Business Behaviors

Why Can’t Businesses Just Provide What People Need?

Consumers influence the market by demanding what they value. But do producers have equal impact in the market? Are producers at the mercy of consumer demands, or can producers supply whatever they want?

Imagine that a group of people discover an uninhabited frontier and settle down to start a new life there. Consumers exist immediately. People need to consume food to survive, and they need clothing, shelter, and other goods and services right away. Odds are that producers would emerge shortly after because, as we know, trade makes life easier for everyone. Consumers may demand, but without the efforts of the producers, demands are just a wish list.

Read on to explore three concepts that drive business behavior: prices that allow for profit, profit margin, and competition.

Producers are people who own businesses. And just like consumers, they often respond in predictable ways. For producers, the business is their job. It is where they earn income to buy what they need and want. Producers must charge a price sufficient to cover their expenses, with money left over—profits—to reinvest and grow. In other words, businesses exist to make profits. Otherwise, they will ultimately fail. To earn a profit, producers must monitor market conditions and adjust their pricing to adapt. 

Building a Business

Consider this scenario: Teresa was dedicated to drawing in her sketchpad, and her doodles were really good. Friends and family were always looking over her shoulder and asking if they could have the art she was working on. Teresa got the idea to put her drawings on T-shirts and sell them to her friends and family. Soon, she was selling to more and more people, at higher and higher prices. She opened an online store to sell to the public, and eventually she used her art to customize mugs, stickers, and other items. Her business grew, and now she is known as T-Shirt Teresa, with stores in malls across the country selling her doodles.

Teresa is fictional, but her story is real. Across the United States, businesses big and small start with someone passionately pursuing an idea. People make smart, strategic choices about setting a price, using profits, and facing the competition.

Teresa knows that, to be successful, she needs to create value for consumers at acceptable prices. She then must decide to produce even more or invest in growing her business. Business success stems from continually meeting consumer needs and satisfying their wants in creative and innovative ways. 

The desire to earn profits and avoid losses motivates businesses to produce things that consumers need and want. Profits are an incentive for businesses to produce more of their product and to invest more in their business. Losses do the opposite.

Teresa needs to make a profit selling her T-shirts, or she will go out of business. She looks at the total amount of money she makes from sales, called revenue, then subtracts her costs (expenses). The money left over is profit. If no money is left over and she owes money, that’s a loss. Meanwhile, the hope of bigger profits motivates her to continue to grow her company. 

Let’s start with a simple example. When Teresa first started selling T-shirts, she spent $40 from her savings to buy five plain shirts and art supplies. Then she sold five shirts with her artwork on them for $15 each. Did Teresa make a profit? Here’s how to find out:

Now, let’s look at the cost part of the equation. What is cost? The total cost of production is the sum of what has to be paid to use all the resources required to run a business.

Because revenue is the number of items sold multiplied by the price, you can increase revenue by selling more, raising the price, or both.

To increase profits, businesses must increase revenue or cut costs, or both. Fluctuations in the prices of goods, services, and resources inform businesses what customers want, when they want it, and who they want it from. 

Finding the price that allows for a profit is not the only factor that motivates (influences) business behavior, of course. Many factors affect business decisions: concerns about quality of life, changes in market conditions for resources, business competition, government policy, and others factors must all be considered. 

Profit Margins 

Profit margins also affect business behavior. And what affects the business usually has a direct effect on the consumer. Here’s how that works.

To invest or borrow, businesses need to know their profit margin: how much they’re making for each dollar they spend on costs. Or, put another way, business owners (and their creditors) like to determine their profit as a percentage of total sales. To calculate this percentage, they divide the amount of profit by total sales (or revenue). 

For example, if a business has $1,000 in profit and its total sales (or revenue) are $10,000, the percentage of profit is 10 percent. This is the profit margin. 

0.10 OR 10% (profit margin) = $1,000 (profit) ÷ $10,000 (revenue) 

Healthy Profits

Higher profit margins are associated with healthy profits. Healthy profits tell us something about the person running the business. If the profits are healthy, that indicates the businessperson is able to keep abreast of the changing conditions on the producer and consumer sides of the equation. 

Why is this important? Because lenders like to know what a businessperson’s skills are. It helps them determine if the business owner is a good risk. 

Borrowing to invest is easier when profit margins are high. If the percentage of profit is zero, or negative, the business owner will need to reconsider his or her product’s market worthiness and whether investing through borrowing is unsound. 

Knowing what to expect influences the decisions business owners make about resources they will need to acquire, pricing strategies, discounts to offer, and most other aspects of running a business. 

Is Anything More Important than Profit? 

Business owners base their decisions on many factors and often act on values apart from the price system. For example, business owners may:

• Value customer loyalty more than additional profits.

• Contribute money to charitable causes.

• Prefer to produce one product over another or not produce at all.

• Produce a specific product because it’s convenient.

• Need to factor in government regulations when considering their production chances.

Market Competition: Friend or Foe? 

Price and profit margin are important drivers of business behavior. Is there anything else? Yes. A third factor that drives business behavior is competition, and if it affects businesses, it more than likely affects consumers, too. That means that the competition businesses face will also affect you. 

What if there were no competition? 

Imagine that you own a hamburger restaurant and that you are the only restaurant allowed to operate in a 10-mile zone. Think about being the only option hungry people have in your area, and consider the following: 

• Are prices higher or lower than they would be if another hamburger restaurant was across the street? Why? 

• Do you ask the customers what they want and offer more options or stick with what you want to make? Why? 

• If customers complain, do you reach out and try to satisfy them or do you let them walk away? Why? 

Not always, but generally speaking, when there is no competition and only one choice, prices go up, options go down, and customer service gets worse. Why? Because competition affects business behavior by forcing each business to make itself more appealing than other similar businesses.

In a market system, people everywhere compete for resources and products because those things are scarce, meaning the list of things people want exceeds the supply available. So, businesses compete. Is competition healthy or unhealthy for consumers? For businesses? Let’s investigate.

In a market with hundreds or thousands of sellers competing for the business of consumers, no one business has the power to raise prices or withhold products in the hope of getting higher prices. 

Why is that? Any one of the other businesses can step forward with lower prices or expanded output to get consumers’ business. So, consumers win. Competition for consumers helps keep prices low and innovation high. 

Likewise, consumers compete with each other for the privilege of buying available products at prices that are attractive to businesses. If consumers want something and supply is limited, they will compete with each other for it. They signal their wants to businesses by bidding up prices. 

Consumers also reward businesses for innovation and creativity. New products on the market often command high prices. The high prices catch the attention of other businesses. Then these businesses work hard to find ways to bring the cost of producing the innovative products down to increase profits. When they do, prices fall, making the product more affordable to a larger consuming audience. 

Consider the initial prices of flat-screen TVs, computers, or most electronics. They start very high and are only affordable to a narrow audience. Prices and costs decrease as more and more suppliers produce the items at a lower and lower cost per unit. Once again, competition benefits both consumers and producers.

Competition: Driving Ethical Business Behavior 

In free markets, all producers and consumers are pursuing their own self-interest in a world of scarcity. Competition for scarce resources in a market economy results in consumers turning away from failing, uncooperative, and untrustworthy businesses. Why? Competition gives them many alternatives. 

Adam Smith, the father of modern economics, was also a moral philosopher. In his book, The Wealth of Nations, he claimed that not only is it in the long-run interest of individuals to behave efficiently but also, and possibly more importantly, it is in their self-interest to behave honestly and ethically. Cheating, lying, and failing to deliver result in losses and, possibly, failed business arrangements. 

Businesspeople who are untrustworthy, dishonest, and careless do not gain repeat customers, and they do not build a strongly loyal and broad base of customers, especially in competitive markets. Bad transactions with a business can lead consumers to take their business elsewhere—and to spread the word about the bad behavior. Thus, self-interested businesses are motivated to use resources efficiently and to conduct business honestly and responsibly. 

Ethical Behavior = Profits

Consumers have choices. So, producers have to be careful. Inferior goods and services, poor conduct, and unethical behavior are among the many reasons consumers turn to competitors to do business. Profits will rise among trustworthy and loyal businesses; they will fall for others. Shrinking profits or mounting losses provide businesses with reason to change their ways. 

In extreme cases, when the profit-and-loss system fails, the government can be called in to intervene or take action. For example, most customers never see the back of a restaurant, so an owner might be tempted to cut corners. But the owner knows a government inspector might come by, and that is a strong incentive to keep a healthy and clean environment.