Small Business Management: Entrepreneurship and Beyond

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Small Business Management Entrepreneurship and Beyond FIFTH EDITION

TIMOTHY S. HATTEN Mesa State College

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To: Jill, Paige, Brittany, and Taylor

Brief Contents Preface

xvii

P A R T 1: The Challenge

1

Chapter 1: Small Business: An Overview 2 Chapter 2: Small Business Management, Entrepreneurship, and Ownership 23 P A R T 2: Planning in Small Business

51

Chapter 3: Social Responsibility, Ethics, and Strategic Planning 52 Chapter 4: The Business Plan 80 P A R T 3: Early Decisions

107

Chapter 5: Franchising 108 Chapter 6: Taking Over an Existing Business 131 Chapter 7: Starting a New Business 156 P A R T 4: Financial and Legal Management

179

Chapter 8: Accounting Records and Financial Statements 180 Chapter 9: Small Business Finance 213 Chapter 10: The Legal Environment 239 P A R T 5: Marketing the Product or Service 263

11: 12: 13: 14:

Small Small Small Small

Business Business Business Business

Marketing: Marketing: Marketing: Marketing:

P A R T 6: Managing Small Business

Chapter Chapter Chapter Chapter

15: 16: 17: 18:

Notes 480 Index 491 iv

Strategy and Research 264 Product 284 Place 308 Price and Promotion 337

369

International Small Business 370 Professional Small Business Management 399 Human Resource Management 426 Operations Management 459

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Chapter Chapter Chapter Chapter

Contents Preface xvii PA RT 1

The Challenge 1

CHAPTER 1

Small Business: An Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 What Is Small Business? 3 Size Definitions 4 Types of Industries 6 Small Businesses in the U.S. Economy 7 Workforce Diversity and Small Business Ownership 9 The Value of Diversity to Business 11 Secrets of Small Business Success 11 Competitive Advantage 11 Getting Started on the Right Foot 13 Understanding the Risks of Small Business Ownership 14 What Is Business Failure? 14 Causes of Business Failure 16 Business Termination versus Failure 17 Mistakes Leading to Business Failure 17 Failure Rate Controversy 18 Is Government Intervention the Answer? 19 E NTREPRENEURIAL S NAPSHOT : Beer Entrepreneur 15 MANAGER ’S NOTES : Straight from the Source 12 Summary 20 Questions for Review and Discussion 20 Questions for Critical Thinking 21 What Would You Do? 21 Chapter Closing Case 21 CHAPTER 2

© Carlos Hernandez/STOCK4B, Getty Images

Small Business Management, Entrepreneurship, and Ownership . . . . . . . . . . . . . . . . 23 The Entrepreneur-Manager Relationship 24 What Is an Entrepreneur? 24 Entrepreneurship and the Small Business Manager 25 A Model of the Start-Up Process 26 Your Decision for Self-Employment 30 Pros and Cons of Self-Employment 30 Traits of Successful Entrepreneurs 32 Preparing Yourself for Business Ownership 34 Forms of Business Organization 35 Sole Proprietorship 37 Partnership 38 v

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Corporation 42 Specialized Forms of Corporations 45 MANAGER ’ S NOTES: Are You Ready? 25 REALITY C HECK : Small Biz on Campus 32 Summary 46 Questions for Review and Discussion 47 Questions for Critical Thinking 47 What Would You Do? 47 Chapter Closing Case 48

PA RT 2

Planning in Small Business 51

CHAPTER 3

Social Responsibility, Ethics, and Strategic Planning . . . . . . . . . . . . . . . . . . . . . . . . . . 52 Relationship between Social Responsibility, Ethics, and Strategic Planning 53 Social Responsibilities of Small Business 53 Economic Responsibility 54 Legal Obligations 55 Ethical Responsibility 56 Philanthropic Goodwill 57 Ethics and Business Strategy 58 Codes of Ethics 58 Ethics under Pressure 60 Strategic Planning 62 Mission Statement 63 Environmental Analysis 64 Competitive Analysis 66 Strategic Alternatives 73 Goal Setting and Strategies 73 Control Systems 75 Strategic Planning in Action 76 MANAGER ’ S NOTES: Playing Hardball 73 C OMPETITIVE A DVANTAGE: Competitive Intelligence 60 REALITY C HECK : Green Can Be Gold 62 Summary 77 Questions for Review and Discussion 77 Questions for Critical Thinking 78 What Would You Do? 78 Chapter Closing Case 78 CHAPTER 4

The Business Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 Every Business Needs a Plan 81 The Purpose 81 The Practice: Guidelines for Writing a Business Plan 82 Business Plan Contents 86 Cover Page 86 Table of Contents 86 Executive Summary 86 Company Information 87 Environmental and Industry Analysis 87

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Products or Services 89 Marketing Research and Evaluation 89 Manufacturing and Operations Plan 91 Management Team 92 Timeline 93 Critical Risks and Assumptions 93 Benefits to the Community 93 Exit Strategy 94 Financial Plan 94 Appendix 99 Review Process 99 Business Plan Mistakes 99 MANAGER ’S NOTES : Good, Bad, and Ugly Business Plans 83 MANAGER ’S NOTES : How Does Your Plan Rate? 101 C OMPETITIVE A DVANTAGE: Bring It On 94 REALITY C HECK : Feasible, Viable, Good Idea? 98 Summary 103 Questions for Review and Discussion 103 Questions for Critical Thinking 103 What Would You Do? 103 Chapter Closing Case 104

PA RT 3

Early Decisions 107

CHAPTER 5

Franchising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 About Franchising 109 Background 109 Franchising Today 110 Franchising Systems 110 Product-Distribution Franchising 111 Business-Format Franchising 111 Why Open a Franchise? 111 Advantages to Franchisee 112 Disadvantages to Franchisee 113 Advantages to Franchisor 115 Disadvantages to Franchisor 116 Selecting a Franchise 117 Evaluate Your Needs 117 Do Your Research 117 Analyze the Market 121 Disclosure Statements 121 The Franchise Agreement 124 Get Professional Advice 126 International Franchising 126 MANAGER ’S NOTES : Just the Facts … 110 C OMPETITIVE A DVANTAGE: Franchise—Failed! 125 REALITY C HECK : Go to the Source 120 Summary 127 Questions for Review and Discussion 128 Questions for Critical Thinking 128

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What Would You Do? 128 Chapter Closing Case 129 CHAPTER 6

Taking Over an Existing Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 Business-Buyout Alternative 132 Advantages of Buying a Business 133 Disadvantages of Buying a Business 134 How Do You Find a Business for Sale? 135 What Do You Look for in a Business? 136 Due Diligence 137 General Considerations 138 Why Is the Business Being Sold? 138 Financial Condition 139 What Are You Buying? 141 Tangible Assets 141 Intangible Assets 143 Personnel 144 The Seller’s Personal Plans 144 How Much Should You Pay? 145 What Are the Tangible Assets Worth? 146 What Are the Intangible Assets Worth? 146 Buying the Business 148 Terms of Sale 148 Closing the Deal 148 Taking Over a Family Business 149 What Is Different about Family Businesses? 150 Complex Interrelationships 150 Planning Succession 150 General Family Business Policies 151 E NTREPRENEURIAL SNAPSHOT : Their Family Business Tree Is a Sequoia 149 MANAGER ’ S NOTES: Show and Don’t Tell 140 MANAGER ’ S NOTES: What’s It Really Worth? 143 C OMPETITIVE A DVANTAGE: In the Box—Negotiating Strategies 133 Summary 152 Questions for Review and Discussion 153 Questions for Critical Thinking 153 What Would You Do? 153 Chapter Closing Case 154 CHAPTER 7

Starting a New Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156 About Start-ups 157 Advantages of Starting from Scratch 158 Disadvantages of Starting from Scratch 158 Types of New Businesses 158 E-Businesses 159 Home-Based Businesses 160 Starting a Business on the Side 161 Fast-Growth Start-ups 162

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Evaluating Potential Start-ups 162 Business Ideas 162 Where Business Ideas Come From 166 Getting Started 168 What Do You Do First? 168 Importance of Planning to a Start-up 169 How Will You Compete? 171 Customer Service 173 Licenses, Permits, and Regulations 173 Taxes 173 E NTREPRENEURIAL S NAPSHOT : Über Inventor—Old School 172 C OMPETITIVE A DVANTAGE: Creative Release 168 REALITY C HECK : Quotable Quotes 164 REALITY C HECK : Urban Survival Shoes 169 Summary 174 Questions for Review and Discussion 175 Questions for Critical Thinking 175 What Would You Do? 175 Chapter Closing Case 176

PA RT 4

Financial and Legal Management 179

CHAPTER 8

Accounting Records and Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180 Small Business Accounting 182 How Important Are Financial Records? 183 Accurate Information for Management 183 Banking and Tax Requirements 184 Small Business Accounting Basics 184 Double- and Single-Entry Systems 184 Accounting Equations 187 Cash and Accrual Methods of Accounting 188 What Accounting Records Do You Need? 188 Using Financial Statements to Run Your Small Business 193 Analyzing Financial Statements 193 Ratio Analysis 194 Using Financial Ratios 194 Liquidity Ratios 196 Activity Ratios 196 Leverage Ratios 198 Profitability Ratios 199 Managing Cash Flow 201 Cash Flow Defined 201 Cash Flow Fundamentals 201 Cash Flow Management Tools 203 Strategies for Cash Flow Management 205 MANAGER ’S NOTES : Ask … 184 MANAGER ’S NOTES : Small Business Dashboard 185 C OMPETITIVE A DVANTAGE: Open-Book Management 203 REALITY C HECK : Do You Have a Business or a Hobby? 194 Summary 208 Questions for Review and Discussion 209

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Contents

Questions for Critical Thinking 209 What Would You Do? 209 Chapter Closing Case 211 CHAPTER 9

Small Business Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 Small Business Finance 214 Initial Capital Requirements 215 Defining Required Assets 215 The Five “Cs” of Credit 216 Additional Considerations 219 Basic Financial Vocabulary 219 Forms of Capital: Debt and Equity 219 Other Loan Terminology 223 How Can You Find Capital? 223 Loan Application Process 223 Sources of Debt Financing 223 What if a Lender Says “No”? 229 Sources of Equity Financing 229 Choosing a Lender or Investor 234 E NTREPRENEURIAL SNAPSHOT : Brodsky Says … 234 MANAGER ’ S NOTES: Banker Talk 225 REALITY C HECK : Recession Proof Your Small Business 218 REALITY C HECK : Credit Card Start-up Funding—Really?? 230 Summary 236 Questions for Review and Discussion 236 Questions for Critical Thinking 236 What Would You Do? 236 Chapter Closing Case 237 CHAPTER 10

The Legal Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239 Small Business and the Law 240 Laws to Promote Fair Business Competition 241 Laws to Protect Consumers 241 Laws to Protect People in the Workplace 241 Licenses, Restrictions, and Permits 248 Bankruptcy Laws 249 Chapter 7 Bankruptcy 249 Chapter 11 Bankruptcy 250 Chapter 13 Bankruptcy 250 Contract Law for Small Businesses 251 Elements of a Contract 251 Contractual Obligations 251 Laws to Protect Intellectual Property 253 Patents 253 Copyrights 256 Trademarks 257 Global Protection of Intellectual Property 258 MANAGER ’ S NOTES: Legal Answers 252 MANAGER ’ S NOTES: Keeping Your Trademark in Shape 257

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REALITY C HECK : Who Can You Trust? 243 REALITY C HECK : Protect Your App? 254 Summary 258 Questions for Review and Discussion 259 Questions for Critical Thinking 259 What Would You Do? 259 Chapter Closing Case 260

PA RT 5

Marketing the Product or Service 263

CHAPTER 11

Small Business Marketing: Strategy and Research . . . . . . . . . . . . . . . . . . . . . . . . . . . 264 Small Business Marketing 265 Marketing Concept 266 Of Purple Cows 266 Marketing Strategies for Small Businesses 267 Setting Marketing Objectives 267 Developing a Sales Forecast 267 Identifying Target Markets 269 Understanding Consumer Behavior 272 Market Research 275 Market Research Process 276 Limitations of Market Research 280 E NTREPRENEURIAL S NAPSHOT : It Tastes Like What?! 268 C OMPETITIVE A DVANTAGE: Sometimes the Best Marketing Strategy Is a Good Defense 270 REALITY C HECK : SEO—Search Engine Optimization 273 Summary 281 Questions for Review and Discussion 281 Questions for Critical Thinking 282 What Would You Do? 282 Chapter Closing Case 282 CHAPTER 12

Small Business Marketing: Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 284 Using Your Marketing Mix 285 Product: The Heart of the Marketing Mix 285 Developing New Products 286 Inventor’s Paradox 289 Importance of Product Competitive Advantage 291 Packaging 292 Purchasing for Small Business 292 Purchasing Guidelines 292 Purchasing Basics 293 Selecting Suppliers 294 Make-or-Buy Decision 294 Investigating Potential Suppliers 294 Managing Inventory 295 How Much Inventory Do You Need? 295 Costs of Carrying Inventory 298

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Controlling Inventory 299 Reorder Point and Quantity 299 Visual Control 300 Economic Order Quantity 300 ABC Classification 301 Electronic Data Interchange 302 Just-in-Time 303 Materials Requirements Planning 304 E NTREPRENEURIAL SNAPSHOT : Marketing Kings of Furniture 288 REALITY C HECK : The Fairness of Slotting Fees 290 REALITY C HECK : Money on the Shelf 298 Summary 304 Questions for Review and Discussion 305 Questions for Critical Thinking 305 What Would You Do? 306 Chapter Closing Case 306 CHAPTER 13

Small Business Marketing: Place . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308 Small Business Distribution 309 Location for the Long Run 311 State Selection 314 City Selection 316 Site Selection 318 Site Questions 318 Traffic Flow 320 Going Global 320 Location Types 321 Central Business Districts 321 Shopping Centers 322 Stand-Alone Locations 323 Service Locations 323 Incubators 323 Layout and Design 324 Legal Requirements 325 Retail Layouts 325 Service Layouts 326 Manufacturing Layouts 327 Home Office 329 Advantages 329 Disadvantages 330 Lease, Buy, or Build? 330 Leasing 330 Purchasing 332 Building 332 E NTREPRENEURIAL SNAPSHOT : Buck Stops in Idaho 312 MANAGER ’ S NOTES: GIS—Improving Decision Making 319 REALITY C HECK : Incubation Innovation 324 REALITY C HECK : Is It Time to Move? 333 Summary 333 Questions for Review and Discussion 334

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Questions for Critical Thinking 335 What Would You Do? 335 Chapter Closing Case 336 CHAPTER 14

Small Business Marketing: Price and Promotion . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337 The Economics of Pricing 338 Competition 339 Demand 341 Costs 343 Breakeven Analysis 343 Pricing-Setting Techniques 346 Customer-Oriented Pricing Strategies 348 Internal-Oriented Pricing Strategies 349 Creativity in Pricing 351 Credit Policies 351 Extending Credit to Your Customers 353 Collecting Overdue Accounts 354 Promotion 355 Advertising 356 Personal Selling 361 Public Relations 362 Sales Promotions 363 Promotional Mix 364 MANAGER ’S NOTES : Customers—Your Key to Sales 350 C OMPETITIVE A DVANTAGE: Guppy in a Shark Tank: Small Business, Big Trade Shows 357 REALITY C HECK : Even in a Recession, Don’t Give Away the Farm 342 REALITY C HECK : What Price Is Too Low … or Too High? 347 Summary 364 Questions for Review and Discussion 365 Questions for Critical Thinking 365 What Would You Do? 365 Chapter Closing Case 366

PA RT 6

Managing Small Business 369

CHAPTER 15

International Small Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370 Preparing to Go International 371 Growth of Small Business 372 International Business Plan 372 Take the Global Test 373 Establishing Business in Another Country 374 Exporting 375 Importing 375 International Licensing 375 International Joint Ventures and Strategic Alliances 375 Direct Investment 377 Exporting 379 Indirect Exporting 379

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Direct Exporting 382 Identifying Potential Export Markets 382 Importing 385 Financial Mechanisms for Going International 385 International Finance 386 Managing International Accounts 386 Countertrade and Barter 387 Information Assistance 388 The International Challenge 388 Understanding Other Cultures 388 International Trading Regions 392 ISO 9000 395 ENTREPRENEURIAL SNAPSHOT : Tony and Maureen Wheeler 378 MANAGER ’ S NOTES: Always a Handshake and a Smile, Right? 392 C OMPETITIVE A DVANTAGE: Outsourcing—Key Factors for Success 376 REALITY C HECK : China—Here We Come … or Not 380 Summary 395 Questions for Review and Discussion 396 Questions for Critical Thinking 396 What Would You Do? 397 Chapter Closing Case 397 CHAPTER 16

Professional Small Business Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 399 Managing Small Business 400 Four Functions of Management 401 What Managers Do 401 Small Business Growth 403 Your Growing Firm 404 Transition to Professional Management 406 The Next Step: An Exit Strategy 406 Leadership in Action 409 Leadership Attributes 410 Negotiation 413 Delegation 414 Motivating Employees 414 Can You Motivate without Using Money? 417 Employee Theft 419 Special Management Concerns: Time and Stress Management 419 Time Management 419 Stress Management 421 MANAGER ’ S NOTES: Help Me, Help Me, Help Me 402 MANAGER ’ S NOTES: Entrepreneurial Evolution 412 C OMPETITIVE A DVANTAGE: More Hours in Your Day 420 REALITY C HECK : Leadership Tips 411 REALITY C HECK : Motivate More with Less 418 Summary 423 Questions for Review and Discussion 423 Questions for Critical Thinking 424 What Would You Do? 424 Chapter Closing Case 424

Contents

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CHAPTER 17

Human Resource Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 426 Hiring the Right Employees 427 Job Analysis 428 Job Description 429 Job Specifications 430 Employee Recruitment 430 Advertising for Employees 430 Employment Agencies 430 Internet Job Sites 431 Executive Recruiters (Headhunters) 432 Employee Referrals 432 Relatives and Friends 432 Other Sources 433 Selecting Employees 434 Application Forms and Résumés 434 Interviewing 434 Testing 437 Temporary Employees and Professional Employer Organizations (PEOs) 439 Placing and Training Employees 440 Employee Training and Development 441 Ways to Train 441 Compensating Employees 443 Determining Wage Rates 443 Incentive-Pay Programs 444 Benefits 446 When Problems Arise: Employee Discipline and Termination 450 Disciplinary Measures 450 Dismissing Employees 453 E NTREPRENEURIAL S NAPSHOT : Cooking up a Cause 445 MANAGER ’S NOTES : Finding the Right One 428 MANAGER ’S NOTES : Don’t Even Ask! 435 MANAGER ’S NOTES : Sixty-Second Guide to Hiring the Right Employee 442 C OMPETITIVE A DVANTAGE: Perks That Small Businesses Can Afford 450 REALITY C HECK : Working with Gen Yers 432 REALITY C HECK : We Need to Talk … 454 Summary 455 Questions for Review and Discussion 456 Questions for Critical Thinking 456 What Would You Do? 457 Chapter Closing Case 457 CHAPTER 18

Operations Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459 Elements of an Operating System 461 Inputs 461 Transformation Processes 461 Outputs 461 Control Systems 462 Feedback 463

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Types of Operations Management 463 Operations Management for Manufacturing Businesses 463 Operations Management for Service Businesses 464 What Is Productivity? 464 Ways to Measure Manufacturing Productivity 465 Ways to Measure Service Productivity 466 What about Scheduling Operations? 467 Scheduling Methods 467 Routing 468 Sequencing 470 Dispatching 470 Quality-Centered Management 470 Six Sigma in Small Business 470 Quality Circles 472 How Do You Control Operations? 473 Feedforward Quality Control 473 Concurrent Quality Control 473 Feedback Quality Control 476 MANAGER ’ S NOTES: Six Sigma Online 473 C OMPETITIVE A DVANTAGE: So How Do I Increase Productivity? 468 REALITY C HECK : How Good Is Good Enough? 469 REALITY C HECK : Six Sigma: Beyond Manufacturing 474 Summary 477 Questions for Review and Discussion 477 Questions for Critical Thinking 478 What Would You Do? 478 Chapter Closing Case 478 Notes 480 Index 491

Preface Are you thinking about starting your own business some day? For many students, preparation for small business ownership begins with a course in small business management. My goal as a teacher (and the purpose of this text) is to help students fulfill their dreams of becoming entrepreneurs and achieving the independence that comes with small business success. The theme of this book revolves around creating and maintaining a sustainable competitive advantage in a small business. Running a small business is difficult in today’s rapidly evolving environment. At no other time has it been so important for businesses to hold a competitive advantage. Every chapter in this book can be used to create your competitive advantage—whether it be your idea, your product, your location, or your marketing plan. Running a small business is like being in a race with no finish line. You must continually strive to satisfy the changing wants and needs of your customers. This book can help you run your best race. The writing style is personal and conversational. I have tried to avoid excessive use of jargon by explaining topics in simple, understandable language. The book is written in the first person, present tense, because I, the author, am speaking directly to you, the student. I believe that a good example can help make even the most complex concept more understandable and interesting to read. To strengthen the flow of the material and reinforce important points, examples have been carefully selected from the business press and small business owners I have known.

New to This Edition In preparing this fifth edition, I incorporated suggestions from teachers and students who used the previous edition. In addition, an advisory board of educators from around the country helped me determine the best ways to meet the needs of students in this course. Here are some of the changes that have been made in this edition: •

© Carlos Hernandez/STOCK4B, Getty Images

•

•

•

Since small business management courses are so application oriented, special attention has been paid to the end-of-chapter cases—15 of which are brand new. The actual small business owner’s decision and expert commentary are included in the instructor material. Topics critical to small business have been added or updated. For example, since the economic recession has lingered like an unwanted houseguest, multiple boxes and examples have been included on running a small business in times of economic downturn. Speaking of highlight boxes, they are great for focusing attention, but we understand that there should not be too many of them, nor should they be too long. The best examples of small business practices have been presented in chapter-opening vignettes and feature boxes, then discussed further in the body of the text. Of the 68 highlight boxes, 57 are brand new, and the 11 others have been updated. Of the 18 chapter openers, all 18 are brand new. Every effort has been made to prevent “new edition bloat.” Attention has been paid to items to delete and not just to add in order to stay current and streamlined. xvii

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Highlight Feature Boxes To highlight important issues in small business management, four types of boxed features are used: Entrepreneurial Snapshot, Manager’s Notes, Reality Check, and Competitive Advantage: Innovation and Sustainability. In this edition, the number of boxes was reduced to avoid reader confusion, and the length of boxes was shortened to hold the reader’s attention. (Believe it or not, a rumor exists that some students actually skip reading these highlight boxes. Of course, you would never do this, as you would miss some of the juiciest stories.) Here are some examples of each type of highlight box: Entrepreneurial Snapshot New to this fifth edition, these boxes reveal fascinating behind-the-scenes stories of people who have created some very interesting businesses. Examples include: • • • • • • •

Kevin Plank, creator of Under Armour Tom Szaky, founder of TerraCycle Thomas Edison, über inventor Norm Brodsky, entrepreneur of multiple businesses and Inc. magazine columnist Eliot and Barry Tattleman, of Jordan’s Furniture Chuck & C. J. Buck, of Buck Knives Lorena Garcia, Big Chef Little Chef

Competitive Advantage: Innovation and Sustainability One of the most important (if not the most important) things you create in your small business is your competitive advantage—the factor that you manage better than everyone else. There are many ways to create a competitive advantage, and these boxes point out some of the most interesting: • • • • • •

Competitive Intelligence Creative Release Negotiation Fine Points Economic Action Downturn Guppy in a Shark Tank: Small Business, Big Trade Shows Perks That Small Businesses Can Afford

Manager’s Notes These features include specific tips, tactics, and actions used by successful small business owners: • • • • • • • • • • •

Small Business Readiness Assessment Business Plan Competition Tips Franchise Facts Business Valuation Letter of Confidentiality Small Business Dashboards—Computerized Accounting Packages Ask Your Banker Keep Your Trademark in Shape Making Decisions with GIS Sixty-Second Guide to Hiring Firing an Employee

Reality Check These real-world stories come from streetwise business practitioners who know how it’s done and are willing to share the secrets of their success: • • •

College Students as Entrepreneurs Green Is Gold Feasibility Study

Preface

• • • • • • • • • • •

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Do You Have a Business or Hobby? Open-Book Management Urban Survival Shoes Recession Proof Your Small Business Slotting Fees: Unfair for Small Businesses? Credit Card Startup Funding Incubation Innovation Search Engine Optimization Even in a Recession—Don’t Give Away the Farm China—Here We Come … or Not Working with Gen Yers

Effective Pedagogical Aids The pedagogical features of this book are designed to complement, supplement, and reinforce material from the body of the text. The following features enhance critical thinking and show practical small business applications: • • • • • • •

Chapter opening vignettes, Reality Checks, and extensive use of examples throughout the book show you what real small businesses are doing. Each chapter begins with Learning Objectives, which directly correlate to the chapter topic headings and coverage. These same objectives are then revisited and identified in each Chapter Summary. A running glossary in the margin brings attention to important terms as they appear in the text. Questions for Review and Discussion allow you to assess your retention and comprehension of the chapter concepts. Questions for Critical Thinking prompt you to apply what you have learned to realistic situations. End-of-chapter What Would You Do? exercises are included to stimulate effective problem solving and classroom discussion. Chapter Closing Cases present actual business scenarios, allowing you to think critically about the management challenges presented and to further apply chapter concepts.

Complete Package of Support Materials This edition of Small Business Management provides a support package that will encourage student success and increase instructor effectiveness. Instructor’s Resource CD-ROM This instructor’s CD provides a variety of teaching resources in electronic format, allowing for easy customization to meet specific instructional needs. Files include Lecture PowerPoint slides, Premium PowerPoint slides with supplementary content, Word and PDF files from the Instructor’s Manual, and the Test Bank Word files, along with ExamView, the computerized version of the Test Bank. The comprehensive Instructor’s Resource Manual includes teaching tips for each chapter, additional activities and supplemental content, lecture outlines with special teaching notes, suggested answers to end-of-chapter Questions for Review and Discussion and Questions for Critical Thinking, and comments on the What Would You Do? exercises and the closing case and case questions. A Video Guide is also included at the end of the manual.

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The Test Bank provides true/false, multiple-choice, mini-case, and essay questions, along with an answer key that includes the learning objective covered and text page references. ExamView, a computerized version of the Test Bank, provides instructors with all the tools they need to create, author/edit, customize, and deliver multiple types of tests. Instructors can import questions directly from the test bank, create their own questions, or edit existing questions. CourseMate This new and unique online Web site makes course concepts come alive with interactive learning, study, and exam preparation tools supporting the printed text. CourseMate delivers what students need, including an interactive eBook, dynamic flashcards, interactive quizzes and video exercises, student PowerPoints, and games that test knowledge in a fun way. • • •

Engagement Tracker, a first-of-its-kind tool, monitors individual or group student engagement, progress, and comprehension in your course. Interactive video exercises allow students to relate the real-world events and issues shown in the chapter videos to specific in-text concepts. Interactive quizzes reinforce the text with rejoinders that refer back to the section of the chapter where the concept is discussed.

Instructor Companion Site The Instructor Companion Site can be found at http:// login.cengage.com. It includes a complete Instructor Manual, Word files from both the Instructor Manual and Test Bank, and PowerPoint slides for easy downloading. Student Companion Site The Student Companion Site includes interactive quizzes, a glossary, crossword puzzles, and sample student business plans. It can be found at www.cengagebrain.com. At the home page, students can use the search box at the top of the page to insert the ISBN of the title (from the back cover of their book). This will take them to the product page, where free companion resources can be found. DVD This diverse collection of professionally produced videos can help instructors bring lectures to life by providing thought-provoking insights into real-world companies, products, and issues.

Acknowledgments There are so many people to thank—some who made this book possible, some who made it better. Projects of this magnitude do not happen in a vacuum. Even though my name is on the cover, a lot of talented people contributed their knowledge and skills. George Hoffman, Lynn Guza, Natalie Anderson, and Ellin Derrick all played key roles in the book’s history. Michele Rhoades has been visionary and insightful as the acquisitions editor in bringing this book into the Cengage list. I am so fortunate to have been reunited with Joanne Dauksewicz as my patient, nurturing development editor— she is fabulous. Emily Nesheim, content project manager, and Devanand Srinivasan, senior project manager, were wonderful in coordinating the production process. There are many other people whose names I unfortunately do not know who worked their magic in helping to make the beautiful book you hold in your hands, and I sincerely thank them all. Of course, the entire group of Cengage sales reps will have a major impact on the success of this book. I appreciate all of their efforts. Thanks to Morgan Bridge and other faculty contributors. I am especially grateful to Professor Amit Shah, Frostburg State University, for his help with the electronic ancillary program. I would also like to thank the many colleagues

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who have reviewed this text and provided feedback concerning their needs and their students’ needs: Tim Allwine, Lower Columbia College Allen C. Amason, University of Georgia Godwin Ariguzo, University of Massachusetts–Dartmouth Walter H. Beck Sr., Reinhardt College Joseph Bell, University of Arkansas at Little Rock Rudy Butler, Trenton State College J. Stephen Childers Jr., Radford University Michael Cicero, Highline Community College John Cipolla, Lynn University Richard Cuba, University of Baltimore Gary M. Donnelly, Casper College Peter Eimer, D’Youville College Vena Garrett, Orange Coast College Arlen Gastinau, Valencia Community College West Caroline Glackin, Delaware State University Doug Hamilton, Berkeley College of Business Gerald Hollier, University of Texas at Brownsville David Hudson, Spalding University Philip G. Kearney, Niagara County Community College Paul Keaton, University of Wisconsin–La Crosse Mary Beth Klinger, College of Southern Maryland Paul Lamberson, University of Southern Mississippi–Hattiesburg MaryLou Lockerby, College of Dupage–Glen Ellyn Anthony S. Marshall, Columbia College Carl McClain, Palomar College Norman D. McElvany, Johnson State College Milton Miller, Carteret Community College–Morehead City Bill Motz, Lansing Community College Suzy Murray, Piedmont Technical College James C. Nicholas, University of Bridgeport Grantley E. Nurse, Raritan Valley Community College Cliff Olson, Southern Adventist University Roger A. Pae, Cuyahoga Community College Nancy Payne, College of Dupage–Glen Ellyn Michael Pitts, Virginia Commonwealth University Julia Truitt Poynter, Transylvania University George B. Roorbach, Lyndon State College

Preface

Marty St. John, Westmoreland County College Joe Salamone, SUNY Buffalo Tom Sgritta, University of North Carolina, Charlotte Gary Shields, Wayne State University Pradip Shukla, Chapman University Joseph Simon, Caspar College Bernard Skown, Stevens Institute of Technology William Soukoup, University of San Diego David Steck, Hillsborough Community College Jim Steele, Chattanooga State Technical Community College Ray Sumners, Westwood College of Technology Sharon A. Taylor, Colorado Community Colleges Online Charles Tofloy, George Washington University Jon Tomlinson, University of Northwestern Ohio Barrry Van Hook, Arizona State University Mike Wakefield, Colorado State University–Pueblo Warren Weber, California Polytechnic State University John Withey, Indiana University Alan Zieber, Portland State University Finally, my family: Saying thanks and giving acknowledgment to my family members is not enough, given the patience, sacrifice, and inspiration they have provided. My wife, Jill; daughters, Paige and Brittany; and son, Taylor, are the best. The perseverance and work ethic needed for a job of this magnitude were instilled in me by my father, Drexel, and mother, Marjorie—now gone but never forgotten. Timothy S. Hatten

About the Author Timothy S. Hatten is a professor at Mesa State College in Grand Junction, Colorado, where he has served as the chair of business administration and director of the MBA program. He is currently codirector of the Entrepreneurial Business Institute. He received his PhD from the University of Missouri–Columbia, his MS from Central Missouri State University, and his BA from Western State College in Gunnison, Colorado. He is a Fulbright Scholar. He taught small business management and entrepreneurship at Reykjavik University in Iceland and business planning at the Russian-American Business Center in Magadan, Russia. Dr. Hatten has been passionate about small and family businesses his whole life. He grew up with the family-owned International Harvester farm equipment dealership in Bethany, Missouri, which his father started. Later, he owned and managed a Chevrolet/Buick/Cadillac dealership with his father, Drexel, and brother, Gary. Since entering academia, Dr. Hatten has actively brought students and small businesses together through the Small Business Institute Courtesy of Tim Hatten

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program. He counsels and leads small business seminars through the Business Incubation Center in Grand Junction, Colorado. He approached writing this textbook as if it were a small business. His intent was to make a product (in this case, a book) that would benefit his customers (students and faculty). Dr. Hatten is fortunate to live on the Western Slope of Colorado, where he has the opportunity to share his love of the mountains with his family. Please send questions, comments, and suggestions to [email protected].

© Jakob Helbig/Getty Images

PART 1

The Challenge

Chapter 1

Small Business: An Overview Chapter 2

Small Business Management, Entrepreneurship, and Ownership When most people think of American business, corporate giants like General Motors, IBM, and Walmart generally come to mind first. There is no question that the companies that make up the Fortune 500 control vast resources, products, and services that set world standards and employ many people. But as you will discover in these first two chapters, small businesses and the entrepreneurs who start them play a vital role in the American economy. Chapter 1 illustrates the economic and social impact of small businesses. Chapter 2 discusses the process and factors related to entrepreneurship.

1 Small Business: An Overview

CHAPTER LEARNING OUTCOMES After reading this chapter, you should be able to: 1. Describe the characteristics of small business. 2. Recognize the role of small business in the U.S. economy. 3. Understand the importance of diversity in the marketplace and the workplace. 4. Identify some of the opportunities available to small businesses. 5. Suggest ways to court success in a small business venture. 6. Name the most common causes of small business failure.

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ntrepreneurs are people who often think big…they occasionally end up making a change in the world…and they usually have a lot of confidence. Elon Musk is a guy who does all of the above—and he’s still in his thirties. Musk is co-founder and chairman of Tesla Motors, maker of the world’s only pure electric, high-performance cars. Most alternative fuel vehicles are thought of as being both style and performance challenged. Not the Tesla. The initial model, a two-seater roadster, goes from zero to 60 miles per hour in a screaming 3.7 seconds while producing zero emissions. It also sports a very cool carbon-fiber body and will travel over 300 miles between charges. The four-door family-oriented model still goes from zero to 60 in 5.7 seconds. Not bad for a grocery hauler. In addition to Tesla Motors, Musk is chief technology officer for SpaceX, one of the most advanced private companies building rockets for space transportation—ultimately aiming to establish a colony on Mars. The U.S. government takes Musk seriously: as the National Aeronautics and Space Administration (NASA) phases out the space shuttle program, it awarded SpaceX a $1.6 billion contract to haul cargo to the space station. Oh, and by the way, Musk is also building professionalism and efficiency into the home solar energy systems with his company SolarCity. How does a person accomplish so much so young? Musk has always been an entrepreneur. At 12 years of age, growing up in South Africa, Elon created a video game titled Blaster and sold it to a computer magazine for the unheard of sum of $500. Later in life, after graduating with bachelor degrees in finance and physics, he was headed for grad school at Stanford with $2,000, a car, a computer, and no friends in the Bay Area. Instead of getting his PhD, he founded a company called Zip2, which he sold two years later for $307 million in cash to Compaq. Rather than living easy and large on the $22 million in his pocket, Musk looked at the problem of getting paid for transactions online. He created the company PayPal, changing the

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Chapter 1: Small Business: An Overview

way we pay for stuff for Internet purchases, and sold it to eBay a couple of years later for $1.5 billion. Elon Musk is a shining example of a serial entrepreneur (starting business after business) who builds innovative businesses which begin small, grow in size and impact, create much-needed jobs, and change the way we live. His accomplishments earned him the title Automotive Executive of the Year Innovator Award for 2010. Sources: Lee Hawkins, “Tesla’s Long Haul,” The Wall Street Journal, January 12, 2010; Ben Oliver, “CAR Meets the World’s Coolest Geek” CAR, March 5, 2010, 113; John O’Dell, “Tesla Roadster Logs New Record,” www.edmunds.com, October 27, 2009; Max Chafkin, “Entrepreneur of the Year—Elon Musk,” Inc., December 2007, 115–125; Michael Copeland, “Tesla’s Wild Ride,” Fortune, July 21, 2008, 82–94; Ronald Grover, “To the Moon: Elon Musk’s High-Power Visions,” BusinessWeek Online, October 14, 2009, 18; and Dave Guilford, “Tesla’s Tiny—But CEO Is Full of Confidence,” Automotive News, October 21, 2009, 38.

What Is Small Business? As the driver of the free enterprise system, small business generates a great deal of energy, innovation, and profit for millions of Americans. While the names of huge Fortune 500 corporations may be household words pumped into our lives via a multitude of media, small businesses have always been a central part of American life. In his 1835 book Democracy in America, Alexis de Tocqueville commented, “What astonishes me in the United States is not so much the marvellous grandeur of some undertakings as the innumerable multitude of small ones.” If de Tocqueville were alive today, aside from being more than 200 years old, he would probably still be amazed at the contributions made by small businesses. The U.S. Small Business Administration (SBA) Office of Advocacy estimates that there were 26.8 million businesses in the United States in 2006. Census data show that 22 percent of those 26.8 million businesses have employees, and 78 percent do not.1 The IRS estimate may be overstated because one business can own other businesses, but all of the

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Part 1: The Challenge

businesses are nevertheless counted separately. What a great time to be in (and be studying) small business! Check out the following facts. Did you realize that small businesses: • • • • • • • • •

small business A business is generally considered small if it is independently owned, operated, and financed; has fewer than 100 employees; and has relatively little impact on its industry.

Represent more than 99.7 percent of all employers? Employ more than half of all private sector employees? Pay 44 percent of total U.S. private payroll? Created 64 percent of net new jobs over the past 15 years? Represented 97.3 percent of all identified exporters and produced 30.2 percent of the known export value in FY 2007? Produce 13 times more patents per employee than large firms? Create more than 50 percent of private gross domestic product (GDP)? Hire 40 percent of high-tech workers (such as scientists, engineers, and computer programmers)? Are 52 percent home based and 2 percent franchises?2

Small businesses include everything from the stay-at-home parent who provides day care for other children, to the factory worker who makes after-hours deliveries, to the owner of a chain of fast-food restaurants. The 26.8 million businesses identified by the SBA included more than 9 million Americans who operate “sideline” businesses, parttime enterprises that supplement the owner’s income.3 Another 12 million people make owning and operating a small business their primary occupation. Seven million of these business owners employ only themselves—as carpenters, independent sales representatives, freelance writers, and other types of single-person businesses. The U.S. Census Bureau tracks firms by number of employees. These data show that approximately 5.9 million firms hire employees, and 19.5 million firms exist with no employees.4 The firms included in the census figures are those that have a tangible location and claim income on a tax return. Figure 1.1 shows that 61 percent of employer firms (established firms with employees) have fewer than 5 employees. Slightly more than 100,000 businesses have 100 employees or more. Most people are surprised to learn that of the millions of businesses in the United States, only approximately 17,000 businesses have 500 or more workers on their payroll.

Size Definitions The definition of small business depends on the criteria for determining what is “small” and what qualifies as a “business.” The most common criterion used to distinguish

F I G U R E 1- 1

Almost All Established Firms Are Small Businesses

61% 3,670,028 firms

0–4 employees 18% 1,060,787 firms

5–9 employees

11% 646,816 firms

10–19 employees

9% 535,865 firms

20–99 employees

2% 90,560 firms

100–499 employees