterprise. Your customer has the power to decide if he wants to accept the product of your business enterprise. When you were producing for yourself you would work on your products until they were acceptable to you. In the market, your survival and enrichment depends on your customer's acceptance.
On the other hand, when you have earned money, you have the power to accept or reject any product that can be purchased. Your acceptance of the product is a requirement for the production process to function for the products that you buy from the business enterprises that are there to serve you.
The mission of the business enterprise is the survival and enrichment of all the stakeholders. This is only possible if the customer is willing to buy the goods that are being produced and the customer will accept the goods only if the business enterprise produces what the customer wants.
In a market with many customers and many suppliers, the mission of the business enterprises is the same as when you were working alone in the island. The customers are the last step of the wealth production process and the suppliers are there to meet the needs of the customers and for everybody to be supplied and enriched. You, your customers, your employees, your suppliers are a team organized in the market, with the final acceptance of the customers, to increase the wealth of all the participants.
The Employee
When you are hired as an employee in a business enterprise, you do not have to worry about which products need to be built. The owner or the business enterprise has already decided this. You are joining a team that is making a product or performing a service and you need to find out which tasks are yours and execute them with excellence to service the customer. Being an employee means you have been accepted to participate in a wealth production process. You might need to get direction and be trained to produce the product according to the customer requirements. The success of the business enterprise is highly dependent upon you delivering the product or service with a quality that will result in the satisfaction of the customer. The correct execution of the employee's job determines if the customer is going to come back. If the customers are not satisfied and do not come back, the business enterprise will experience losses, will have to cut the size of the enterprise, and you could lose your job.
As a new employee, you might not be very good in your job until you go up in the learning curve. Eventually, to keep your team competitive and your job secure, you have to be as good and as fast in your job as anybody else. You have to think that you are a member of a team in a competition. You cannot let down your team or your team will want to get rid of you. The team cannot risk the possibility that it will be disbanded because it was not able to fulfill its mission better than any competitor. If you are not an asset to the team, the team will replace you because the team cannot afford to struggle with your performance when somebody else can do the job.
You should use the full power of your mind to do the job in the best possible way. The survival of your business enterprise depends on your creativity and attention to the needs of the customers and the requirements of the business enterprise to fulfill them.
You should be obedient to the management hierarchy and to your customers. There are many ways to do a job and how to prioritize the many things that need to be done and somebody has to decide which the right way to go is. Business enterprises have a hierarchy that is derived from the owner. One of the purposes of the management hierarchy is to make the right decisions without much delay. Without a management hierarchy, a business enterprise would consume itself in debate and lose customers in the process. The management hierarchy provides a way for decisions to be made in an expedient way and to assign the results of these decisions to a person that is responsible.
As an employee, you should look after the resources of the business enterprise that has accepted you and execute your job with the minimum waste possible. Waste increases the cost of the products and reduces the competitiveness of your team.
You should protect the well-being of the team and of your customers. If you would see anybody doing something detrimental to the team, such as somebody stealing from the team, you should report it because the survival of the team is at stake.
You should treat the business enterprise where you belong as a survival team of which you are a member. Your business enterprise is a team that is producing the goods that pay for the items that you need. This means that you and your family depend on the health of the business enterprise in which you work.
You should not allow other employees to take advantage of the business enterprise to which you belong because eventually it will lose competitiveness or it will break down in corruption. If one person takes advantage of the enterprise with immunity, another person will also want to take advantage also and eventually the enterprise will break down.
You have to produce more value than your pay since the business enterprise has to pay all the expenses incurred in making the total sales, including your income, and clear a profit. The business enterprise has to pay for the tools, the building, the taxes, and many other expenses that are necessary for the business to be carried on.
As an employee, you should approach your job with the same mentality of the owner. You would be a member of a team that produces a product that meets the needs of your customers. This is done for the purpose of your customer’s and your own survival.
You should become concerned if your business enterprise is not doing the things that need to be done in the best possible way because it means that another enterprise will do them right and your enterprise will lose its customers.
A business enterprise is obliged to pay only the salary that the market requires. Your salary in the business enterprise is mainly dependent on the supply of people that can perform your job. A business enterprise cannot afford to pay more than the market rate for the positions that it hires because if it does, another business enterprise will not do it and the enterprise that pays more than the market will have a higher cost. On the other hand, a business enterprise that is being successful can reward its employees better than the one that is failing. To increase your income in a business enterprise, you have to prove yourself useful in position of increased skill and responsibility.
The Manager
When a business enterprise grows, the owner has to hire employees to do the tasks that need to be done. When the employees are too many, the owner has to hire managers that will help him oversee the correct performance of the employees in their delivery of the product to the customers.
If you are a manager, it is your responsibility to ensure that the customer needs are met and that the resources of the enterprise are used appropriately without waste.
There is great value in the capability of organizing and managing a business enterprise. It is of great importance that the right work be done so that everybody can eat. It is of greater importance to find out methods to improve the processes so that everybody can become richer.
As the complexity of the business enterprise increases, a manager is expected to execute the policies, to know what creates wealth in the industry, and to know what it takes to keep people employed.
There is a thousand ways to skin a cat. This is one of the reasons that a business enterprise needs a management hierarchy. The management hierarchy makes sure that decisions are made in the path that is thought to be the best for the business enterprise but most important, that he decisions are made timely. Many times the success of a business enterprise depends on the correct actions to be done at the right time. Many decisions cannot be debated for a long time and the managers are there to decide. If decisions take too long or are wrongly made, another enterprise that decides and acts fast and correctly will take the customers away.
A business enterprise derives its mission from the people. The people, through the market, transfer the responsibility for wealth production to the owner of the business enterprise. The owner transfers the mission to the top manager of the enterprise. The mission from the top gets broken into objectives for each team that is usually represented by a manager in the hierarchy.
In the very large business enterprises, the owner also delegates the entrepreneurship function to professional managers and engineers. It is a great challenge for the owners of a business enterprise to transmit the entrepreneurial skill to the hired management of the company.
The Service Industry
In the manufacture of products, you have to sell a unit of a product for a price that will cover all its costs. In the service industry, what are for sale are the units of human time with a skill. The price of the human time to be hired will be higher for the skills that require more human capital, such as the skill of a brain surgeon. This will be true as long as the supply of the skill is small compared to the demand. There are skills that require human capital, such as musicians, but the supply is large that the wages are not high.
A business enterprise that sells units of human time, such as the service of a haircut, needs to charge for the service enough to pay for the labor of the person, a contribution to fixed costs, and a profit for the investments of the enterprise.
The skill and availability of a service and the demand for the service determine the income of a person that lends a service. This is why skills that are highly demanded and are hard to acquire are paid very high.
The Business Enterprise Roles and Responsibilities
The business enterprise has roles and responsibilities for each person. In a role, a person takes his role and responsibility to contribute to the wealth of the people. The wages of each position depend on the human capital and the supply and demand of each position.
Monopoly
When one supplier finds a better wealth production process, it can increase production and sell for a price that is below the price of the competitors. This advantage makes it possible for this enterprise to capture most of the market becoming a near monopoly. An enterprise in this situation is not motivated to increase prices arbitrarily as it is the popular belief because this puts the brakes on the expansion. Upon finding a successful wealth production formula, a business enterprise is motivated to increase production and sales as fast as possible and this can only be achieved by keeping prices below the market and dropping them further when sales start to slow down.
Another reason a near monopoly business enterprise is not motivated to increase prices is that this action will invite competitors to reestablish production. Competitors will try to enter the market with their old methods and by copying the best method using reverse engineering.
The business enterprise that achieves a near monopoly becomes a target for all competitors. The near monopoly situation usually will only be temporary until the competitors present alternative competitive offering or they copy the better wealth production process.
A company that is able to reach a market share so large that makes it a near monopoly has to have a constant stream of innovation and new products and processes that are always better than the competitors. The price of a product in a market moves quickly to a normal price with a normal profit. Profits at a high percentage are only available at the beginning of the sales when the product or investment is an innovation. When a new product or process is available, it is only a matter of time when competitors enter the market and the profit rate will get close to a normal profit rate. To make profit margins greater than the normal profit rate, a company has to be innovating constantly.
When a company earns a dominant position in the market, the position is only tenable as long as the business keeps meeting the customer needs. When the market shifts, many companies that have a near monopoly are not able to shift with the market needs and lose market share.
Quality
When you were hypothetically producing for yourself in the island, the quality of the products that you would make would be defined by you. You would decide what level of quality you would want in your products and how much effort to put to achieve it. To avoid waste, you would be very forgiving of many imperfections in the quality of the products that you produced as long as it did what it was intended to do.
If you would do want to do barter with your neighbor, the quality of the products that would make would have to be accepted by your neighbor and you would have to accept the quality of the products that your neighbor would make. You have to produce a product with sufficient quality for your neighbor to accept and your neighbor would have to produce a product with sufficient quality for you to accept. Both of you would be interested in making the product at the lowest cost but without risking a rejection.
In a market with several suppliers, the quality is defined by the most capable producer. The most capable producer sets the expectation. When the consumers have the option to buy a product from the most capable producer, they will prefer the higher quality product and get used to it. The best producer will be the one that can produce the best quality and the best price according to the needs of the market.
The best producer also sets the level require to enter the market. If you do not have a product that is at least as good as the one that is in the market, you are not going to be able to enter a market where there are established suppliers with a proven product. A new supplier has to offer an advantage over what is available. To succeed in a freely competing market, your business enterprise has to be equal or better than the competition. Competition forces you and your business enterprise to be constantly looking for the best way to produce a product. All suppliers in the free market have to perform as well as it is possible with the existing technology. Any supplier that falls behind in its investment for the best process available will eventually lose the business.
The Corporation
The growth of your business enterprise would be limited by the amount of resources that you have and the amount that you could borrow before you would reach the production point to supply all customers. To organize a business enterprise of a larger size, it is necessary to pool the resources of many people into what is called a corporation.
A corporation is a legal entity that is able to conduct business as if it was a person. This legal entity is formed by selling shares of the enterprise and each shareholder becomes an owner. The corporation is structured with a contract that governs how the resources will be managed.
The origin of the corporation goes back to the 1600’s when people that wanted to invest in exploration of the earth raised money by combining their resources into what was called “joint-stock” companies. This companies were legally defined as being owned by the owners of the stock but were limited in their responsibility, in case of a loss, only to the money invested. This method of financing became very effective to form large business enterprises.
The management of a corporation is usually entrusted to a hierarchy of hired managers that might or might not be shareholders. Sometimes one or several of the founders or investors of a corporation will have enough stock on the corporation to exert owner power and supervision. In very large corporations with thousands of shareholders, the interest of the management could be toward the survival of the business enterprise instead of the maximization of profit. The management of a corporation might tend to run the business as if it had been there all the time without the owner mentality. An owner or founder would usually be a big part of the formation of a business enterprise and will remember how it was when it did not exist. One of the biggest challenges for a corporation is to instill the owner mentality in its management and employees.
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