Firms start when entrepreneurs organise resources and take risks in the expectation of earning a profit. More specifically, enterprises tend to be set up for one or more of the following reasons:
Some firms originate to solve a problem faced by consumers, by other firms, or by government. For example, internet comparison websites solve the problem faced by consumers of having limited time to research the whole market for the best current deals.
Many firms start in order to exploit an original idea or an invention. If the invention can be turned into a good or service which adds value, it can command a price, and earn a profit. For example, Dyson plc (Dyson Group plc) was established by James Dyson to exploit his inventions and designs created and produced when he was in his early twenties.
Some firms start because the entrepreneur identifies a gap in an existing or emerging market, such as online delivery businesses, like Amazon.
Many firms enter a market because to produce an existing product more cheaply, or more effectively, than existing firms in the market. For example, Tesco plc started in 1919 when co-founder Jack Cohen sold cheap groceries from a single stall in London’s East End.
Many firms exploit information that is not readily available, such as estate agents and travel agents, like Kuoni.
In all cases, entrepreneurs anticipate that they will be successful and earn themselves a profit for their personal risk-taking and entrepreneurial skill. Private firms can only survive if they satisfy consumer demand effectively.
Entrepreneurs need finance to test, produce, and distribute their products. Finance can be obtained from a number of sources, including:
The entrepreneur’s own funds, called private equity
Selling shares in their business, called share capital
Borrowing from individuals, banks via loans and mortgages, or from other firms
Credit from suppliers, which is similar to
There are several types of enterprise, each one distinguished by its legal ownership, including:
Sole traders are the life-blood of a market economy. Sole traders are common in retailing and local services like plumbing and catering. With local services demand limited, so the scope for expansion is also limited. The sole trader owns the assets of the business, makes all the business decisions, bears all the risks, and, of course, retains all the profits.
Partnerships are owned, and usually managed, by a small number of partners, each of whom can specialise in a particular aspect of the business. Decisions will be jointly arrived at, and the risks and rewards will be spread between the partners. In certain types of partnership, not all partners bear equal risks, and some partners may have a limited liability for debts incurred by the businesses. Partnerships are common in professional and financial services such as:
Limited companies are legally ‘incorporated’ firms, which means that they have their own legal identity, and are owned by shareholders who have limited liability for the firm’s debts. Unlike sole traders and ordinary partnerships, limited, or joint-stock companies, are set up to take advantage of the principle of limited liability.
The rapid development of limited companies in the 18th Century provided a stimulus to the growth of private enterprise and the spread of free-market capitalism. This was because limited liability encouraged ordinary individuals to part their savings, and so provide finance for small or growing enterprises, without the risk of losing any more than the initial outlay. Today, private limited companies are common in all areas of economic activity in all sectors of the economy; from screenwriters and film producers, to restaurants and hotels.
In a limited company, shareholders appoint directors to take the key business decisions, though often the directors are also shareholders. Directors make decisions collectively as members of the Board of Directors.
Most of the significant risk taking is made by the Board of Directors, though day-to-day decision-making is devolved to professional managers.
Like private limited companies, public limited companies are also legally incorporated and are owned by shareholders who have limited liability for the firm’s debts, the difference being that ‘public’ companies are allowed to sell shares to the general public.
To enable them to ‘go public’, and ‘list’ their shares on the stock exchange they must satisfy strict criteria laid down by law covering the liquidity of the business, publication of financial accounts, and number of previous years trading.
The regulations governing public limited companies in the UK are increasingly complex, and this partly explains the recent trend towards ‘de-listing’ and returning to private limited status.
The main advantage of being a ‘plc’ is that it is much easier to raise funds because shares can be offered for sale to any member of the public. Shares can also be re-sold to other members of the public via stock exchanges, so it is easy for investors to regain their liquidity.
Despite the tough regulations, most large firms prefer to remain ‘plc’s, or their equivalent in other countries.
Public corporations, such as the British Broadcasting Corporation (BBC), are organisations owned by the state. They are funded in a number of ways, including:
Government grants and subsidies
Charges for supplying their service
A Board of Governors rather than a Board of Directors usually control public corporations. If their income is greater than their costs they make a ‘surplus’ rather than a profit.
Widespread privatisation between 1980 and 2000 led to a reduction in the number of public corporations. Despite being owned by the state, public corporations are frequently managed along ‘commercial’ lines, as in the case of the BBC.
In addition to public corporations, many other organisations are not established to make a profit, though they may earn revenue and be run on commercial lines.
Do firms need entrepreneurs?
According to the neo-Classical economists, entrepreneurs are not needed in perfectly competitive markets. This is because in perfectly competitive markets, all participants have perfect knowledge and economic transactions have no risk attached.
However, in the real world of imperfect markets, entrepreneurs can exploit their knowledge and generate a profit by so doing.