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click on Chapter 3”Chapter Overviews to preview
Running a business involves risks
chapter information.
as well as expectations.
Forms of Business Organization
Main Idea bankruptcy, corporation, charter, stock, stockholder,
Businesses may be organized as individual proprietor- shareholder, dividend, bond, principal, interest,
ships, partnerships, or corporations. double taxation
Reading Strategy
After studying this section, you will be able to:
Graphic Organizer As you read about business organi-
1. Describe the characteristics of the sole
zations, complete a graphic organizer similar to the
one below to explain how the three types of business
2. Understand the advantages and disadvantages of
organizations differ from one another.
the partnership.
3. Describe the structure and features of the

Applying Economic Concepts
Unlimited Liability Some forms of business organiza-
Key Terms tion can leave you holding the bag”including all the
sole proprietorship, proprietorship, unlimited liability, bills”for the entire business. Read to see how personal
inventory, limited life, partnership, limited partnership, liability is affected by the type of business owned.

here are three main forms of business organi-
Cover Stor y zations in the economy today”the sole pro-
prietorship, the partnership like the one Scott
Melton describes in the cover story, and the corpo-
Raw Feelings ration. Each offers its owners significant advantages
and disadvantages.
got a
Scott Melton thinks he
raw deal. Melton,
recently opened Sush Sole Proprietorships
Nights on Main Street
in Deep Ellum [Texas], The most common form of business
filed for Chapter 11 organization in the United States is the sole
bankruptcy in April for proprietorship or proprietorship”a business owned
Sushi Deep Ellum Inc., and run by one person. Although relatively the most
the general partnership numerous and profitable of all business organiza-
Mounting bills are one of
he formed to operate tions, proprietorships are the smallest in size. As
the risks of business.
Deep Sushi. . . . Last
Figure 3.1 on page 58 shows, proprietorships earn
June, Deep Sushi™s lim
almost one-fifth of the net income earned by all
ited partners, a group
and other human meat businesses, even though they make only a fraction of
or so anesthesiologists
of 10 ey
boot. Not only that, th
ders, gave Melton the total sales.
men g
left me holding the ba
d him, he says. “They
stiffe il-
id taxes . . . including ut
$57,000 worth of unpa Forming a Proprietorship
ities and vendor bills. . The sole proprietorship is the easiest form of
e, May 20“26,
”Dallas Observer Onlin business to start because it involves almost no
requirements except for occasional business

Figure 3.1 The second advantage is the relative ease of man-
agement. Decisions may be made quickly, without
having to consult a co-owner, boss, or “higher-up.”
Corporations, Partnerships, This flexibility means that the owner can make an
and Sole Proprietorships immediate decision if a problem comes up.
A third advantage is that the owner enjoys the
Corporations profits of successful management without having
to share them with other owners. The possibility of
Partnerships 19.9% 73.1% suffering a loss exists, but the lure of profits makes
Sole Proprietorships
people willing to take risks.
Fourth, the proprietorship does not have to pay
separate business income taxes because the busi-
ness is not recognized as a separate legal entity. The
owner still must pay individual income taxes on
Type of Organization
profits taken from the sole proprietorship, but the
business itself is exempt from any tax on income.
Suppose, for example, Mr. Winters owns and
operates a small hardware store in a local shopping
center and a small auto repair business in his garage
next to his home. Because neither business
depends on the other, and because the only thing
Net Income (profit)
they have in common is ownership, the two busi-
Source: 1998 Statistical Abstract
nesses appear as separate and distinct economic
activities. For tax purposes, however, everything is
Using Graphs Businesses can be organized
lumped together at the end of the year. When Mr.
in the United States in a number of ways.
Winters files his personal income taxes, the profits
Which business
from each business, along with wages and salaries
earned from other sources, are combined. He does
accounts for the
not pay taxes on each of the businesses separately.
largest amount Visit epp.glencoe.com and click on
A fifth advantage of the proprietorship is the
of sales? Textbook Updates”Chapter 3 for
psychological satisfaction. Some people want the
an update of the data.
personal satisfaction of being their own boss.
Other people have a strong desire to see their name
in print, have dreams of great wealth or community
licenses and fees. Most proprietorships are ready
status, or want to make their mark in history.
for business as soon as they set up operations. You
A sixth advantage is the ease of getting out of
could start a proprietorship simply by putting up a
business. In this case, all the proprietor has to do is
lemonade stand in your front yard. Someone else
pay any outstanding bills and then stop offering
might decide to mow lawns, do gardening, or open
goods or services for sale.
a restaurant. A proprietorship can be run on the
Internet, out of a garage, or from an office in a pro-
fessional building.
One main disadvantage of a proprietorship is
Advantages that the owner has unlimited liability. This means
The first advantage of a sole proprietorship is the that the owner is personally and fully responsible
ease of starting up. If someone has an idea or an for all losses and debts of the business. If the
opportunity to make a profit, he or she has only to business fails, the owner™s personal possessions
decide to go into business and then do it. may be taken away to satisfy business debts.

A fourth disadvantage is that the proprietor
Business Organizations
often has limited managerial experience. The
owner-manager of a small company may be an
inventor who is highly qualified as an engineer, but
lacks the “business sense” or time to oversee the
orderly growth of the company. This owner may
have 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 attracting
qualified employees. Because proprietorships tend
to be small, employees often have to be skilled in
several areas. In addition, many top high school
and college graduates are more likely to be
attracted to positions with larger, well-established
firms than small ones. This is especially true when
Sole Proprietorships The sole proprietorship is
larger firms offer fringe benefits”employee benefits
the most common form of business organization.
such as paid vacations, sick leave, retirement, and
What are some of the reasons for setting up a
sole proprietorship? health or medical insurance”in addition to wages
and salaries.
A sixth disadvantage of the sole proprietorship is
limited life. This means that the firm legally ceases to
To illustrate, consider the earlier case of Mr.
exist when the owner dies, quits, or sells the business.
Winters who owns and operates two businesses. If
the hardware business should fail, Mr. Winters™ per-
sonal wealth, which includes the automobile repair
shop, may be legally taken away to pay off debts
arising from the hardware store.
A second disadvantage of a proprietorship is the
difficulty in raising financial capital. Generally, a
great deal of money is needed to set up a business,
and even more is required to support its expansion. Business Inventories The Business Inventories
A problem may arise because the personal financial report measures the monthly percentage changes
resources available to most sole proprietors are lim- in inventories from manufacturers, retailers, and
ited. Banks and other lenders usually do not want wholesalers. The report is useful in predicting
to lend money to new or very small businesses. As inventories within the gross domestic product
a result, the proprietor often has to raise financial (GDP), which can be volatile from quarter to quar-
capital by tapping savings, using credit cards, or ter. Business inventories are reported monthly by
the Commerce Department. Business inventories
borrowing from family members.
data, released in the third week of each month,
A third disadvantage of a proprietorship is that
show the monthly percentage change in invento-
of size and efficiency. A retail store, for example,
ries from manufacturers, retailers, and whole-
may need to hire a minimum number of employees
salers. Because the majority of the data is old by
just to stay open during normal business hours. It the time it is released, it is usually not a key report
may also need to carry a minimum inventory”a to the markets. One portion of the report
stock of finished goods and parts in reserve”to that does draw a bit of attention, though, is the
satisfy customers or to keep production flowing inventory-to-sales ratio. This particular component
smoothly. Because of limited capital, the propri- is useful in forecasting, since increasing inventory-
etor may not be able to hire enough personnel or to-sales ratios signals a cutback in production.
stock enough inventory to operate the business

Partnerships Forming a Partnership
Like a proprietorship, a partnership is relatively
A partnership is a business jointly owned by
easy to start. Because more than one owner is
two or more persons. It shares many of the
involved, formal legal papers called articles of part-
same strengths and weaknesses of a sole proprietor-
nership are usually drawn up to specify arrange-
ship. As shown in Figure 3.1, partnerships are the
ments between partners. Although not always
least numerous form of business organization,
required, these papers state ahead of time how
accounting for the smallest proportion of sales and
profits (or losses) will be divided.
net income.
The articles of partnership may specify that the
profits be divided equally or by any other arrange-
Types of Partnerships ment suitable to the partners. They also may state
The most common form of partnership is a the way future partners can be taken into the busi-
general partnership, one in which all partners are ness and the way the property of the business will be
responsible for the management and financial obli- distributed if the partnership ends. Individuals who
gations of the business. In a limited partnership, at join as partners must be very careful because they are
least one partner is not active in the daily running financially responsible for personal as well as busi-
of the business, although he or she may have con- ness debts of their partners (except for those debts
tributed funds to finance the operation. specifically exempted in the partnership contract).

Entrepreneurs of of trade and reaching
out to their customers
directly. Dell Computer
the New Economy grew twice as fast as
other personal computer
During the 1700s and 1800s, a series of innovations in manufacturers by allow-
agriculture and industry led to profound economic and ing buyers to configure
social change throughout many regions of the world. Urban their own PCs online.
industrial economies emerged in these areas and eventually
Another reason for
spread around the world. This transformation, which
Dell™s success is veloc-
became known as the Industrial Revolution, began when
ity. According to Dell,
power-driven machinery in factories replaced work done in
business velocity is Michael Dell
homes, altering the way people had lived and worked for shrinking time and dis-
hundreds of years. tance between a company and its suppliers as well as
In the late twentieth century, the world underwent a its customers. “The reduction of time, the reduction of
technological revolution as significant as the Industrial inventory, and the reduction of physical materials and
Revolution. Computers and the Internet are at the heart of assets can drive a tremendous improvement in business
efficiency,” notes Dell. “Customers™ purchasing decisions
this transformation.
become faster and they have direct access to informa-
Dell Computer Few have done more to take advan- tion they need immediately. Customers can compare
tage of the promise of the Internet than Michael Dell. products around the world over the Internet. This has
Under his leadership Dell Computer is in the forefront of dramatic implications for companies that previously had
making the Web the foundation of an existing business. based their strategies on having a physical location,
Many producers, like Dell, are bypassing regular channels and having customers go and buy their products.”

Advantages income taxes on them at the end of the year. Each
partner has to submit a special schedule to the
Like the sole proprietorship, the first advantage
Internal Revenue Service detailing the profits from
of the partnership is its ease of establishment. Even
the partnership, but this is for informational pur-
the costs of the partnership articles, which normally
poses only and does not give a partnership any spe-
involve attorney fees and a filing fee for the state,
cial legal status.
are minimal if they are spread over several partners.
Fourth, partnerships can usually attract financial
Ease of management is the second advantage.
capital more easily than proprietorships. They are
Generally, each partner brings different areas of
generally a little bigger and, if established, have a
expertise to the business: one might have a talent
better chance at getting a bank loan. If money can-
for marketing, another for production, another for
not be borrowed, the existing partners can always
bookkeeping and finance, and yet another for ship-
take in new partners who bring financial capital with
ping and distribution. While partners usually agree
them as part of their price for joining the business.
ahead of time to consult with each other before
A fifth advantage of a partnership is the slightly
making major decisions, partners generally have a
larger size, which often makes for more efficient
great deal of freedom to make lesser ones.
operations. In some
A third advantage is the lack of special taxes on a
areas, such as medi-
partnership. As in a proprietorship, the partners with-
cine and law, a
draw profits from the firm and then pay individual

Did You Know?
Internet Commerce As use of
the Internet spreads throughout the
world, the U.S. share of Internet com-
merce will fall. In 2003, the United
States will account for about 50% of
Online Auctions The auction, a centuries-old tradi-
Internet-based commerce, com-
tion that links communities of buyers and sellers, is
pared with 75% in 1998.
taking a new form on the Internet. One of the first to
sell used goods online was the Gibson Guitar Company.
The company offered older-model, used guitars for sale
on the Web in 1996. Gibson™s site was a huge success,
in large part due to the celebrated reputation of its

The pioneer of person-to-person online trading is eBay.
Launching its site in 1995, eBay at first offered only An abundance of collectibles
and other goods are available
small collectibles such as Beanie Babies and Pez dis- through online auctions.
pensers. Today, the company connects millions of buy-
ers and sellers worldwide. It helps people buy and sell
products in more than 1,000 categories, including
antiques, books, collectibles, electronics, sports memo-
rabilia, and toys.

Under the leadership of CEO Margaret Whitman, eBay
helped establish negotiated pricing, a concept that
influenced Web selling on items such as airplane tick-
ets. The success of eBay has proven that customers will
buy used merchandise online”a significant step for
many businesses in accepting the idea of the online

relatively small firm with three or four partners the unlimited liability feature of a sole proprietor-
may be just the right size for the market. Other ship. It is more complicated, however, because
partnerships, such as accounting firms, may have more owners are involved. As a result, most people
hundreds of partners offering services throughout are extremely careful when they choose a business
the United States. partner.
A sixth advantage is that many partnerships find In the case of a limited partnership, the limited
it easier to attract top talent into their organiza- partners have limited liability. This means that the
tions. Because most partnerships offer specialized investor™s responsibility for the debts of the busi-
services, top graduates seek out stable, well-paying ness is limited by the size of his or her investment
firms to apply their recently acquired skills in law, in the firm. If the business fails and large debts
accounting, and other fields. remain, the limited partner loses only his or her
original investment, leaving the general partners to
make up the rest.
Like the proprietorship, a partnership has limited
life. When a partner dies or leaves, the partnership
The main disadvantage of a general partnership
must be dissolved and reorganized. However, the
is that each partner is fully responsible for the acts
new partnership may try to reach an agreement
of all other partners. If one partner causes the firm
with the older partnership to keep its old name for
to suffer a huge loss, each partner is fully and per-
public image purposes.
sonally responsible for the loss. This is the same as
Another weakness is the potential for conflict
between partners. Sometimes partners discover that
they do not get along, and they either have to learn
Business Organizations
to work together or leave the business. If the part-
nership is large, it is fairly easy for these types of
problems to develop, even though everyone
thought they would get along well in the first place.
Partnerships offer entrepreneurs increased access
to financial capital, but”as Scott Melton the former
general partner of Deep Sushi found out”things do
not always work out as planned. First, his business
filed for bankruptcy, a court-granted permission to
an individual or business to cease or delay debt
payments. Then, because the limited partners had
no liability beyond their initial investments, Scott
was left with the rest of the bills. As a result, he also
filed for bankruptcy.

As shown in Figure 3.1, corporations
account for approximately one-fifth of the
firms in the United States and about 90 percent of
all sales. A corporation is a form of business
organization recognized by law as a separate legal
Partnerships Finding the right partner or part- entity having all the rights of an individual. This
ners is essential in a partnership. What is the status gives the corporation the right to buy and
difference between a general partnership and a
sell property, enter into legal contracts, and to sue
limited partnership?
and be sued.

Forming a Corporation Figure 3.2
Unlike a sole proprietorship or partnership, a
corporation is a very formal and legal arrange-
Stock Ownership
ment. People who would like to incorporate, or
form a corporation, must file for permission from
the national government or the state where the
business will have its headquarters. If approved, a
charter”a government document that gives per-
mission to create a corporation”is granted. The
charter states the name of the company, address,
purpose of business, and other features of the
The charter also specifies the number of shares 1
of stock, or ownership certificates in the firm. These 200th
shares are sold to investors, called stockholders or
shareholders. The money is then used to set up
the corporation. If the corporation is profitable, it
may eventually issue a dividend”a check represent- Making Comparisons If a corporation
has a total of 200 shares of stock, and if
ing a portion of the corporate earnings”to each
you could somehow divide the firm into
200 equal parts, the owner of a single
share of stock would own 1/200th of the
Corporate Structure corporation. A common stockholder, then,
owns part of a company™s plant and
When an investor purchases stock, he or she
equipment and has a voice in how the
becomes an owner with certain ownership rights.
business is managed. How does common
The extent of these rights depends on the type of
stock differ from preferred stock?
stock purchased, common or preferred.
Common stock represents basic ownership of a
corporation. The owner of common stock usually
receives one vote for each share of stock. This vote
is used to elect a board of directors whose duty is the common stockholder might even elect himself
to direct the corporation™s business by setting or herself, and other family members, to the board
broad policies and goals. The board also hires a of directors.
professional management team to run the business In practice, this is not done very often because
on a daily basis. most corporations are so large and the number of
Preferred stock represents nonvoting ownership shares held by the typical stockholder is so small.
shares of the corporation. These stockholders Most small stockholders either do not vote, or they
receive dividends before common stockholders turn their votes over to someone else. This is done
receive theirs. If the corporation goes out of busi- with the use of a proxy, a ballot that gives a stock-
ness, and if some property and funds remain after holder™s representative the right to vote on corpo-
other debts have been paid, preferred stockholders rate matters.
get their investment back before common stock- Finally, Figure 3.3 presents an organizational
holders. Because the stock is nonvoting, preferred chart which shows how the different parts of the
stockholders do not have the right to elect mem- organization relate to one another. The chart shows
bers to the board of directors. the basic components of the business”sales, pro-
In theory, a stockholder who owns a majority of duction, finance, payroll, etc.”as well as the lines
a corporation™s common stock can elect board of authority so that everybody knows who they
members and control the company. In some cases, report to.

Figure 3.3

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

Board of Directors who selects

The President who hires

Vice President Sales Vice President Production Vice President Finance

Domestic International Quality Research & Payroll
Control Development

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

Advantages corporation cannot pay all of its obligations and
goes out of business. Because of limited liability,
The main advantage of a corporation is the ease
stockholder losses are limited to the money they
of raising financial capital. If the corporation needs
invested in stock. Even if other debts remain, the
more capital, it can sell additional stock to
stockholders are not responsible for them.
investors. The revenue can then be used to finance
Because limited liability is so attractive, many
or expand operations. A corporation may also
firms incorporate just to take advantage of it.
borrow money by issuing bonds. A bond is a writ-
Suppose Mr. Winters, who owns the hardware store
ten promise to repay the amount borrowed at a
and the auto repair business, now decides to set up
later date. The amount borrowed is known as the
each business as a corporation. If the hardware busi-
principal. While the money is borrowed, the cor-
ness should fail, his personal wealth, which includes
poration pays interest, the price paid for the use of
the automobile repair business, is safe. Mr. Winters
another™s money.
may lose all the money invested in the hardware
A second advantage of a corporation is that the
business, but that would be the extent of his loss.
directors of the corporation can hire professional
Another advantage is unlimited life, meaning
managers to run the firm. This means that the
that the corporation continues to exist even when
owners, or stockholders, can still own a portion of
ownership changes. Because the corporation is
the corporation without having to know a great
recognized as a separate legal entity, the name of
deal about the business itself.
the company stays the same, and the corporation
A third advantage is that the corporation provides
continues to do business.
limited liability for its owners. This means that the
The ease of transferring ownership is also a
corporation itself, not its owners, is fully responsible
strength of the corporation. If a shareholder no
for its debts and obligations. To illustrate, suppose a

longer wants to be an owner, he or she simply sells the proprietorship and partnership, where owner-
ship and management are one and the same.
the stock to someone else, who then becomes the
A third disadvantage is the double taxation of
new owner. As a result, it is much easier for the
corporate profits. Stockholders™ dividends are taxed
owner of a corporation to find a new buyer than it
twice”once as corporate profit and again as per-
is for a sole proprietor or a partnership.
sonal income. This tax status is a consequence of
the corporation™s special status as a separate legal
Disadvantages entity. This also means that the corporation is
required to keep detailed records of sales and
One disadvantage of the corporate structure is
expenses so that it can compute and pay taxes on
the difficulty and expense of getting a charter.
its profits.
Depending on the state, attorney™s fees and filing
Finally, corporations are subject to more govern-
expenses can cost several thousand dollars. Because
ment regulation than other forms of business.
of this expense, many people prefer to set up pro-
Corporations must register with the state in which
prietorships or partnerships.
they are chartered. If a corporation wants to sell its
A second disadvantage of the corporation is that
stock to the public, it must register with the federal
the owners, or shareholders, have little say in how
Securities and Exchange Commission (SEC). It will
the business is run after they have voted for the
also have to provide financial information concern-
board of directors. This is because the directors
ing sales and profits on a regular basis to the general
turn day-to-day operations over to a professional
public. Even an attempt to take over another busi-
management team, resulting in the separation of
ownership and management. This is different from ness may require federal government approval.

Business Organizations

Corporations A corpora-
tion is an organization
owned by many people but
treated by law as though it
were a person. As a corpora-
tion the company can raise
money by selling shares of
ownership in the business
to hundreds or thousands of
people. Owners of common
stock elect a board of direc-
tors. The board of directors,
in turn, hires managers to
run the business. How do
the holders of common
stock differ from the hold-
ers of preferred stock?

Government and Business companies providing such necessities as electricity,
gas, telephone service, or transportation service,
Regulation were especially rigorous. Recently, states have
reduced regulations in order to encourage compe-
The concept of competitive markets, free
tition. In the next section, you will read about the
from government intervention, has always
ways businesses can grow and expand.
been a strong part of the U.S. economy. However,
in the mid-nineteenth century, states tried to
restrict the powers of corporations. By the 1890s,
Business Development
however, courts and legislatures, influenced by
State governments are very active in trying
business interests and aware that giant corporations
to attract new industry. Governors often travel
were becoming indispensable, had relaxed control
throughout the country or even to foreign countries
over business. States that continued to restrict cor-
to draw new business to their states. Television adver-
porations found their major businesses moving to
tising, billboards, brochures, and newspaper adver-
other states where the laws were more lenient.
tisements promote travel or business opportunities.
Beginning in the 1930s, state governments sold
Business Regulation industrial development bonds to people or institu-
tions and used the money to help finance indus-
In the twentieth century, various consumer
tries that relocated or expanded within the state.
groups demanded regulation of giant corporations.
The state paid off the bond within a specified time
In response, federal and state governments passed
period from money that the industry paid back to
stronger regulations. States helped set insurance
the state in the form of taxes. Today a state may
companies™ rates, administered licensing exams,
offer an incentive such as a tax credit, or a reduc-
and generally protected consumer interests.
tion in taxes, in return for the creation of new jobs
Legislation regulated all kinds of corporations, but
or new business investment.
laws regulating banks, insurance companies, and

Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Unlimited Liability Interview one or two
organizer activity on page 57, explain why business owners in your community and ask
partnerships are able to attract more capital them about the formal structure of their
than sole proprietorships. business. Ask them how they feel about the
issue of unlimited liability. Inquire whether
2. Key Terms Define sole proprietorship, propri-
the issue had any influence on the legal form
etorship, unlimited liability, inventory, limited
of business they selected.
life, partnership, limited liability, bankruptcy,
corporation, charter, stock, stockholder, share-
holder, dividend, bond, principal, interest,
double taxation.
7. Drawing Conclusions When a corporation
3. Identify the characteristics and organization wants to introduce a potentially profitable
of the sole proprietorship.
but risky product, it frequently sets up a
4. Discuss the advantages and disadvantages of separate company that has its own corpo-
the partnership. rate structure. Why do you think the corpo-
ration does this?
5. Discuss the structure and features of the
corporation. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

A Pioneer in
Corporate America:
Kenneth I.

What does it take to succeed at
one of America™s largest and most
prestigious corporations? Kenneth a management consulting firm How does Chenault view his
Chenault knows the answer. At the before joining American Express tremendous responsibilities as the
young age of 45, Chenault became in 1981. highest-ranking African American
president and chief operating offi- in corporate America?
cer (COO) of American Express, CHALLENGES AND “With American Express being
the sixty-fifth largest company in O P P O RT U N I T I E S a large, publicly held company, I
the country. would be scrutinized under any
At first Chenault was responsible
Chenault is the first African circumstances,” Chenault said. “If
for strategic planning at American
American to serve as president of a you don™t enhance shareholder
Express. Soon, his intelligence and
top-100 company. Some people value, it doesn™t matter who you
hard work propelled him up
have compared him to Jackie are, you will have a problem. . . .
through the corporate ranks. Each
Robinson, who broke the color [I]f I do well, I would be very
promotion brought Chenault new
barrier in baseball in 1947. hopeful that it would encourage
challenges”and new opportunities.
Coincidentally”and perhaps fit- other companies to give people the
His greatest opportunity is as
tingly”Chenault became COO in opportunity to succeed.”
president and COO. Chenault is
1997, the 50th anniversary year of Kenneth Chenault himself had
responsible for integrating strategies
Robinson™s breakthrough. the opportunity to succeed. And
across all of American Express™s
he has proven he knew how to take
many business units. He has been
STEPPING STONES advantage of it.
in the forefront of company efforts
Remarkably, Kenneth Chenault to increase market share by expand-
did not start his career in business. ing product offerings, globalizing
Examining the Profile
Instead, he obtained an under- the business, and opening American
graduate degree in history, and Express™s card network to bank part- 1. Drawing Conclusions What personal
then earned a law degree at ners around the world. Chenault is qualities do you think Chenault has
Harvard. He had keen instincts for also responsible for global advertis- that helped make him a success?
business, however, and worked for ing and brand management. 2. For Further Research Learn about
and report on Chenault™s philanthropic
contributions in New York City.

Business Growth and Expansion
Main Idea Key Terms
Businesses grow through merging with other compa- merger, income statement, net income, depreciation,
nies and by investing in the machinery, tools, and cash flow, horizontal merger, vertical merger, con-
equipment used to produce goods and services. glomerate, multinational

Reading Strategy
After studying this section, you will be able to:
Graphic Organizer As you read the section, complete
1. Explain how businesses can reinvest their profits to
a graphic organizer similar to the one below by com-
grow and expand.
paring a vertical merger to a horizontal merger.
2. Recognize the reasons that cause firms to merge.
3. Identify two different types of mergers.
Vertical merger
Applying Economic Concepts
Similarities Business Growth Businesses can grow by reinvesting
their profits in themselves, or they can combine with
Horizontal merger
another business. Read to find out what influences

business can grow in one of two ways. First,
Cover Stor y it can grow by reinvesting some of its prof-
its. A business can also expand by engaging,
Kroger Bags Fred Meyer much like Kroger did, in a merger”a combination
of two or more businesses to form a single firm.
Grocery store giant
Kroger Co. agreed
Monday to purchase Growth Through Reinvestment
rival Fred Meyer Co. in
a $12.8 billion deal that Most businesses use some of the revenue
will enable Kroger to they receive from sales to invest in factories,
reclaim its status as the machinery, and new technologies. We can use the
nation™s largest super- income statement”a report showing a business™s
market company. . . . e
Supermarket companies ar sales, expenses, and profits for a certain period”to
growing through mergers.
[Analysts say] the illustrate the process. An income statement can
merger is a good deal te the
one that should crea reflect various periods of financial activity, such as
for both companies, ive in
ssary to remain competit three months or a year.
economies of scale nece
the tough supermarket in ead
able Kroger to [stay] ah
The merger also will en
Estimating Cash Flows
ich otherwise would
of rival Albertson™s, wh ut of
h its $11.7 billion buyo As illustrated in Figure 3.4, the business first
eclipsed Kroger throug with
August. . . . Combined
American Stores Co. in records its total sales for the period. Next, it finds
fifth-largest grocery ch
Meyer, currently the its net income by subtracting all of its expenses,
0 supermarkets in 31 sta
Kroger will operate 2,20 including taxes, from its revenues. These expenses
annual sales.
boasting $43 billion in include the cost of any goods such as inventory,
”CNNfn, October 19,

wages and salaries, interest payments,
Figure 3.4
and depreciation, a non-cash charge
the firm takes for the general wear
Business Growth
and tear on its capital goods.
Depreciation is called a non-cash
Through Reinvestment
charge because, unlike other expenses
shown in the figure, the money is
never paid to anyone else. For exam- First Quarter Income Statement
ple, interest may be paid to a bank,
Sales of Goods and Services: $1,000
wages may be paid to employees, but
less: Cost of goods sold 400
the money allocated to depreciation Wages and salaries 250
never goes anywhere”it simply stays Interest payments 50
in the business. Depreciation 100
Investment in
The concept of cash flow, the sum new plant,
Earnings Before Tax: $200
equipment, and
of net income and non-cash charges less: Taxes (at 40%) 80
such as depreciation, is the bottom
line, or real measure of profits for the Net Income: $120
plus: Non-cash charges 100
business. This is because the cash Allows
flow represents the total amount of Cash Flow: $220
new funds the business generates
from operations.

Using Charts One way for a business to grow is to invest
Reinvesting Cash Flows some of its cash flow in new plant, equipment, and
The business owners, either directly technologies so that it can generate even more sales in the
in the case of the proprietorship or future. Which of the items on the income statement
partnership, or indirectly through the represents the real measure of profits for the
board of directors in the case of the business?
corporation, decide how the cash flow
will be allocated. Some of it can be
merged, the new organization was called the Chase
paid back to owners as their reward for risk taking, or
Manhattan Bank of New York”a name later changed
the funds can be reinvested in the form of new plant,
to Chase Manhattan Corporation to reflect its geo-
equipment, and technologies.
graphically expanding business.
When cash flows are reinvested in the business,
Mergers take place for a variety of reasons. A
the firm can produce additional products. This
firm may seek a merger to grow faster, to become
generates additional sales and a larger cash flow
more efficient, to acquire or deliver a better prod-
during the next sales period. As long as the firm
uct, to eliminate a rival, or to change its image.
remains profitable, and as long as the reinvested
cash flow is larger than the wear and tear on the
equipment, the firm will grow.
Reasons for Merging
Some managers find that they cannot grow as
Growth Through Mergers fast as they would like using the funds they gener-
When firms merge, one gives up its separate ate internally. As a result, the firm may look for
legal identity. For public recognition pur- another firm with which to merge. Sometimes a
poses, however, the name of the new company may merger makes sense, and other times it may not,
reflect the identities of the merged companies. but the desire to be bigger”if not the biggest”is
When Chase National Bank and Bank of Manhattan one reason that mergers take place.

lips. He charges up to $1,000 to host his two-to-
three-hour “Let™s Smile Operation” seminars, in
WHEN YOU SAY PROFITS, which students exercise recalcitrant facial muscles

SMILE and 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 in
Understanding the values of your customers is an
its worst economic crisis in decades. “If Japan smiled
important part of doing business. In this excerpt,
more, perhaps this nasty recession would end.”
an analyst promotes the importance of smiling to
Look what it has done for Kadokawa, who has
a group of Japanese businesspeople.
also written a popular book, The Power of a
Some 30 somber businessmen in plain blue suits
Laughing Face. His clients, however, mostly men, are
are biting down on chopsticks and feeling silly.
having a harder time of it. “Won™t I look stupid if I
“Now pull them out slowly,” instructs their teacher,
smile?” asks one. “Is it good for your health?”
Yoshihiko Kadokawa, and suddenly the Japanese
inquires another. Kadokawa assures them that
men seem to be grinning. . . . “There you go, you
showing their pearly whites is the key to prosperity.
are now smiling,” beams Kadokawa, 47. “Doesn™t it
Perhaps his most helpful tip: Study Bill Clinton.
feel great?”
“Look at the way he smiles,” says Kadokawa. “That
Second nature to politicians and game show
is real power.”
hosts, the toothy grin has long been a cultural no- ”People Weekly, May 10, 1999
no in Japan, where some people still cover their
mouths when they laugh in public and children are
Critical Thinking
taught to limit their expressiveness, lest they upset
the wa, or sense of group harmony. But Kadokawa,
1. Analyzing Information What is Kadokawa
a former department store executive who noticed trying to teach the group?
that his friendliest clerks racked up the biggest
2. Synthesizing Information How important
sales, wants to turn Japan into the land of happy
is it for business people who work with
people from other countries to understand
their values?

Efficiency is another reason for mergers. When that they could offer faster internet access and tele-
two firms merge, they no longer need two presi- phone service in a single package.
dents, two treasurers, and two personnel directors. Sometimes firms merge to catch up with, or
The firm can have more retail outlets or manufac- even eliminate, their rivals. Royal Caribbean
turing capabilities without significantly increasing Cruises acquired Celebrity Cruise Lines in 1997
management costs. In addition, the new firm may and nearly doubled in size, becoming the second
be able to get better discounts by making volume largest cruise line behind Carnival. When the office
purchases, and make more effective use of its adver- supply store Staples tried to acquire Office Depot
tising. Sometimes the merging firms can achieve in the same year, however, the government blocked
two objectives at once”such as dominant size and the merger on the grounds that it would reduce
improved efficiency”as in the case of the Kroger- competition in the industry.
Meyer merger. Finally, a company may use a merger to lose its
Some mergers are driven by the need to acquire corporate identity. In 1997 ValuJet merged with
new product lines. Recent telecommunications AirWays to form AirTran Holdings Corporation.
industry mergers, for example, were driven by the The new company flew the same planes and routes
desire for some firms to provide better communi- as the original company, but AirTran hoped the
cations services. As a result, former telephone name change would help the public forget ValuJet™s
companies like AT&T bought cable TV firms so tragic 1996 Everglades crash that claimed 110 lives.

Types of Mergers Figure 3.5
Economists generally recognize
two types of mergers. The first is a
Business Combinations
horizontal merger, which takes
place when two or more firms that
produce the same kind of product Horizontal Merger
join forces. The merger of the two
banks, Chase National and the Bank
of Manhattan, is one such example.
+ =
When firms involved in different
steps of manufacturing or market-
People™s Building
ing join together, we have a vertical Nickel Savings Bank Nickel Savings
& Loan Association & Loan Association
merger. An automaker merging
with a tire company is one example
of a vertical merger. Another is the Vertical Merger
U.S. Steel Corporation. At one
time, it mined its own ore, shipped
it across the Great Lakes, smelted it,
and made steel into many different
products. Vertical mergers take
place when companies believe that Hickory Tree Farms
it is important to protect them-
selves against the loss of suppliers.

A corporation may become so
Boston Enterprises
large through mergers and acquisi-
tions that it becomes a conglomerate.
A conglomerate is a firm that has at
least four businesses, each making
unrelated products, none of which is
Fast Delivery, INC.
responsible for a majority of its sales.
Diversification is one of the main
reasons for conglomerate mergers.
Some firms believe that if they do
not “put all their eggs in one bas-
ket,” their overall sales and profits
will be protected. Isolated eco-
nomic happenings, such as bad
weather or the sudden change of Boston Enterprises
consumer tastes, may affect some
product lines at some point, but
not all at one time.
During the 1970s and early Using Charts Horizontal and vertical mergers are two
1980s, conglomerate mergers were kinds of mergers. What is the difference between
popular in the United States. The these two kinds of mergers?
cigarette and tobacco firm of R.J.

ECONOMICS Reynolds became a leading con-
Figure 3.6
AT A GLANCE glomerate, at one time owning the
largest containerized shipping firm
in the country (Sea-Land), the
Conglomerate Structure nation™s second largest fast-food
chain (Kentucky Fried Chicken),
the nation™s largest fruit and veg-
Office Products
etable processor (Del Monte), and
ACCO office supplies
the second largest producer of wine
Swingline staplers
and distilled spirits (Heublein).
Day-Timers personal
Since the late 1980s, the number
of conglomerates in the United
States has declined. In Asia, how-
Sporting Equipment ever, conglomerates remain strong.
Titleist golf balls Samsung, Gold Star, and Daewoo
Foot-Joy golf shoes
are still very dominant in Korea, as
Bulls Eye putters
are Mitsubishi, Panasonic, and
Sony in Japan.
Hardware and Home
Moen faucets
Other large corporations have
Master Lock
become international in scope. A
Waterloo toolboxes
multinational is a corporation that
has manufacturing or service opera-
tions in a number of different
Spirits and Wines
countries. It is, in effect, a citizen
of several countries at one time. As
such, a multinational is subject to
the laws of, and is likely to pay
Sales by Category taxes in, each country where it has
operations. General Motors,
Hardware 31%
Nabisco, British Petroleum, Royal
Office Products 17%
Dutch Shell, Mitsubishi, and Sony
Spirits and Wines 34% are examples of global corporations
Sporting Goods 18% that have attained worldwide eco-
nomic importance.
Multinationals are important
because they have the ability to
Source: http://www.fortunebrands.com
move resources, goods, services,
and financial capital across national
Using Charts A conglomerate is a firm that has at least four
borders. A multinational with its
businesses, each of which makes unrelated products and
headquarters in Canada, for exam-
none of which is responsible for a majority of its sales.
ple, is likely to sell bonds in France.
Fortune Brands is an American conglomerate with a wide
The proceeds may then be used to
range of products. About 25 percent of Fortune Brand's sales
expand a plant in Mexico that
come from international sales . How does a conglomerate
sales. How does
makes products for sale in the
differ from a multinational?
United States. Multinationals may

also be conglomerates if they make a number of
unrelated products, but when they conduct their
operations in several different countries they are
more likely to be called a multinational. Buyer
Multinationals are usually welcome because
they transfer new technology and generate new Buyers purchase merchandise
for resale to the public. They
jobs in areas where jobs are needed. Multinationals
choose the suppliers, negotiate
also produce tax revenues for the host country,
the price, and award contracts.
which helps that nation™s economy.
At times, multinationals have been known to The Work
abuse their power by paying low wages to workers, Duties include anticipating con-
exporting scarce natural resources, or by adversely sumer demand, staying
interfering with the development of local busi- informed about new products,
nesses. Some analysts point out that multinational attending trade shows, and
corporations will be increasingly able to demand checking shipments. Buyers
tax, regulatory, and wage concessions by threaten- assist in sales promotions and advertising campaigns, as
ing to move their operations to another country. well as checking on displays. Buyers must have the abil-
Only highly educated people or those with skills ity to plan, make decisions quickly, work under pressure,
will benefit as wages remain low. Other analysts and identify products that will sell. Most buyers work in
predict uneven development. One region of the wholesale and retail trade companies, such as grocery or
world will grow at the expense of another. department stores, or in manufacturing. Many others
work in government or in service industries.
Most economists, however, welcome the low-
cost production and quality that competition in Qualifications
the global economy brings. They also believe a
Most buyers have completed a college degree with a busi-
greater use of research and new technology will
ness emphasis. Familiarity with the merchandise as well as
raise the standard of living for all people. On bal- with wholesaling and retailing practices is important.
ance, the advantages of multinationals far outweigh
the disadvantages.

Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Business Growth In a newspaper or maga-
organizer activity on page 68, explain how zine, find an article about a merger. What
mergers improve efficiency. companies merged? What reasons, if any,
were given for the merger? What statistics
2. Key Terms Define merger, income statement,
were provided? Write a one-page paper in
net income, depreciation, cash flow, horizon-
which you answer these questions.
tal merger, vertical merger, conglomerate,
3. Describe how a firm can generate funds inter-
nally to grow and expand. 7. Making Comparisons What are the benefits
4. Identify five reasons why firms merge. and drawbacks of multinationals to their
host countries?
5. Describe the different ways a business can
merge. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

JUNE 28, 1999
Its secret: conveying the allure of different
Cosmetic companies like L™Or©al have
cultures through its many products. Whether it™s
found a profitable strategy: acquire
selling Italian elegance, New York street smarts,
smaller cosmetic companies and promote
or French beauty through its brands, L™Or©al is
the culture from which they came. With
reaching out to a vast range of people across
this formula, and with the help of chief incomes and cultures. . . .
executive Lindsay Owen-Jones, L™Or©al™s L™Or©al™s work with Maybelline is a prime
example. In 1996, L™Or©al acquired Maybelline
profits have dramatically increased.
for $758 million and began a makeover of the
brand. The key: figuratively stamping “urban
American chic” all over Maybelline products to
The Beauty of promote their American origins. . . .
“That™s a big challenge for this company to
Global Branding add brands, yet keep the differentiation,” says
Marlene Eskin, publisher of Market View
research reports on the cosmetics industry.
It™s a sunny afternoon outside Parkson™s
department store in Shanghai, and a marketing ”Reprinted from June 28, 1999 issue of Business Week, by special
permission, copyright © 1999 by The McGraw-Hill Companies, Inc.
battle is raging for the attention of Chinese
women. Tall, pouty models in beige skirts and
sheer tops pass out flyers promoting Revlon™s
new spring colors. But their efforts [are being]
drowned out by L™Or©al™s eye-catching show for
its Maybelline brand.
To a pulsating rhythm, two gangly models in
shimmering lycra tops dance on a podium
before a large backdrop depicting the New York
City skyline. The music stops, and a makeup
artist transforms a model™s face while a Chinese
saleswoman delivers the punch line. “This
brand comes from America. It™s very trendy,”
Department store in Shanghai, China
she shouts into the microphone. “If you want
to be fashionable, just choose Maybelline.”
Few of the women in the admiring crowd
Examining the Newsclip
realize that the trendy “New York” Maybelline
brand belongs to French cosmetics giant 1. Analyzing Information How has L™Or©al become more
L™Or©al. In the battle for global beauty markets, competitive in the global market?
$12.4 billion L™Or©al has developed a winning 2. Summarizing Information In your own words, explain
formula: a growing portfolio of international why it is a challenge for a company to “add brands, yet
brands that have transformed the French com- keep differentiation”?
pany into the U.N. of beauty. . . .

Other Organizations

Main Idea Key Terms
Producer and worker cooperatives are associations in nonprofit organization, cooperative, co-op, credit
which the members join in production and marketing union, labor union, collective bargaining, professional
to lower costs for their members™ benefit. association, chamber of commerce, Better Business
Bureau, public utility
Reading Strategy
Graphic Organizer As you read the section, complete
After studying this section, you will be able to:
a graphic organizer similar to the one below by
1. Describe nonprofit organizations.
describing the different kinds of cooperatives.
2. Explain the direct and indirect role of government
in our economy.
Cooperatives Applying Economic Concepts
Nonprofit Organizations Do you belong to a church,
club, or civic organization? Read to find out how
these organizations fit into our economic system.

ost businesses use scarce resources to pro-
Cover Stor y duce goods and services in hopes of earn-
ing a profit for their owners. Other
organizations, like the baby-sitting co-op described
Baby-Sitting Co-Ops a Gro in the cover story, operate on a “not-for-profit” basis.
A nonprofit organization operates in a businesslike
Trend way to promote the collective interests of its mem-
When Candace bers rather than to seek financial gain for its owners.
and Roger Kuebel of
Larchmont, N.Y., flew
to Grenada for a
Community and Civic Organizations
week™s vacation, they
did something most Baby-sitting duties Examples of nonprofit institutions include
parents of young organizations such as schools, churches, hos-
dren do only in their hter, pitals, welfare groups, and adoption agencies. Most
their two-year-old daug
eams. The Kuebels left
dr r-
o responsible adults”pa of these organizations are legally incorporated to
eather, in the care of tw
H care
also didn™t pay a child take advantage of unlimited life and limited liability.
ts themselves . . . they
They are similar to profit-seeking businesses, but do
service any costly fees. ng
ey belong to a baby-sitti not issue stock, pay dividends, or pay income taxes.
The couple™s secret: Th
These organizations often provide goods and
cooperative. e:
by-sitting co-op is simpl
The idea behind the ba services to their members while they pursue other
ing duties without ev
milies swap baby-sitt rewards such as improving educational standards,
usually rely on a coupon
changing money. Co-ops seeing the sick become well, and helping those in
ex to
upons have an incentive
stem: members with co
sy need. Their activities often produce revenues in
w on coupons need to sit
use them, while those lo excess of expenses, but they use the surplus to
1, 1998
On the Web, February
”The New York Times further the work of their institutions.

Nonprofit community and civic organizations Consumer Cooperatives
use scarce factors of production to serve many The consumer cooperative is a voluntary associ-
needs. Their efforts are difficult to analyze eco- ation that buys bulk amounts of goods such as
nomically, however, because the value of their food and clothing on behalf of its members.
products is not easy to measure. Even so, the large Members usually help keep the cost of the opera-
number of these organizations shows that they are tion down by devoting several hours a week or
an important part of our economic system. month to the operation. If successful, the co-op is
able to offer its members products at prices lower
than those charged by regular businesses.
Another example of a nonprofit organiza-
Service Cooperatives
tion is the cooperative, or co-op. A cooper-
A service cooperative provides services such as
ative is a voluntary association of people formed to
insurance, credit, and baby-sitting to its members,
carry on some kind of economic activity that will
rather than goods. One example is a credit union,
benefit its members. Cooperatives fall into three
a financial organization that accepts deposits from,
major classes: consumer, service, and producer.
and makes loans to, employees of a particular com-
pany or government agency. In most cases, credit
ECONOMICS union members can borrow at better rates and
Figure 3.7
AT A GLANCE more quickly than they could from for-profit banks
or commercial loan companies.
Cooperatives in the
United States Producer Cooperatives
Producers, like consumers, can also have co-ops.
Credit Unions
A producer cooperative helps members promote or
sell their products. In the United States, most
Memorial Societies
cooperatives of this kind are made up of farmers.
The co-op helps the farmers sell their crops directly
Housing Policy
to central markets or to companies that use the
members™ products. Some co-ops, such as the
Ocean Spray cranberry co-op, market their prod-
ucts directly to consumers.

Farm Purchasing and Marketing
Labor, Professional, and Business
Preschool Education
Non-profit organizations are not just limited
Consumer Goods
to co-ops and civic groups. Many other
groups also organize this way to promote the inter-
ests of their members.
Using Charts The cooperative is a volun-
Using The cooperative is a volun-
tary association of people formed to carry Labor Unions
people formed to carry
on some kind of economic activity that will
Another important economic institution is the
benefit its members. How do the three
do the three
labor union, an organization of workers formed
kinds of cooperatives differ?
kinds cooperatives
to represent its members™ interests in various


Benefits A cooperative is an
organization that is owned by
and operated for the benefit
of those using its services.
Consumer cooperatives, ser-
vice cooperatives, and pro-
ducer cooperatives perform
different functions. What are
the benefits of a consumer

employment matters. The union participates in working conditions, skill levels, and public percep-
collective bargaining when it negotiates with man- tions of the profession.
agement over issues such as pay, working hours, The American Medical Association (AMA) and
health care coverage, life insurance, vacations, and the American Bar Association (ABA) are two exam-
other job-related matters. ples of interest groups that include members of spe-
Unions pressure the government to pass laws cific professions. Basically, these two groups
that will benefit and protect their workers. The influence the licensing and training of doctors and
largest labor organization in the United States is the lawyers, and both groups are actively involved in
American Federation of Labor-Congress of political issues. Professional associations also repre-
Industrial Organizations (AFL-CIO), an association sent bankers, teachers, college professors, police
of unions whose members do all kinds of work. The officers, and hundreds of other professions. While
American Postal Workers Union and the American these associations are concerned primarily with the
Federation of Teachers, for example, are both AFL- standards of their professions, they also seek to
CIO unions. Many other unions, such as the influence government policy on issues that are
National Education Association for Teachers, are important to them.
independent and represent workers in specific

Professional Associations
Many workers belong to professional societies,
trade associations, or academies. While these
Student Web Activity Visit the Economics: Principles


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