AP Business with Personal Finance · Lesson 1

What a business is, and how it competes

Know Know it

A business is an organization that sells goods or services to customers, usually to earn a profit: revenue minus expenses. Revenue is all the money that comes in from sales; expenses are the costs of running the business, such as supplies, wages and rent. A nonprofit also sells goods or services, but it puts any surplus back into its mission instead of paying it to owners.

Every business combines the factors of production: land (natural resources), labor (people’s work), capital (tools, machines and buildings) and entrepreneurship (the person who brings the others together and takes the risk). Businesses sit in the primary sector (taking raw materials from nature, such as farming or mining), the secondary sector (making goods) or the tertiary sector (providing services).

How a business is owned decides who controls it and who pays if it fails. A sole proprietorship has one owner with unlimited liability: the owner personally owes every business debt. In a general partnership, two or more owners share the profits, the decisions and the unlimited liability. A corporation is a separate legal person owned by shareholders, who have limited liability but face more rules and paperwork. A limited liability company (LLC) gives its owners limited liability with fewer formalities. A cooperative is owned by the members who use it.

A market is any place where buyers and sellers trade. When demand rises or supply falls, prices tend to rise. Market structures describe how much competition there is: perfect competition (many sellers of identical products, none able to set the price), monopolistic competition (many sellers of slightly different products), oligopoly (a few large sellers who watch each other) and monopoly (one seller with no close substitutes). Direct competitors sell the same kind of product; indirect competitors meet the same need in a different way.

A competitive advantage lets a business serve customers better or more cheaply than rivals, in a way that is hard to copy. Firms build one through cost leadership (the lowest costs, so they can charge the lowest prices), differentiation (something special that customers will pay more for) or focus (serving one narrow group very well). A unique selling proposition says the advantage in one line. Market share is a firm’s sales divided by the whole market’s sales, times 100.

Trap Revenue is not profit

A business with high sales can still lose money. Revenue is every dollar that comes in; profit is what remains after every expense is paid. When a question asks for profit, subtract all of the expenses it lists, not just the biggest one.

Worked example Easy

A fictional food truck, Saffron Wheels, takes in 18,400 dollars in sales in one month. That month it spends 7,900 dollars on food, 6,200 dollars on wages and 2,500 dollars on fuel, permits and repairs. What is its profit for the month?

  1. 10,500 dollars
  2. 1,800 dollarsAnswer
  3. 16,600 dollars
  4. 4,300 dollars

How to solve it

  1. Add the expenses: 7,900 + 6,200 + 2,500 = 16,600 dollars.
  2. Subtract from revenue: 18,400 - 16,600 = 1,800 dollars.
  3. The truck made a profit of 1,800 dollars for the month.

Why each choice is right or wrong

  • A. Incorrect. 10,500 dollars subtracts only the 7,900 dollars of food, leaving out wages and the other costs.
  • B. Correct. Profit is revenue minus all expenses: 18,400 - 7,900 - 6,200 - 2,500 = 1,800 dollars.
  • C. Incorrect. 16,600 dollars is the total of the three expenses, not what is left of the revenue after paying them.
  • D. Incorrect. 4,300 dollars subtracts food and wages but forgets the 2,500 dollars for fuel, permits and repairs.

Explain Explain it

Task verbs: explain, calculate

To explain a competitive advantage, name what the business offers customers that rivals do not, then give the reason rivals cannot simply match it. Test each claimed advantage with one question: if a rival wanted to copy this tomorrow, what would stop it? If the honest answer is nothing, the advantage will not last.

To name a strategy, ask two questions. Who is the business trying to serve: the whole market or one narrow group? And how does it win them: with the lowest cost, or with something special?

Worked example Medium

Two fictional bike shops sit on the same street. Gearbox sells the cheapest bikes in town: it buys in bulk from one large maker and keeps a small staff. Spoke & Fern sells only custom, hand-built bikes for riders who are unusually tall, and it charges high prices for them.

Which competitive strategy does Spoke & Fern use?

  1. Cost leadership, by offering the lowest prices in the whole market
  2. Mass marketing, by selling one standard bike to every type of rider
  3. A focus strategy: a special product for one narrow groupAnswer
  4. Price matching, by charging whatever Gearbox charges for a bike

How to solve it

  1. Who does it serve? Only unusually tall riders: a narrow group.
  2. How does it win them? With custom, hand-built bikes at high prices: something special, not the lowest cost.
  3. A narrow group plus a special product is a focus strategy.

Why each choice is right or wrong

  • A. Incorrect. Cost leadership is Gearbox’s strategy; Spoke & Fern charges high prices, not the lowest ones.
  • B. Incorrect. Mass marketing sells one product to everyone, but Spoke & Fern builds custom bikes for tall riders only.
  • C. Correct. Spoke & Fern serves one narrow group, unusually tall riders, with a special product they pay more for.
  • D. Incorrect. Spoke & Fern’s high prices are far from Gearbox’s low ones, so it is not price matching.

Explain Your turn

Two fictional coffee roasters sell in the same city. Ember Hill cut its prices this month so that they are now the lowest in town. Copperline owns a roasting method it invented and patented, which gives its coffee a flavor customers ask for by name. Explain which roaster has the more lasting competitive advantage. Give one reason the other roaster’s advantage may not last.

Write it, then compare. Nothing you type here is saved or graded.

Compare with a model answer

A full answer does this

  • Names Copperline as having the more lasting advantage
  • Explains why Copperline’s advantage is hard to copy
  • Gives a reason Ember Hill’s low prices may not last

Model answer

Copperline has the more lasting advantage. Its patent legally stops other roasters from using its roasting method, so they cannot offer coffee with the same flavor that customers ask for. Ember Hill’s advantage may not last, because any rival can cut its own prices to match, and Ember Hill may not be able to keep prices that low without hurting its profit.

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