chap03 fundamental economic concepts

Do you work at a

business? Belong to a

church? Participate in a club?

Chances are these institutions

play a significant role in your

life. To learn more about how

business organizations and

economic institutions operate,

view the Chapter 4 video lesson:

Business Organizations

Chapter Overview Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 3—Chapter Overviews to previewchapter information. Running a business involves risks

as well as expectations.Running a business involves risksas well as expectations.

http://epp.glencoe.com

Forms of Business Organization

Main IdeaBusinesses may be organized as individual proprietor-ships, partnerships, or corporations.

Reading StrategyGraphic Organizer As you read about business organi-zations, complete a graphic organizer similar to theone below to explain how the three types of businessorganizations differ from one another.

Key Termssole proprietorship, proprietorship, unlimited liability,inventory, limited life, partnership, limited partnership,

bankruptcy, corporation, charter, stock, stockholder,shareholder, dividend, bond, principal, interest,double taxation

ObjectivesAfter studying this section, you will be able to:1. Describe the characteristics of the sole

proprietorship.2. Understand the advantages and disadvantages of

the partnership.3. Describe the structure and features of the

corporation.

Applying Economic ConceptsUnlimited Liability Some forms of business organiza-tion can leave you holding the bag—including all thebills—for the entire business. Read to see how personalliability is affected by the type of business owned.

Proprietorships

Partnerships

Corporations

Cover Story

Raw FeelingsScott Melton thinks he got a

raw deal. Melton, who

recently opened Sushi

Nights on Main Street

in Deep Ellum [Texas],

filed for Chapter 11

bankruptcy in April for

Sushi Deep Ellum Inc.,

the general partnership

he formed to operate

Deep Sushi. . . . Last

June, Deep Sushi’s lim-

ited partners. . . gave

Melton the boot. Not only that, they stiffed him, he

says. “They left me holding the bag for $57,000

worth of unpaid taxes . . . including utilities and ven-

dor bills. . . .

—Dallas Observer Online, May 20–26, 1999

T here are three main forms of business organi-zations in the economy today—the sole pro-prietorship, the partnership like the one Scott

Melton describes in the cover story, and the corpo-ration. Each offers its owners significant advantagesand disadvantages.

Sole ProprietorshipsThe most common form of businessorganization in the United States is the sole

proprietorship or proprietorship—a business ownedand run by one person. Although relatively the mostnumerous and profitable of all business organiza-tions, proprietorships are the smallest in size. AsFigure 3.1 on page 58 shows, proprietorships earnabout one-sixth of the net income earned by all busi-nesses, even though they make only a fraction oftotal sales.

Forming a ProprietorshipThe sole proprietorship is the easiest form of

business to start because it involves almost norequirements except for occasional business

Mounting bills are one of

the risks of business.

CHAPTER 3: BUSINESS ORGANIZATIONS 57

057_GLENEPP 10/23/03 3:50 PM Page 57

licenses and fees. Most proprietorships are readyfor business as soon as they set up operations. Youcould start a proprietorship simply by putting up alemonade stand in your front yard. Someone elsemight decide to mow lawns, do gardening, or opena restaurant. A proprietorship can be run on theInternet, out of a garage, or from an office in a pro-fessional building.

AdvantagesThe first advantage of a sole proprietorship is the

ease of starting up. If someone has an idea or anopportunity to make a profit, he or she has only todecide to go into business and then do it.

The second advantage is the relative ease of man-agement. Decisions may be made quickly, withouthaving to consult a co-owner, boss, or “higher-up.”This flexibility means that the owner can make animmediate decision if a problem comes up.

A third advantage is that the owner enjoys theprofits of successful management without havingto share them with other owners. The possibility ofsuffering a loss exists, but the lure of profits makespeople willing to take risks.

Fourth, the proprietorship does not have to payseparate business income taxes because the busi-ness is not recognized as a separate legal entity. Theowner still must pay individual income taxes onprofits taken from the sole proprietorship, but thebusiness itself is exempt from any tax on income.

Suppose, for example, Mr. Winters owns andoperates a small hardware store in a local shoppingcenter and a small auto repair business in his garagenext to his home. Because neither businessdepends on the other, and because the only thingthey have in common is ownership, the two busi-nesses appear as separate and distinct economicactivities. For tax purposes, however, everything islumped together at the end of the year. When Mr.Winters files his personal income taxes, the profitsfrom each business, along with wages and salariesearned from other sources, are combined. He doesnot pay taxes on each of the businesses separately.

A fifth advantage of the proprietorship is thepsychological satisfaction. Some people want thepersonal satisfaction of being their own boss.Other people have a strong desire to see their namein print, have dreams of great wealth or communitystatus, or want to make their mark in history.

A sixth advantage is the ease of getting out ofbusiness. In this case, all the proprietor has to do ispay any outstanding bills and then stop offeringgoods or services for sale.

DisadvantagesOne main disadvantage of a proprietorship is

that the owner has unlimited liability. This meansthat the owner is personally and fully responsiblefor all losses and debts of the business. If thebusiness fails, the owner’s personal possessionsmay be taken away to satisfy business debts.

E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E Figure 3.1Figure 3.1

Using GraphsUsing Graphs Businesses can be organized in the United States in a number of ways. Which businessorganizationaccounts for the largest amount of sales?

20.2% 71.9%

7.9%

4.7%8.8%

68.1%

86.5%

15.2%16.7%

Number of Organizations

Sales

Net Income (profit)

Corporations

Partnerships

Sole Proprietorships

Source: 2002 Statistical Abstract of the United States

Corporations, Partnerships,and Sole Proprietorships

Visit epp.glencoe.com and click onTextbook Updates—Chapter 3 foran update of the data.

58 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS

058_GLENEPP 10/3/03 3:55 PM Page 58


To illustrate, consider the earlier case of Mr.Winters who owns and operates two businesses. Ifthe hardware business should fail, Mr. Winters’ per-sonal wealth, which includes the automobile repairshop, may be legally taken away to pay off debtsarising from the hardware store.

A second disadvantage of a proprietorship is thedifficulty in raising financial capital. Generally, agreat deal of money is needed to set up a business,and even more is required to support its expansion.A problem may arise because the personal financialresources available to most sole proprietors are lim-ited. Banks and other lenders usually do not wantto lend money to new or very small businesses. Asa result, the proprietor often has to raise financialcapital by tapping savings, using credit cards, orborrowing from family members.

A third disadvantage of a proprietorship is thatof size and efficiency. A retail store, for example,may need to hire a minimum number of employeesjust to stay open during normal business hours. Itmay also need to carry a minimum inventory—astock of finished goods and parts in reserve—tosatisfy customers or to keep production flowingsmoothly. Because of limited capital, the propri-etor may not be able to hire enough personnel orstock enough inventory to operate the businessefficiently.

A fourth disadvantage is that the proprietoroften has limited managerial experience. Theowner-manager of a small company may be aninventor who is highly qualified as an engineer, butlacks the “business sense” or time to oversee theorderly growth of the company. This owner mayhave to hire others to do the types of work—sales,marketing, and accounting—that he or she cannot do.

A fifth disadvantage is the difficulty of attractingqualified employees. Because proprietorships tendto be small, employees often have to be skilled inseveral areas. In addition, many top high schooland college graduates are more likely to beattracted to positions with larger, well-establishedfirms than small ones. This is especially true whenlarger firms offer fringe benefits—employee benefitssuch as paid vacations, sick leave, retirement, andhealth or medical insurance—in addition to wagesand salaries.

A sixth disadvantage of the sole proprietorship islimited life. This means that the firm legally ceases toexist when the owner dies, quits, or sells the business.

INFOBYTEINFOBYTE

Business Inventories The Business Inventoriesreport measures the monthly percentage changesin inventories from manufacturers, retailers, andwholesalers. The report is useful in predictinginventories within the gross domestic product(GDP), which can be volatile from quarter to quar-ter. Business inventories are reported monthly bythe Commerce Department. Business inventoriesdata, released in the third week of each month,show the monthly percentage change in invento-ries from manufacturers, retailers, and whole-salers. Because the majority of the data is old bythe time it is released, it is usually not a key reportto the markets. One portion of the report that does draw a bit of attention, though, is theinventory-to-sales ratio. This particular componentis useful in forecasting, since increasing inventory-to-sales ratios signals a cutback in production.


Sole Proprietorships The sole proprietorship isthe most common form of business organization.What are some of the reasons for setting up asole proprietorship?


Entrepreneurs ofthe New Economy

During the 1700s and 1800s, a series of innovations inagriculture and industry led to profound economic andsocial change throughout many regions of the world. Urbanindustrial economies emerged in these areas and eventuallyspread around the world. This transformation, whichbecame known as the Industrial Revolution, began whenpower-driven machinery in factories replaced work done inhomes, altering the way people had lived and worked forhundreds of years.

In the late twentieth century, the world underwent atechnological revolution as significant as the IndustrialRevolution. Computers and the Internet are at the heart ofthis transformation.

Dell Computer Few have done more to take advan-tage of the promise of the Internet than Michael Dell.Under his leadership Dell Computer is in the forefront ofmaking the Web the foundation of an existing business.Many producers, like Dell, are bypassing regular channels

of trade and reachingout to their customersdirectly. Dell Computergrew twice as fast asother personal computermanufacturers by allow-ing buyers to configuretheir own PCs online.

Another reason forDell’s success is veloc-ity. According to Dell,business velocity isshrinking time and dis-tance between a company and its suppliers as well asits customers. “The reduction of time, the reduction ofinventory, and the reduction of physical materials andassets can drive a tremendous improvement in businessefficiency,” notes Dell. “Customers’ purchasing decisionsbecome faster and they have direct access to informa-tion they need immediately. Customers can compareproducts around the world over the Internet. This hasdramatic implications for companies that previously hadbased their strategies on having a physical location,and having customers go and buy their products.”

Michael Dell

PartnershipsA partnership is a business jointly owned bytwo or more persons. It shares many of the

same strengths and weaknesses of a sole proprietor-ship. As shown in Figure 3.1, partnerships are theleast numerous form of business organization,accounting for the second smallest proportion ofsales and net income.

Types of PartnershipsThe most common form of partnership is a

general partnership, one in which all partners areresponsible for the management and financial obli-gations of the business. In a limited partnership, atleast one partner is not active in the daily runningof the business, although he or she may have con-tributed funds to finance the operation.

Forming a PartnershipLike a proprietorship, a partnership is relatively

easy to start. Because more than one owner isinvolved, formal legal papers called articles of part-nership are usually drawn up to specify arrange-ments between partners. Although not alwaysrequired, these papers state ahead of time howprofits (or losses) will be divided.

The articles of partnership may specify that theprofits be divided equally or by any other arrange-ment suitable to the partners. They also may statethe way future partners can be taken into the busi-ness and the way the property of the business will bedistributed if the partnership ends. Individuals whojoin as partners must be very careful because they arefinancially responsible for personal as well as busi-ness debts of their partners (except for those debtsspecifically exempted in the partnership contract).


060_GLENEPP 10/3/03 3:56 PM Page 60

AdvantagesLike the sole proprietorship, the first advantage

of the partnership is its ease of establishment. Eventhe costs of the partnership articles, which normallyinvolve attorney fees and a filing fee for the state,are minimal if they are spread over several partners.

Ease of management is the second advantage.Generally, each partner brings different areas ofexpertise to the business: one might have a talentfor marketing, another for production, another forbookkeeping and finance, and yet another for ship-ping and distribution. While partners usually agreeahead of time to consult with each other beforemaking major decisions, partners generally have agreat deal of freedom to make lesser ones.

A third advantage is the lack of special taxes on apartnership. As in a proprietorship, the partners with-draw profits from the firm and then pay individual

income taxes on them at the end of the year. Eachpartner has to submit a special schedule to theInternal Revenue Service detailing the profits fromthe partnership, but this is for informational pur-poses only and does not give a partnership any spe-cial legal status.

Fourth, partnerships can usually attract financialcapital more easily than proprietorships. They aregenerally a little bigger and, if established, have abetter chance at getting a bank loan. If money can-not be borrowed, the existing partners can alwaystake in new partners who bring financial capital withthem as part of their price for joining the business.

A fifth advantage of a partnership is the slightlylarger size, which often makes for more efficientoperations. In someareas, such as medi-cine and law, a

Online Auctions The auction, a centuries-old tradi-tion that links communities of buyers and sellers, istaking a new form on the Internet. One of the first tosell used goods online was the Gibson Guitar Company.The company offered older-model, used guitars for saleon the Web in 1996. Gibson’s site was a huge success,in large part due to the celebrated reputation of itsproducts.

The pioneer of person-to-person online trading is eBay.Launching its site in 1995, eBay at first offered onlysmall collectibles such as Beanie Babies and Pez dis-pensers. Today, the company connects millions of buy-ers and sellers worldwide. It helps people buy and sellproducts in nearly 18,000 categories, includingantiques, books, collectibles, electronics, sports memo-rabilia, and toys.

Under the leadership of president and CEO MargaretWhitman, eBay helped establish negotiated pricing, aconcept that influenced Web selling on items such asairplane tickets. The success of eBay has proven thatcustomers will buy used merchandise online—a signifi-cant step for many businesses in accepting the idea ofthe online auction.

An abundance of collectiblesand other goods are availablethrough online auctions.

Did You Know?Internet Commerce As use of

the Internet spreads throughout theworld, the U.S. share of Internet com-merce will fall. In 2003, the UnitedStates accounted for about 50% ofInternet-based commerce, compared

with about 75% in 1998.


061_GLENEPP 12/8/03 2:58 PM 1

relatively small firm with three or four partnersmay be just the right size for the market. Otherpartnerships, such as accounting firms, may havehundreds of partners offering services throughoutthe United States.

A sixth advantage is that many partnerships findit easier to attract top talent into their organiza-tions. Because most partnerships offer specializedservices, top graduates seek out stable, well-payingfirms to apply their recently acquired skills in law,accounting, and other fields.

DisadvantagesThe main disadvantage of a general partnership

is that each partner is fully responsible for the actsof all other partners. If one partner causes the firmto suffer a huge loss, each partner is fully and per-sonally responsible for the loss. This is the same as

the unlimited liability feature of a sole proprietor-ship. It is more complicated, however, becausemore owners are involved. As a result, most peopleare extremely careful when they choose a businesspartner.

In the case of a limited partnership, the limitedpartners have limited liability. This means that theinvestor’s responsibility for the debts of the busi-ness is limited by the size of his or her investmentin the firm. If the business fails and large debtsremain, the limited partner loses only his or heroriginal investment, leaving the general partners tomake up the rest.

Like the proprietorship, a partnership has limitedlife. When a partner dies or leaves, the partnershipmust be dissolved and reorganized. However, thenew partnership may try to reach an agreementwith the older partnership to keep its old name forpublic image purposes.

Another weakness is the potential for conflictbetween partners. Sometimes partners discover thatthey do not get along, and they either have to learnto work together or leave the business. If the part-nership is large, it is fairly easy for these types ofproblems to develop, even though everyonethought they would get along well in the first place.

Partnerships offer entrepreneurs increased accessto financial capital, but—as Scott Melton the formergeneral partner of Deep Sushi found out—things donot always work out as planned. First, his businessfiled for bankruptcy, a court-granted permission toan individual or business to cease or delay debtpayments. Then, because the limited partners hadno liability beyond their initial investments, Scottwas left with the rest of the bills. As a result, he alsofiled for bankruptcy.

CorporationsAs shown in Figure 3.1, corporationsaccount for approximately one-fifth of the

firms in the United States and about 90 percent ofall sales. A corporation is a form of businessorganization recognized by law as a separate legalentity having all the rights of an individual. Thisstatus gives the corporation the right to buy andsell property, enter into legal contracts, and to sueand be sued.


Partnerships Finding the right partner or part-ners is essential in a partnership. What is thedifference between a general partnership and alimited partnership?


Forming a CorporationUnlike a sole proprietorship or partnership, a

corporation is a very formal and legal arrange-ment. People who would like to incorporate, orform a corporation, must file for permission fromthe national government or the state where thebusiness will have its headquarters. If approved, acharter—a government document that gives per-mission to create a corporation—is granted. Thecharter states the name of the company, address,purpose of business, and other features of thebusiness.

The charter also specifies the number of sharesof stock, or ownership certificates in the firm. Theseshares are sold to investors, called stockholders orshareholders. The money is then used to set upthe corporation. If the corporation is profitable, itmay eventually issue a dividend—a check represent-ing a portion of the corporate earnings—to eachstockholder.

Corporate StructureWhen an investor purchases stock, he or she

becomes an owner with certain ownership rights.The extent of these rights depends on the type ofstock purchased, common or preferred.

Common stock represents basic ownership of acorporation. The owner of common stock usuallyreceives one vote for each share of stock. This voteis used to elect a board of directors whose duty isto direct the corporation’s business by settingbroad policies and goals. The board also hires aprofessional management team to run the businesson a daily basis.

Preferred stock represents nonvoting ownershipshares of the corporation. These stockholdersreceive dividends before common stockholdersreceive theirs. If the corporation goes out of busi-ness, and if some property and funds remain afterother debts have been paid, preferred stockholdersget their investment back before common stock-holders. Because the stock is nonvoting, preferredstockholders do not have the right to elect mem-bers to the board of directors.

In theory, a stockholder who owns a majority ofa corporation’s common stock can elect boardmembers and control the company. In some cases,

the common stockholder might even elect himselfor herself, and other family members, to the boardof directors.

In practice, this is not done very often becausemost corporations are so large and the number ofshares held by the typical stockholder is so small.Most small stockholders either do not vote, or theyturn their votes over to someone else. This is donewith the use of a proxy, a ballot that gives a stock-holder’s representative the right to vote on corpo-rate matters.

Finally, Figure 3.3 presents an organizationalchart which shows how the different parts of theorganization relate to one another. The chart showsthe basic components of the business—sales, pro-duction, finance, payroll, etc.—as well as the linesof authority so that everybody knows who theyreport to.

Figure 3.2Figure 3.2E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E

Stock Ownership

1200th

Making ComparisonsMaking Comparisons If a corporation has a total of 200 shares of stock, and if you could somehow divide the firm into 200 equal parts, the owner of a singleshare of stock would own 1/200th of thecorporation. A common stockholder, then, owns part of a company’s plant and equipment and has a voice in how the business is managed. How does common stock differ from preferred stock?


AdvantagesThe main advantage of a corporation is the ease

of raising financial capital. If the corporation needsmore capital, it can sell additional stock toinvestors. The revenue can then be used to financeor expand operations. A corporation may alsoborrow money by issuing bonds. A bond is a writ-ten promise to repay the amount borrowed at alater date. The amount borrowed is known as theprincipal. While the money is borrowed, the cor-poration pays interest, the price paid for the use ofanother’s money.

A second advantage of a corporation is that thedirectors of the corporation can hire professionalmanagers to run the firm. This means that theowners, or stockholders, can still own a portion ofthe corporation without having to know a greatdeal about the business itself.

A third advantage is that the corporation provideslimited liability for its owners. This means that thecorporation itself, not its owners, is fully responsiblefor its debts and obligations. To illustrate, suppose a

corporation cannot pay all of its obligations andgoes out of business. Because of limited liability,stockholder losses are limited to the money theyinvested in stock. Even if other debts remain, thestockholders are not responsible for them.

Because limited liability is so attractive, manyfirms incorporate just to take advantage of it.Suppose Mr. Winters, who owns the hardware storeand the auto repair business, now decides to set upeach business as a corporation. If the hardware busi-ness should fail, his personal wealth, which includesthe automobile repair business, is safe. Mr. Wintersmay lose all the money invested in the hardwarebusiness, but that would be the extent of his loss.

Another advantage is unlimited life, meaningthat the corporation continues to exist even whenownership changes. Because the corporation isrecognized as a separate legal entity, the name ofthe company stays the same, and the corporationcontinues to do business.

The ease of transferring ownership is also astrength of the corporation. If a shareholder no


Ownership, Control, and Organization of a Typical CorporationThe Owners Shareholders elect the

Board of Directors who selects

The President who hires

Vice President Sales Vice President Production Vice President Finance

Domestic International QualityControl

Research &Development

Payroll

Using ChartsUsing Charts This organizational chart shows the chain of command of a typical organization. Who reports directly to the vice president of production?


longer wants to be an owner, he or she simply sellsthe stock to someone else, who then becomes thenew owner. As a result, it is much easier for theowner of a corporation to find a new buyer than itis for a sole proprietor or a partnership.

DisadvantagesOne disadvantage of the corporate structure is

the difficulty and expense of getting a charter.Depending on the state, attorney’s fees and filingexpenses can cost several thousand dollars. Becauseof this expense, many people prefer to set up pro-prietorships or partnerships.

A second disadvantage of the corporation is thatthe owners, or shareholders, have little say in howthe business is run after they have voted for theboard of directors. This is because the directorsturn day-to-day operations over to a professionalmanagement team, resulting in the separation ofownership and management. This is different from

the proprietorship and partnership, where owner-ship and management are one and the same.

A third disadvantage is the double taxation ofcorporate profits. Stockholders’ dividends are taxedtwice—once as corporate profit and again as per-sonal income. This tax status is a consequence ofthe corporation’s special status as a separate legalentity. This also means that the corporation isrequired to keep detailed records of sales andexpenses so that it can compute and pay taxes onits profits.

Finally, corporations are subject to more govern-ment regulation than other forms of business.Corporations must register with the state in whichthey are chartered. If a corporation wants to sell itsstock to the public, it must register with the federalSecurities and Exchange Commission (SEC). It willalso have to provide financial information concern-ing sales and profits on a regular basis to the generalpublic. Even an attempt to take over another busi-ness may require federal government approval.


Corporations A corpora-tion is an organizationowned by many people buttreated by law as though itwere a person. As a corpora-tion the company can raisemoney by selling shares ofownership in the businessto hundreds or thousands ofpeople. Owners of commonstock elect a board of direc-tors. The board of directors,in turn, hires managers torun the business. How dothe holders of commonstock differ from the hold-ers of preferred stock?


Government and BusinessRegulation

The concept of competitive markets, freefrom government intervention, has always

been a strong part of the U.S. economy. However,in the mid-nineteenth century, states tried torestrict the powers of corporations. By the 1890s,however, courts and legislatures, influenced bybusiness interests and aware that giant corporationswere becoming indispensable, had relaxed controlover business. States that continued to restrict cor-porations found their major businesses moving toother states where the laws were more lenient.

Business RegulationIn the twentieth century, various consumer

groups demanded regulation of giant corporations.In response, federal and state governments passedstronger regulations. States helped set insurancecompanies’ rates, administered licensing exams,and generally protected consumer interests.Legislation regulated all kinds of corporations, butlaws regulating banks, insurance companies, and

companies providing such necessities as electricity,gas, telephone service, or transportation service,were especially rigorous. Recently, states havereduced regulations in order to encourage compe-tition. In the next section, you will read about theways businesses can grow and expand.

Business DevelopmentState governments are very active in trying

to attract new industry. Governors often travelthroughout the country or even to foreign countriesto draw new business to their states. Television adver-tising, billboards, brochures, and newspaper adver-tisements promote travel or business opportunities.

Beginning in the 1930s, state governments soldindustrial development bonds to people or institu-tions and used the money to help finance indus-tries that relocated or expanded within the state.The state paid off the bond within a specified timeperiod from money that the industry paid back tothe state in the form of taxes. Today a state mayoffer an incentive such as a tax credit, or a reduc-tion in taxes, in return for the creation of new jobsor new business investment.

Checking for Understanding1. Main Idea Using your notes from the graphic

organizer activity on page 57, explain whypartnerships are able to attract more capitalthan sole proprietorships.

2. Key Terms Define sole proprietorship, propri-etorship, unlimited liability, inventory, limitedlife, partnership, limited partnership, bank-ruptcy, corporation, charter, stock, stock-holder, shareholder, dividend, bond, principal,interest, double taxation.

3. Identify the characteristics and organizationof the sole proprietorship.

4. Discuss the advantages and disadvantages ofthe partnership.

5. Discuss the structure and features of the corporation.

Applying Economic Concepts6. Unlimited Liability Interview one or two

business owners in your community and askthem about the formal structure of theirbusiness. Ask them how they feel about theissue of unlimited liability. Inquire whetherthe issue had any influence on the legal formof business they selected.

7. Drawing Conclusions When a corporationwants to introduce a potentially profitablebut risky product, it frequently sets up aseparate company that has its own corpo-rate structure. Why do you think the corpo-ration does this?

Practice and assess key social studies skills withthe Glencoe Skillbuilder Interactive Workbook,Level 2.



A Pioneer in Corporate America:

Kenneth I.Chenault

(1951–)

What does it take to succeed atone of America’s largest and mostprestigious corporations? KennethChenault knows the answer. At theyoung age of 45, Chenault becamepresident and chief operating offi-cer (COO) of American Express,one of the hundred largest compa-nies in the country.

Chenault is the first AfricanAmerican to serve as president of atop-100 company. Some peoplehave compared him to JackieRobinson, who broke the colorbarrier in baseball in 1947.Coincidentally—and perhaps fit-tingly—Chenault became COO in1997, the 50th anniversary year ofRobinson’s breakthrough.

STEPPING STONES

Remarkably, Kenneth Chenaultdid not start his career in business.Instead, he obtained an under-graduate degree in history, andthen earned a law degree atHarvard. He had keen instincts forbusiness, however, and worked for

a management consulting firm before joining American Express in 1981.

CHALLENGES ANDOPPORTUNIT IES

At first Chenault was responsiblefor strategic planning. His intelli-gence and hard work led him up thecorporate ranks. Promotionsbrought Chenault new challenges—and opportunities.

His greatest opportunity now isas chairman and chief executive offi-cer (CEO). Chenault is responsiblefor integrating strategies across all ofAmerican Express’s many businessunits. He has been in the forefrontof company efforts to increase mar-ket share by expanding productofferings, globalizing the business,and opening American Express’scard network to bank partnersaround the world. Chenault is alsoresponsible for global advertisingand brand management.

How does Chenault view histremendous responsibilities as thehighest-ranking African Americanin corporate America?

“With American Express beinga large, publicly held company, Iwould be scrutinized under anycircumstances,” Chenault said “Ifyou don’t enhance shareholdervalue, it doesn’t matter who youare, you will have a problem. . . .[I]f I do well, I would be veryhopeful that it would encourageother companies to give people theopportunity to succeed.”

Kenneth Chenault himself hadthe opportunity to succeed. Andhe has proven he knew how to takeadvantage of it.

Examining the Profile1. Drawing Conclusions What personal

ethics and qualities do you think helpmake Chenault a success?

2. For Further Research Learn aboutand report on Chenault’s philanthropiccontributions in New York City.

Business Growth and Expansion

Main IdeaBusinesses grow through merging with other compa-nies and by investing in the machinery, tools, andequipment used to produce goods and services.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below by com-paring a vertical merger to a horizontal merger.

Key Termsmerger, income statement, net income, depreciation,cash flow, horizontal merger, vertical merger, con-glomerate, multinational

ObjectivesAfter studying this section, you will be able to:1. Explain how businesses can reinvest their profits to

grow and expand.2. Recognize the reasons that cause firms to merge.3. Identify two different types of mergers.

Applying Economic ConceptsBusiness Growth Businesses can grow by reinvestingtheir profits in themselves, or they can combine withanother business. Read to find out what influencesgrowth.

Similarities

Vertical merger

Horizontal merger

Cover Story

Oracle Takes $5 Billion Jab at

PeopleSoftOracle, the huge

b u s i n e s s - s o f t w a r e

maker led by Lawrence

J. Ellison, made a $5.1

billion hostile takeover

offer yesterday for

PeopleSoft in a conspic-

uous effort to extin-

guish one of its biggest

rivals.Indeed, PeopleSoft has been steadily taking mar-

ket share from Oracle over the last few years, but the

continuing slump in technology sales [has made com-

petition] difficult for both companies.

Analysts said that whatever the outcome of the

fight, Oracle’s bid had already inflicted pain on its

rival. “Oracle wins either way,”said Jim Shepherd, an

analyst . . . “Either they get PeopleSoft, or they’ve

managed to mess up the PeopleSoft–J.D. Edwards

deal, and steal their press and enthusiasm.”

—New York Times, June 7, 2003

Software companies are going

through mergers.

A business can grow in one of two ways. First,it can grow by reinvesting some of its prof-its. A business can also expand by engaging,

as Oracle tried to do, in a merger—a combination oftwo or more businesses to form a single firm.

Growth Through ReinvestmentMost businesses use some of the revenuethey receive from sales to invest in factories,

machinery, and new technologies. We can use theincome statement—a report showing a business’ssales, expenses, and profits for a certain period—toillustrate the process. An income statement canreflect various periods of financial activity, such asthree months or a year.

Estimating Cash FlowsAs illustrated in Figure 3.4, the business first

records its total sales for the period. Next, it findsits net income by subtracting all of its expenses,including taxes, from its revenues. These expensesinclude the cost of any goods such as inventory,

68

068_GLENEPP 10/3/03 4:11 PM Page 68

wages and salaries, interest payments,and depreciation, a non-cash chargethe firm takes for the general wearand tear on its capital goods.

Depreciation is called a non-cashcharge because, unlike other expensesshown in the figure, the money isnever paid to anyone else. For exam-ple, interest may be paid to a bank,wages may be paid to employees, butthe money allocated to depreciationnever goes anywhere—it simply staysin the business.

The concept of cash flow, the sumof net income and non-cash chargessuch as depreciation, is the bottomline, or real measure of profits for thebusiness. This is because the cashflow represents the total amount ofnew funds the business generatesfrom operations.

Reinvesting Cash FlowsThe business owners, either directly

in the case of the proprietorship orpartnership, or indirectly through theboard of directors in the case of thecorporation, decide how the cash flowwill be allocated. Some of it can bepaid back to owners as their reward for risk taking, orthe funds can be reinvested in the form of new plant,equipment, and technologies.

When cash flows are reinvested in the business,the firm can produce additional products. Thisgenerates additional sales and a larger cash flowduring the next sales period. As long as the firmremains profitable, and as long as the reinvestedcash flow is larger than the wear and tear on theequipment, the firm will grow.

Growth Through MergersWhen firms merge, one gives up its separatelegal identity. For public recognition pur-

poses, however, the name of the new company mayreflect the identities of the merged companies.When Chase National Bank and Bank of Manhattan

merged, the new organization was called the ChaseManhattan Bank of New York—a name later changedto Chase Manhattan Corporation to reflect its geo-graphically expanding business.

Mergers take place for a variety of reasons. Afirm may seek a merger to grow faster, to becomemore efficient, to acquire or deliver a better prod-uct, to eliminate a rival, or to change its image.

Reasons for MergingSome managers find that they cannot grow as

fast as they would like using the funds they gener-ate internally. As a result, the firm may look foranother firm with which to merge. Sometimes amerger makes sense, and other times it may not,but the desire to be bigger—if not the biggest—isone reason that mergers take place.


Business Growth Through Reinvestment

Using Charts Using Charts One way for a business to grow is to invest some of its cash flow in new plant, equipment, and technologies so that it can generate even more sales in the future. Which of the items on the income statement represents the real measure of profits for the business?

First Quarter Income Statement

Sales of Goods and Services:less:

$1,00040025050

100Investment in new plant,

equipment, and technologies

Cost of goods soldWages and salariesInterest paymentsDepreciation

Earnings Before Tax:less:

$20080Taxes (at 40%)

Non-cash chargesNet Income:

plus: $120

100

Cash Flow: $220Allows

Generates


Efficiency is another reason for mergers. Whentwo firms merge, they no longer need two presi-dents, two treasurers, and two personnel directors.The firm can have more retail outlets or manufac-turing capabilities without significantly increasingmanagement costs. In addition, the new firm maybe able to get better discounts by making volumepurchases, and make more effective use of its adver-tising. Sometimes the merging firms can achievetwo objectives at once—such as dominant size andimproved efficiency—as in the case of the Kroger-Meyer merger.

Some mergers are driven by the need to acquirenew product lines. Recent telecommunicationsindustry mergers, for example, were driven by thedesire for some firms to provide better communi-cations services. As a result, former telephonecompanies like AT&T bought cable TV firms so

that they could offer faster internet access and tele-phone service in a single package.

Sometimes firms merge to catch up with, oreven eliminate, their rivals. Royal CaribbeanCruises acquired Celebrity Cruise Lines in 1997and nearly doubled in size, becoming the secondlargest cruise line behind Carnival. When the officesupply store Staples tried to acquire Office Depotin the same year, however, the government blockedthe merger on the grounds that it would reducecompetition in the industry.

Finally, a company may use a merger to lose itscorporate identity. In 1997 ValuJet merged withAirWays to form AirTran Holdings Corporation.The new company flew the same planes and routesas the original company, but AirTran hoped thename change would help the public forget ValuJet’stragic 1996 Everglades crash that claimed 110 lives.

WHEN YOU SAY PROFITS,SMILEUnderstanding the values of your customers is animportant part of doing business. In this excerpt,an analyst promotes the importance of smiling toa group of Japanese businesspeople.

Some 30 somber businessmen in plain blue suitsare biting down on chopsticks and feeling silly.“Now pull them out slowly,” instructs their teacher,Yoshihiko Kadokawa, and suddenly the Japanesemen seem to be grinning. . . . “There you go, youare now smiling,” beams Kadokawa, 47. “Doesn’t itfeel great?”

Second nature to politicians and game showhosts, the toothy grin has long been a cultural no-no in Japan, where some people still cover theirmouths when they laugh in public and children aretaught to limit their expressiveness, lest they upsetthe wa, or sense of group harmony. But Kadokawa,a former department store executive who noticedthat his friendliest clerks racked up the biggestsales, wants to turn Japan into the land of happy

lips. He charges up to $1,000 to host his two-to-three-hour “Let’s Smile Operation” seminars, inwhich students exercise recalcitrant facial musclesand try to grasp the notion that smiles equal sales.“If you do not smile, you cannot make a profit,”says Kadokawa, mindful that his country is mired inits worst economic crisis in decades. “If Japan smiledmore, perhaps this nasty recession would end.”

Look what it has done for Kadokawa, who hasalso written a popular book, The Power of aLaughing Face. His clients, however, mostly men, arehaving a harder time of it. “Won’t I look stupid if Ismile?” asks one. “Is it good for your health?”inquires another. Kadokawa assures them thatshowing their pearly whites is the key to prosperity.Perhaps his most helpful tip: Study Bill Clinton.“Look at the way he smiles,” says Kadokawa. “Thatis real power.”

—People Weekly, May 10, 1999

1. Analyzing Information What is Kadokawatrying to teach the group?

2. Synthesizing Information How importantis it for business people who work withpeople from other countries to understandtheir values?

Critical Thinking


Types of MergersEconomists generally recognize

two types of mergers. The first is ahorizontal merger, which takesplace when two or more firms thatproduce the same kind of productjoin forces. The merger of the twobanks, Chase National and the Bankof Manhattan, is one such example.

When firms involved in differentsteps of manufacturing or market-ing join together, we have a verticalmerger. An automaker mergingwith a tire company is one exampleof a vertical merger. Another is theU.S. Steel Corporation. At onetime, it mined its own ore, shippedit across the Great Lakes, smelted it,and made steel into many differentproducts. Vertical mergers takeplace when companies believe thatit is important to protect them-selves against the loss of suppliers.

ConglomeratesA corporation may become so

large through mergers and acquisi-tions that it becomes a conglomerate.A conglomerate is a firm that has atleast four businesses, each makingunrelated products, none of which isresponsible for a majority of its sales.

Diversification is one of the mainreasons for conglomerate mergers.Some firms believe that if they donot “put all their eggs in one bas-ket,” their overall sales and profitswill be protected. Isolated eco-nomic happenings, such as badweather or the sudden change ofconsumer tastes, may affect someproduct lines at some point, butnot all at one time.

During the 1970s and early1980s, conglomerate mergers werepopular in the United States. Thecigarette and tobacco firm of R.J.

E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E

Business Combinations

Figure 3.5Figure 3.5

Using Charts Horizontal and vertical mergers are two kinds of mergers. What is the difference between these two kinds of mergers?

Using Charts Horizontal and vertical mergers are two kinds of mergers. What is the difference between these two kinds of mergers?

Fast Delivery, INC.

Vertical Merger

Hickory Tree Farms

+

+

Boston BaseballBat, Inc.

Boston BaseballBat, Inc.

=

Nickel Savings Bank

+ =

People’s Building& Loan Association

Nickel Savings& Loan Association

Horizontal Merger


Reynolds became a leading con-glomerate, at one time owning thelargest containerized shipping firmin the country (Sea-Land), thenation’s second largest fast-foodchain (Kentucky Fried Chicken),the nation’s largest fruit and veg-etable processor (Del Monte), andthe second largest producer of wineand distilled spirits (Heublein).

Since the late 1980s, the numberof conglomerates in the UnitedStates has declined. In Asia, how-ever, conglomerates remain strong.Samsung, Gold Star, and Daewooare still very dominant in Korea, asare Mitsubishi, Panasonic, andSony in Japan.

MultinationalsOther large corporations have

become international in scope. Amultinational is a corporation thathas manufacturing or service opera-tions in a number of differentcountries. It is, in effect, a citizenof several countries at one time. Assuch, a multinational is subject tothe laws of, and is likely to paytaxes in, each country where it hasoperations. General Motors,Nabisco, British Petroleum, RoyalDutch Shell, Mitsubishi, and Sonyare examples of global corporationsthat have attained worldwide eco-nomic importance.

Multinationals are importantbecause they have the ability tomove resources, goods, services,and financial capital across nationalborders. A multinational with itsheadquarters in Canada, for exam-ple, is likely to sell bonds in France.The proceeds may then be used toexpand a plant in Mexico thatmakes products for sale in theUnited States. Multinationals may


Conglomerate Structure

Using Charts A conglomerate is a firm that has at least four businesses, each of which makes unrelated products and none of which is responsible for a majority of its sales. Fortune Brands is an American conglomerate with a wide range of products. About 25 percent of Fortune Brand's sales come from international sales . How does a conglomerate differ from a multinational?

Using Charts A conglomerate is a firm that has at least four businesses, each of which makes unrelated products and none of which is responsible for a majority of its sales. Fortune Brands is an American conglomerate with a wide range of products. About 25 percent of Fortune Brand’s sales come from international sales. How does a conglomerate differ from a multinational?

Spirits and Wines

Office ProductsACCO office suppliesSwingline staplersDay-Timers personal organizers

Golf ProductsTitleist golf ballsFoot-Joy golf shoesCobra golf clubs

Home ProductsMoen faucetsMaster LockWaterloo toolboxes

Source: http://www.fortunebrands.com, 2003

31%46%

15% 8%

Office ProductsGolf Products

Home ProductsSpirits and Wines

8%15%

46%31%

Sales by Category


072_GLENEPP 10/3/03 4:14 PM Page 72


also be conglomerates if they make a number ofunrelated products, but when they conduct theiroperations in several different countries they aremore likely to be called a multinational.

Multinationals are usually welcome becausethey transfer new technology and generate newjobs in areas where jobs are needed. Multinationalsalso produce tax revenues for the host country,which helps that nation’s economy.

At times, multinationals have been known toabuse their power by paying low wages to workers,exporting scarce natural resources, or by adverselyinterfering with the development of local busi-nesses. Some analysts point out that multinationalcorporations will be increasingly able to demandtax, regulatory, and wage concessions by threaten-ing to move their operations to another country.Only highly educated people or those with skillswill benefit as wages remain low. Other analystspredict uneven development. One region of theworld will grow at the expense of another.

Most economists, however, welcome the low-cost production and quality that competition inthe global economy brings. They also believe agreater use of research and new technology willraise the standard of living for all people. On bal-ance, the advantages of multinationals far outweighthe disadvantages.


organizer activity on page 68, explain howmergers improve efficiency.

2. Key Terms Define merger, income statement,net income, depreciation, cash flow, horizon-tal merger, vertical merger, conglomerate,multinational.

3. Describe how a firm can generate funds inter-nally to grow and expand.

4. Identify five reasons why firms merge.

5. Describe the different ways a business canmerge.

Applying Economic Concepts6. Business Growth In a newspaper or maga-

zine, find an article about a merger. Whatcompanies merged? What reasons, if any,were given for the merger? What statisticswere provided? Write a one-page paper inwhich you answer these questions.

7. Making Comparisons What are the possibleethical benefits and drawbacks of multina-tionals to their host countries?

Buyers purchase merchandisefor resale to the public. Theychoose the suppliers, negotiatethe price, and award contracts.

The WorkDuties include anticipating con-sumer demand, stayinginformed about new products,attending trade shows, andchecking shipments. Buyersassist in sales promotions and advertising campaigns, aswell as checking on displays. Buyers must have the abil-ity to plan, make decisions quickly, work under pressure,and identify products that will sell. Most buyers work inwholesale and retail trade companies, such as grocery ordepartment stores, or in manufacturing. Many otherswork in government or in service industries.

QualificationsMost buyers have completed a college degree with a busi-ness emphasis. Familiarity with the merchandise as well aswith wholesaling and retailing practices is important.

Buyer


Cosmetic companies like L’Oréal havefound a profitable strategy: acquiresmaller cosmetic companies and promotethe culture from which they came. Withthis formula, and with the help of chiefexecutive Lindsay Owen-Jones, L’Oréal’sprofits have dramatically increased.

The Beauty ofGlobal Branding

It’s a sunny afternoon outside Parkson’sdepartment store in Shanghai, and a marketingbattle is raging for the attention of Chinesewomen. Tall, pouty models in beige skirts andsheer tops pass out flyers promoting Revlon’snew spring colors. But their efforts [are being]drowned out by L’Oréal’s eye-catching show forits Maybelline brand.

To a pulsating rhythm, two gangly models inshimmering lycra tops dance on a podiumbefore a large backdrop depicting the New YorkCity skyline. The music stops, and a makeupartist transforms a model’s face while a Chinesesaleswoman delivers the punch line. “Thisbrand comes from America. It’s very trendy,”she shouts into the microphone. “If you wantto be fashionable, just choose Maybelline.”

Few of the women in the admiring crowdrealize that the trendy “New York” Maybellinebrand belongs to French cosmetics giantL’Oréal. In the battle for global beauty markets,$12.4 billion L’Oréal has developed a winningformula: a growing portfolio of internationalbrands that have transformed the French com-pany into the U.N. of beauty. . . .

Its secret: conveying the allure of differentcultures through its many products. Whether it’sselling Italian elegance, New York street smarts,or French beauty through its brands, L’Oréal isreaching out to a vast range of people acrossincomes and cultures. . . .

L’Oréal’s work with Maybelline is a primeexample. In 1996, L’Oréal acquired Maybellinefor $758 million and began a makeover of thebrand. The key: figuratively stamping “urbanAmerican chic” all over Maybelline products topromote their American origins. . . .

“That’s a big challenge for this company toadd brands, yet keep the differentiation,” saysMarlene Eskin, publisher of Market Viewresearch reports on the cosmetics industry.—Reprinted from June 28, 1999 issue of Business Week, by special

permission, copyright © 1999 by The McGraw-Hill Companies, Inc.

Examining the Newsclip1. Analyzing Information How has L’Oréal become more

competitive in the global market?

2. Summarizing Information In your own words, explainwhy it is a challenge for a company to “add brands, yetkeep differentiation”?

JUNE 28, 1999 N e w s c l i p

Department store in Shanghai, China


Main IdeaProducer and worker cooperatives are associations inwhich the members join in production and marketingto lower costs for their members’ benefit.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below bydescribing the different kinds of cooperatives.

Cooperatives

Other Organizations

M ost businesses use scarce resources to pro-duce goods and services in hopes of earn-ing a profit for their owners. Other

organizations, like the baby-sitting co-op describedin the cover story, operate on a “not-for-profit” basis.A nonprofit organization operates in a businesslikeway to promote the collective interests of its mem-bers rather than to seek financial gain for its owners.

Community and Civic OrganizationsExamples of nonprofit institutions includeorganizations such as schools, churches, hos-

pitals, welfare groups, and adoption agencies. Mostof these organizations are legally incorporated totake advantage of unlimited life and limited liability.They are similar to profit-seeking businesses, but donot issue stock, pay dividends, or pay income taxes.

These organizations often provide goods andservices to their members while they pursue otherrewards such as improving educational standards,seeing the sick become well, and helping those inneed. Their activities often produce revenues inexcess of expenses, but they use the surplus tofurther the work of their institutions.

Key Termsnonprofit organization, cooperative, co-op, creditunion, labor union, collective bargaining, professionalassociation, chamber of commerce, Better BusinessBureau, public utility

ObjectivesAfter studying this section, you will be able to:1. Describe nonprofit organizations.2. Explain the direct and indirect role of government

in our economy.

Applying Economic ConceptsNonprofit Organizations Do you belong to a church,club, or civic organization? Read to find out howthese organizations fit into our economic system.

Cover Story

Baby-Sitting Co-Ops a Growing

TrendWhen Candace

and Roger Kuebel of

Larchmont, N.Y., flew

to Grenada for a

week’s vacation, they

did something most

parents of young chil-

dren do only in their

dreams. The Kuebels left their two-year-old daughter,

Heather, in the care of two responsible adults—par-

ents themselves . . . they also didn’t pay a child care

service any costly fees.

The couple’s secret: They belong to a baby-sitting

cooperative.The idea behind the baby-sitting co-op is simple:

Families swap baby-sitting duties without ever

exchanging money. Co-ops usually rely on a coupon

system: members with coupons have an incentive to

use them, while those low on coupons need to sit.

—The New York Times On the Web, February 1, 1998

Baby-sitting duties


Nonprofit community and civic organizationsuse scarce factors of production to serve manyneeds. Their efforts are difficult to analyze eco-nomically, however, because the value of theirproducts is not easy to measure. Even so, the largenumber of these organizations shows that they arean important part of our economic system.

CooperativesAnother example of a nonprofit organiza-tion is the cooperative, or co-op. A cooper-

ative is a voluntary association of people formed tocarry on some kind of economic activity that willbenefit its members. Cooperatives fall into threemajor classes: consumer, service, and producer.

Consumer CooperativesThe consumer cooperative is a voluntary associ-

ation that buys bulk amounts of goods such asfood and clothing on behalf of its members.Members usually help keep the cost of the opera-tion down by devoting several hours a week ormonth to the operation. If successful, the co-op isable to offer its members products at prices lowerthan those charged by regular businesses.

Service CooperativesA service cooperative provides services such as

insurance, credit, and baby-sitting to its members,rather than goods. One example is a credit union,a financial organization that accepts deposits from,and makes loans to, employees of a particular com-pany or government agency. In most cases, creditunion members can borrow at better rates andmore quickly than they could from for-profit banksor commercial loan companies.

Producer CooperativesProducers, like consumers, can also have co-ops.

A producer cooperative helps members promote orsell their products. In the United States, mostcooperatives of this kind are made up of farmers.The co-op helps the farmers sell their crops directlyto central markets or to companies that use themembers’ products. Some co-ops, such as theOcean Spray cranberry co-op, market their prod-ucts directly to consumers.

Labor, Professional, and BusinessOrganizations

Non-profit organizations are not just limitedto co-ops and civic groups. Many other

groups also organize this way to promote the inter-ests of their members.

Labor UnionsAnother important economic institution is the

labor union, an organization of workers formedto represent its members’ interests in various

E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E

Cooperatives in theUnited States

Credit Unions

Memorial Societies

Housing

Figure 3.7Figure 3.7

Insurance

Students

Farm Purchasing and Marketing

Preschool Education

Consumer Goods

Health

Policy

B CA

Using Charts The cooperative is a volun-tary association of people formed to carry on some kind of economic activity that will benefit its members. How do the three kinds of cooperatives differ?

Using Charts The cooperative is a volun-tary association of people formed to carry on some kind of economic activity that will benefit its members. How do the three kinds of cooperatives differ?


employment matters. The union participates incollective bargaining when it negotiates with man-agement over issues such as pay, working hours,health care coverage, life insurance, vacations, andother job-related matters.

Unions pressure the government to pass lawsthat will benefit and protect their workers. Thelargest labor organization in the United States is theAmerican Federation of Labor-Congress ofIndustrial Organizations (AFL-CIO), an associationof unions whose members do all kinds of work. TheAmerican Postal Workers Union and the AmericanFederation of Teachers, for example, are both AFL-CIO unions. Many other unions, such as theNational Education Association for Teachers, areindependent and represent workers in specificindustries.

Professional AssociationsMany workers belong to professional societies,

trade associations, or academies. While thesegroups are similar to unions, they do not work inquite the same way. One such organization is aprofessional association—a group of people in aspecialized occupation that works to improve the

working conditions, skill levels, and public percep-tions of the profession.

The American Medical Association (AMA) andthe American Bar Association (ABA) are two exam-ples of interest groups that include members of spe-cific professions. Basically, these two groupsinfluence the licensing and training of doctors andlawyers, and both groups are actively involved inpolitical issues. Professional associations also repre-sent bankers, teachers, college professors, policeofficers, and hundreds of other professions. Whilethese associations are concerned primarily with thestandards of their professions, they also seek toinfluence government policy on issues that areimportant to them.

Student Web Activity Visit the Economics: Principlesand Practices Web site at epp.glencoe.com and clickon Chapter 3—Student Web Activities for an activityon the Better Business Bureau.

Cooperatives

Benefits A cooperative is anorganization that is owned byand operated for the benefitof those using its services.Consumer cooperatives, ser-vice cooperatives, and pro-ducer cooperatives performdifferent functions. What arethe benefits of a consumercooperative?



Business AssociationsBusinesses also organize to promote their collec-

tive interests. Most cities and towns have a chamberof commerce that promotes the welfare of its mem-bers and of the community. The typical chambersponsors activities ranging from educational pro-grams to neighborhood clean-up campaigns to lob-bying for favorable business legislation.

Many business organizations represent specifickinds of businesses. These are called industry ortrade associations. Trade associations are interestedin shaping the government’s policy on such eco-nomic issues as free enterprise, imports and tariffs,the minimum wage, new construction, and govern-ment contracts for construction and manufacturing.The Telecommunications Industry Association, forinstance, represents manufacturers and suppliers ofcommunications and information technologyproducts on issues affecting its members.

Some business associations help protect theconsumer. The Better Business Bureau, a non-profit organization sponsored by local businesses

to provide general information on companies, isone of these. It maintains records on consumerinquiries and complaints and sometimes offersvarious consumer education programs.

GovernmentGovernment is another nonprofit economicorganization. Sometimes government plays

a direct role in the economy, while at other timesthe role is indirect.

Direct Role of GovernmentMany government agencies produce and distrib-

ute goods and services to consumers, giving govern-ment a direct role in the economy. The role is“direct” because the government supplies a good orservice that competes with private businesses.

One example is the Tennessee Valley Authority(TVA). The TVA supplies electric power for almostall of Tennessee and parts of Alabama, Georgia,Kentucky, Mississippi, North Carolina, and Virginia.This power competes directly with the power sup-plied by other, privately owned, power companies.

Another example is the Federal Deposit InsuranceCorporation (FDIC), which insures deposits in ournation’s banks. Because the insurance the FDICsupplies could be provided by privately ownedinsurance companies, the FDIC is also an exampleof the direct role of government.

Perhaps the best known of the government cor-porations is the U.S. Postal Service (USPS).Originally an executive department called the PostOffice Department, the USPS became a govern-ment corporation in 1970.

Many of these federal agencies are organized asgovernment-owned corporations. Like those of pri-vately owned businesses, these corporations have aboard of directors that hires a professional man-agement team to oversee daily operations. Thesecorporations charge for the products they produce,and the revenue goes back into the “business.” Ifthe corporation has losses, however, they are cov-ered by funds supplied by Congress.

State and local governments provide police andfire protection, rescue services, schools, and courtsystems. At the same time, all levels of government

What’s in a Name? People often define themselvesby the work they do. Many common English sur-names are based on occupations. Examples areSmith, Cooper, Carpenter, Weaver, Baker, and Potter.

The Changing WorkplaceIn studying the workplace, some analysts feelthat certain trends will continue. People willchange jobs several times during their lifetimes.The compressed work schedule—working ashorter workweek with more hours per day—will continue to make inroads. Analysts alsobelieve that lifelong learning is a key to careersuccess. New jobs require advanced skills, edu-cation, and training. Therefore, the need forcontinuing to learn and develop new skills ismore important than ever before.

—Source: Computer Industry Almanac


help develop and maintain roads, libraries, andparks. In these ways, government plays a direct partin the productive process.

Indirect Role of GovernmentThe government plays an indirect role when it acts

as an umpire to make sure the market economy oper-ates smoothly and efficiently. One such case is theregulation of public utilities, investor- or municipal-owned companies that offer important products tothe public, such as water or electric service.

Because many public utilities have few competi-tors, people often want government supervision.For example, government established regulatorycontrol over the cable television industry in 1993because it felt that some operators were chargingtoo much. Without competition, utilities and othercompanies having exclusive rights in certain areasmay not offer services at reasonable rates.

The government also plays an indirect role whenit grants money to people in the form of SocialSecurity, veterans’ benefits, financial aid to collegestudents, and unemployment compensation. Suchpayments give the recipients of these funds a power

they otherwise might not have—the power to“vote” and to make their demands known in themarket. This power influences the production ofgoods and services that, in turn, affects the alloca-tion of scarce resources.


organizer activity on page 75, describe thedifferent types of cooperatives.

2. Key Terms Define nonprofit organization,cooperative, co-op, credit union, labor union,collective bargaining, professional association,chamber of commerce, Better BusinessBureau, public utility.

3. Identify the purpose of the different types ofnonprofit organizations.

4. Provide examples that illustrate the govern-ment’s direct and indirect roles as an eco-nomic institution.

Applying Economic Concepts5. Nonprofit Organizations Name a nonprofit

organization that you or one of your friends

have joined. Research the history of the organ-ization to find out how it began and its statedgoals. State the purpose of the organization,and then compare its activities to profit-mak-ing organizations. If your organization collectsmore than it spends, what does it do with theextra money?

6. Classifying Information Make a list of 10activities performed by your local govern-ment. Classify each as to its direct or indi-rect influences on the local economy.

7. Making Comparisons Why do many peopleprefer to deal with credit unions ratherthan banks?


Promoting Interests

Methods Labor unions, professional and busi-ness organizations, and interest groups drawfrom the financial resources and expertise oftheir members. Who makes up the membershipof a professional association?


Learning the SkillTo take good notes, follow these steps.

• When taking notes on material presented in class,write the key points, along with the importantfacts and figures, in a notebook.

• Write quickly and neatly, using abbreviations andphrases.

• Copy words, statements, or diagrams drawn onthe chalkboard.

• Ask the teacher to repeat important points youhave missed or do not understand.

• When studying textbook material, organize yournotes into an outline. When outlining writtenmaterial, first read the material to identify themain ideas. Next, identify the subheads. Placedetails supporting or explaining subheads underthe appropriate head.

• For a research report, take notes on cards. Note-cards should include the title, author, and thepage number of sources.

Practice and assess key social studies skills with the

Taking NotesEffective note taking involves more than just writing facts in short phrases.It involves breaking up the information into meaningful parts so that it canbe understood and remembered.

Business in the United States can beorganized in a number of ways.

Practicing the SkillSuppose you are writing a research report on the topic,

Business Organizations. First, identify main idea questionsabout this topic, such as “What are the different kinds ofbusiness organizations?” “How are they formed?” and“What are their advantages and disadvantages?” Then findmaterial about each main-idea question.

Using this textbook as a source, read the material on“Forms of Business Organization,” beginning on page 57.Then, review the material and prepare notes like thosebelow.

Topic: Business OrganizationsMain Idea: Different kinds1. The sole proprietorship is one kind of

bus. org.2.3.

Main Idea: Formation differs by kind of org.1.2.3.

Scan a local newspaper for a short editorial or anarticle about an event pertaining to business orthe economy. Take notes by writing the main ideaand supporting facts. Summarize the article usingonly your notes.

Practice and assess key social studies skills with theGlencoe Skillbuilder Interactive Workbook, Level 2.


S e c t i o n 1

Forms of Business Organization(pages 57–66)

• Sole proprietorships are small, easy-to-manageenterprises owned by one person. They are relativelynumerous and profitable. Disadvantages includeraising financial capital and attracting qualifiedemployees.

• Partnerships are ownedby two or more persons.Their slightly larger sizemakes it easier to attractfinancial capital andqualified workers. Disad-vantages include theunlimited liability of eachgeneral partner for the actsof the other partners, the limited life of the partner-ship, and the potential for conflict among partners.

• Corporations are owned by shareholders who voteto elect the board of directors. Shareholders havelimited liability and are not liable for the actions ordebts of the corporation. The relatively large size ofthe corporation allows for specialized functions andlarge-scale manufacturing within the firm.

• Disadvantages of corporations include the cost ofobtaining charters, limited shareholder influenceover corporate policies, and having to deal withsome government regulations.

• The corporation is recognized as a separate legalentity and so must pay a separate corporate incometax not paid by proprietorships and partnerships.

S e c t i o n 2

Business Growth and Expansion (pages 68–73)

• Businesses can grow by reinvesting their cash flowsin plant, equipment, and new technology.

• Businesses can also expand through mergers. Mostmergers take place because firms want to becomebigger, more efficient, acquire a new product, catchup to or eliminate a competitor, or change its corpo-rate identity.

• A horizontal merger takes place when two firms thatproduce similiar products come together. A verticalmerger is one that involves two or more firms at dif-ferent stages of manufacturing or marketing.

• A conglomerate is a large firm that has at least fourdifferent businesses, none of which is responsible fora majority of sales.

• A multinational can be an ordinary corporation or aconglomerate, but it has manufacturing or serviceoperations in several differentcountries. Multinationals intro-duce new technology, generatejobs, and produce tax revenues for the host countries.

S e c t i o n 3

Other Organizations (pages 75–79)

• Nonprofit organizations function like a business,but on a not-for-profit basis to further a cause or forthe welfare of their members.

• The cooperative, or co-op, is one of the major non-profit organizations. The co-op can be organized toprovide goods and services, or to help producers.

• Professional associations work to improve the work-ing conditions, skill levels, and public perceptions oftheir profession.

• Businesses often form a chamber of commerce or aBetter Business Bureau to promote their collectiveinterests.

• Government plays a direct role in the economywhen it provides goods and services directly to con-sumers; it plays an indirect role when it providesSocial Security, veterans’ benefits, unemploymentcompensation, and financial aid to college students,or when it regulates businesses.


Identifying Key TermsOn a separate sheet of paper, classify each of the numberedterms below into the following categories (some terms mayapply to more than one category):

• Sole Proprietorships • Corporations• Partnerships • Nonprofit Organizations

1. bond2. stock3. cooperative4. dividend5. unlimited liability6. charter7. labor union8. professional association9. limited partner

10. credit union

Reviewing the FactsSection 1 (pages 57–66)

1. Explain the strengths of a sole proprietorship.

2. Identify the weaknesses of a partnership.

3. Explain the structure and strengths of a corporation.

Section 2 (pages 68–73)

4. Explain how the firm obtains, and then disposesof, its cash flow.

5. Describe the difference between a horizontal anda vertical merger.

6. Explain why a corporation might choose tobecome a conglomerate.

Section 3 (pages 75–79)

7. Describe the difference between a nonprofit insti-tution and other forms of business organizations.

8. List three examples of cooperative associations.

9. Describe the purpose of a labor union.

10. Identify three types of business or professionalorganizations.

11. Compare the direct and the indirect roles of government.

Thinking Critically1. Making Comparisons If you were planning to

open your own business, such as a sportswear storeor a lawn service, which form of business organiza-tion would you prefer—sole proprietorship, part-nership, or corporation? Give reasons for youranswer. To help you organize your response, beginby setting up a diagram like the one below.

2. Drawing Conclusions Do you think mergers arebeneficial for the U.S. economy? Defend yourresponse.

3. Synthesizing Information List the strengths andweaknesses of each type of business organization.Then share the list with the owner of a business inyour community. Ask the owner which items onthe list were the most influential in deciding howto organize his or her business. Write a reportsummarizing your findings.

Self-Check Quiz Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 3—Self-Check Quizzes to preparefor the chapter test.

Type of BusinessOrganization

Advantages Disadvantages



Applying Economic Concepts1. Economic Institutions Cite a case in your commu-

nity where a cooperative would fulfill a definite eco-nomic need. Explain why you think so, and thentell what kind of cooperative you would set up.

2. The Role of Government Which do you think ismore appropriate—the direct or indirect role of government? Defend your position.

3. Unlimited Liability What is the difference betweenthe unlimited liability of proprietorships and part-nerships, and the limited liability of corporations?

4. Business Growth What advantages might a multi-national bring to a host nation?

5. Nonprofit Organizations In what ways does a con-sumer cooperative differ from a service cooperative?

Math PracticeStudy the table that follows. Then answer thequestions.

1. What is the net income for each of the three yearslisted? How did you find the answer?

2. In what year did sole proprietorships have thelargest net income?

3. In what year did sole proprietorships have thelargest net income as a percentage of businessreceipts? How did you find your answer?

Thinking Like an EconomistIdentify two ways a firm’s cash flow can be used.Explain why these uses are a trade-off and explainthe opportunity costs of these choices in terms of the firm’s future growth.

Technology SkillUsing the Internet With the increase in multina-tional corporations, many American citizens areinteracting more and more with different cultures inother countries. Imagine that you and a partner haveset up a multinational corporation that operates inthe global economy. Select a country and use theInternet to research its culture in relation to businessprotocol. Use the information to create a report thatlists procedures and key words your employees willneed to know in order to properly conduct businessin the country. Share your findings with the mem-bers of your class.


Taking Notes Research to find out moreabout an American entrepreneur and his orher role in shaping the U.S. economy. Beforeyou do any research, compile a list of ques-tions to serve as a guide and to narrow yourtopic. Consider such questions as:

1. Whom shall I research?

2. What did he or she invent or promote?

3. How did he or she become a successfulentrepreneur?

4. What effect did this entrepreneur have onthe U.S. economy?

Use your notes to help you write a two-pagetypewritten sketch of the entrepreneur.

Sole Proprietorships, 1990–1999

In millions of dollars Source: Statistical Abstract of the United States, 2002

730,606 807,364

19951990 1999

589,250 638,127 761,428

BusinessReceipts

BusinessDeductions

Net Income

969,347


083_GLENEPP 10/3/03 4:40 PM Page 83

Issues in FreeIssues in FreeIssues in FreeIssues in Free

Issues in FreeIssues in Free

Megamergers Are a Threat

The fierce competitive pressures forcingmegamergers, such as cost-cutting and the need toachieve scale in the global economy, are under-standable. But the mergers raise a broad issue thatgoes beyond traditional concerns. . . .

The big problem with these gigantic mergers isthe growing imbalance between public and privatepower in our society. . . . [N]owadays an era of BigGovernment is being superseded by the age ofglobal goliaths.

Superlarge companies with interests and com-mitments stretching from Boston to Brisbane areunlikely to focus as intensely as smaller ones do onsupport for the local neighborhoods—the schools,the arts, the development of research activities, thetraining of potential workers. . . .

Big companies have disproportionate clout onnational legislation. Our scandalously porous lawsfor campaign contributions leave little doubt thatmegacompanies will exercise huge power overpoliticians when it comes to such issues as envi-ronmental standards, tax policy, Social Security,and health care. . . .

Megacompanies are almost beyond the law,too, because their deep pockets allow them tostymie prosecutors in ways smaller defendants can-not. Or, if they lose in court, they can pay largefines without much damage to their operations.

Corporate giants will also exert massive pres-sure on America’s international behavior. Defensecontractors such as Lockheed Martin, the result ofa 1995 merger, have successfully pushed forNATO expansion and for related military sales toPoland, the Czech Republic, and others.Combined entities such as Boeing-McDonnellDouglas will tighten their already formidable gripon U.S. trade policy. Companies like Exxon-MobilCorp. will deal with oil-producing countries

P R O


ARE MEGAMERGERS HARMFUL?Financial analysts called the 1990s “the decade of the megamerger,” and it’s easy to see why.

The decade saw an unprecedented number of “megamergers”—multi-billion dollar deals thatcombine already huge firms into even larger business giants.

In the oil industry, two giants—Exxon and Mobil—agreed to merge. The value of the deal?An estimated $80 billion—Wall Street’s biggest deal ever. In the telecommunications industry,AT&T acquired cable giant Tele-Communications, Inc. for some $48 billion. Daimler-Benz AG, anauto industry giant, acquired Chrysler Corporation in an estimated $38 billion deal. In the finan-cial industry, German bank Deutsche Bank took over Bankers Trust Corporation (a $10 billion-plus deal), creating the world’s largest bank.

These megamergers are only a few highlights of the trend toward megamergers in manyindustries—a trend that shows no signs of stopping. But what are the consequences ofmegamergers?

As you read the selections, ask yourself: Are megamergers beneficial or harmful?

EnterpriseEnterprise

Enterprisealmost as equals, conducting the most powerfulprivate diplomacy since the British East IndiaCompany wielded near-sovereign clout through-out Asia. . . .

The American economic system is at its bestwhen public and private needs are balanced. Thesheer magnitude of mergers is skewing the equilibrium.

—Jeffrey E. Garten, Dean of the Yale School of Management

Megamergers Are Harmless

We are witnessing an interesting collisionbetween history and headlines. The headlines her-ald a new era of menacing corporate power. . . .

Big business seems to be getting ever bigger andmore powerful.

Well, not exactly. The correct lesson from historyis just the opposite: corporate power is on the wane.

If this seems counterintuitive, it’s also com-mon sense. Big business has been brought toheel politically. Everything from child labor tothe environment has been regulated.Government is the final arbiter of businessbehavior, even if government is often arbitrary.This is an old story. Less recognized—or perhapsforgotten—is the fact that companies have alsolost much market power to set prices and deter-mine what customers buy. . . .

We can all identify the major forces that havecorroded corporate market power: new technol-ogy (personal computers and cable TV); foreigncompetition (automobiles); the end of legalmonopoly (telephones). But there is a less visibleforce that subverts overall corporate power, andthat is economic growth itself. As society becomesricher, people buy a greater array of goods and

services. When the typical market basket grows,producers of traditional goods become less impor-tant. . . .

Megamergers do not contradict this picture. Onereason is that today’s merger is often tomorrow’sbust-up. Some mergers fail because they’re drivenmore by personal ambition than true efficiency. . . .

Some mergers may also be blatantly collusive.Corporate executives regularly complain aboutlost “pricing power”(this may be a reasoninflation has stayedtame). What betterway to restore it thanby buying a competi-tor? This is a genuineantitrust worry, butit’s wrong to see big-ness as automaticallyant i - compet i t ive .Sometimes it’s theother way around.One reason manu-facturers have helddown prices is thattheir superstore cus-tomers—the Wal-Marts and HomeDepots—have thepurchasing power to insist on low prices.

In truth, the inefficient firm—however big—is itsown worst enemy. Its inefficiency curbs its power.Its products become vulnerable to competition; itsmanagers become vulnerable to takeover. . . .

—Robert J. Samuelson, Washington Post Writers Group

Analyzing the Issue1. What is Garten’s basic objection to mega-

mergers? How does he support his position?

2. What fundamental forces, in Samuelson’sview, curb the power of giant corporations?

3. Explain whose position you agree with, andwhy, or explain your reasons for a third position.

C O N

UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS 85

chap03 fundamental economic concepts

Education

type of business

entire business

readyfor business

business organizations

ofthe risks of business

chapter overviews

limited partnership

sole proprietorshipsthe