What is a Firm?
We can define a firm (company, enterprise) as an organization that
employs productive resources to obtain products and/or services which are
offered in the market with the aim of making a profit. A few keywords in this
definition deserve further attention. First, firms are organizations, but not
all organizations are firms. An organization is a complex social system created
by people to cooperate in the achievement of some goal[1].
For instance, a political party is an organization, but its goal is to
contribute to positively transform society by means of collectively exerting
political power. What distinguishes firms from other organizations is the aim
of obtaining a profit through selling products and services in the market.
Second, firms fulfill the social role of production, transforming resources into finished goods and services. Typically, firms use four different basic types of resources in productive activities:
Third, resources are combined and transformed into final products or services which are, in turn, commercialized in markets to customers who are willing to pay for them. If the firm produces something that customers like, it will certainly be able to set prices that can cover production costs and more. If not, covering costs will be difficult and firm survival will be threatened.
The difference between the revenue raised from selling goods and services and the costs incurred in delivering them is the firms’ profit. If it is positive, it means that the production of the firm is more valuable than the resources employed. In that case, the firm is adding value to those resources. Alternatively, if profit is negative (i.e., a loss) then the firm would be destroying value, since the resources are worth more than the products and services obtained from them.
Value creation is a continuous process in which a large number of interrelated firms take part. We can imagine the vertical chain of an industry as the sequence of stages that must be accomplished from raw materials to product delivery to end customers. For instance, the packaged milk industry is rooted in a vertical chain that is shared with the broader dairy products industry. The chain starts with raw materials such as feedstuffs, pastures and cows that farmers combine with veterinary services, chemicals, and capital goods (machinery and tools) to obtain raw milk, which is collected and transported in refrigerated trucks to processing plants. Here the milk undergoes some processing such as pasteurization, homogenization, vitamin fortification, etc. Then the different varieties of processed milk are packaged into appropriate containers (glass, carton, plastic) and transported to distribution points where it is finally delivered to end customers.
[1] More technically we could say that organizations are artificial and goal-oriented social systems. Artificial because they are created by people and goal-oriented because they have an intended purpose.
Second, firms fulfill the social role of production, transforming resources into finished goods and services. Typically, firms use four different basic types of resources in productive activities:
- Natural resources: taken directly from nature without previous transformation (land, air, water, wood, etc.).
- Capital: funds needed to invest in tools, machinery, equipment, technology.
- Human resources: physical and intellectual capabilities of the workers.
- Entrepreneurship: the innovative ideas that shape the business model.
Third, resources are combined and transformed into final products or services which are, in turn, commercialized in markets to customers who are willing to pay for them. If the firm produces something that customers like, it will certainly be able to set prices that can cover production costs and more. If not, covering costs will be difficult and firm survival will be threatened.
The difference between the revenue raised from selling goods and services and the costs incurred in delivering them is the firms’ profit. If it is positive, it means that the production of the firm is more valuable than the resources employed. In that case, the firm is adding value to those resources. Alternatively, if profit is negative (i.e., a loss) then the firm would be destroying value, since the resources are worth more than the products and services obtained from them.
Value creation is a continuous process in which a large number of interrelated firms take part. We can imagine the vertical chain of an industry as the sequence of stages that must be accomplished from raw materials to product delivery to end customers. For instance, the packaged milk industry is rooted in a vertical chain that is shared with the broader dairy products industry. The chain starts with raw materials such as feedstuffs, pastures and cows that farmers combine with veterinary services, chemicals, and capital goods (machinery and tools) to obtain raw milk, which is collected and transported in refrigerated trucks to processing plants. Here the milk undergoes some processing such as pasteurization, homogenization, vitamin fortification, etc. Then the different varieties of processed milk are packaged into appropriate containers (glass, carton, plastic) and transported to distribution points where it is finally delivered to end customers.
[1] More technically we could say that organizations are artificial and goal-oriented social systems. Artificial because they are created by people and goal-oriented because they have an intended purpose.
