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ENTREPRENEURSHIP: STARTING & OPERATING A SMALL BUSINESS

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ENTREPRENEURSHIP: STARTING & OPERATING A SMALL BUSINESS

Fourth Edition

Steve Mariotti • Caroline Glackin

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Library of Congress Cataloging-in-Publication Data Mariotti, Steve, 1953- Entrepreneurship: starting & operating a small business/Steve Mariotti, Caroline Glackin.—Fourth Edition. pages cm Includes index. ISBN 978-0-13-393445-8—ISBN 0-13-393445-4 1. New business enterprises—Management. 2. Entrepreneurship. I. Glackin, Caroline. II. Title. HD62.5.M3567 2015 658.1’1—dc23

2014032028

10 9 8 7 6 5 4 3 2 1

ISBN 10: 0-13-393445-4 ISBN 13: 978-0-13-393445-8

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Special thanks to Shelby Cullom Davis. Also thanks to Kathryn Davis, Shelby M. C. Davis,

Kimberly La Manna, Abby Moffat, and Diana Davis Spencer.

—Steve Mariotti

To my children, Elise and Spencer, whose support and love are essential parts of this book.

To my parents, Howard and Maria Wiedenman, who truly understood the importance of education. My love and gratitude.

—Caroline Glackin

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Brief Contents

UNIT 1 Entrepreneurial Pathways 1 Chapter 1 Entrepreneurs Recognize

Opportunities 2 Chapter 2 The Business Plan: Road Map

to Success 34 Honest Tea Business Plan 65

Chapter 3 Creating Business from Opportunity 92

Unit 1 Entrepreneurial Pathways: SPANX—Idea to Entrepreneurial Opportunity 123

UNIT 2 Integrated Marketing 127 Chapter 4 Exploring Your Market 128 Chapter 5 Developing the Right Marketing

Mix and Plan 156 Chapter 6 Smart Selling and Effective

Customer Service 196 Unit 2 Integrated Marketing:

Kitchen Arts & Letters, Inc.—An Independent Bookstore Defies Industry Odds 219

UNIT 3 Show Me the Money: Finding, Securing, and Managing It 223

Chapter 7 Understanding and Managing Start-Up, Fixed, and Variable Costs 224

Chapter 8 Using Financial Statements to Guide a Business 250

Chapter 9 Cash Flow and Taxes 286 Chapter 10 Financing Strategy & Tactics 316 Unit 3 Show Me the Money: Finding,

Securing, and Managing It— Lee’s Ice Cream 346

UNIT 4 Operating a Small Business Effectively 351

Chapter 11 Addressing Legal Issues and Managing Risk 352

Chapter 12 Operating for Success 384 Chapter 13 Management, Leadership, &

Ethical Practices 416 Unit 4 Operating a Small Business

Effectively: ONLC Training Centers—Virtual IT Training in a Classroom 453

UNIT 5 Cashing in the Brand 457 Chapter 14 Franchising, Licensing,

and Harvesting: Cashing in Your Brand 458

Unit 5 Cashing in the Brand: Honest Tea— From Start-Up to Harvest 477

Appendix 1 Sample Student Business Plan 483 Appendix 2 BizBuilder Business Plan 511 Appendix 3 Resources for Entrepreneurs 519 Appendix 4 Useful Formulas and Equations 525

Glossary 527 Index 533

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UNIT 1 Entrepreneurial Pathways 1

Chapter 1 Entrepreneurs Recognize Opportunities 2 Entrepreneurship 3

What Is an Entrepreneur? 3

The Free-Enterprise System 4

Voluntary Exchange 5

Benefits and Challenges of Free Enterprise 5

What Is a Small Business? 6

Definitions of Success—Monetary and Other 6

Taking the Long View 7

Benefits and Costs of Becoming an Entrepreneur 7

Potential Benefits of Entrepreneurship 8

Potential Costs of Entrepreneurship 9

Cost/Benefit Analysis 10

Opportunity Cost 11

Seeking Advice and Information to Succeed 11

Entrepreneurial Options 13 How Do Entrepreneurs Find Opportunities to Start New Businesses? 15

Entrepreneurs Creatively Exploit Changes in Our World 15

Where Others See Problems, Entrepreneurs Recognize Opportunities 16

Train Your Mind to Recognize Business Opportunities 16

Entrepreneurs Use Their Imaginations 17

An Idea Is Not Necessarily an Opportunity 17

Opportunity Is Situational 18

The Five Roots of Opportunity in the Marketplace 18

Integrating Internal and External Opportunities 18

Establishing Strategies 19

Paths to Small Business Ownership 20 Securing Franchise Rights 21

Buying an Existing Business 21

Licensing Technology 21

The Many Faces of Entrepreneurship 22

Making the Business Work Personally and Professionally 23

A Business Must Make a Profit to Stay in Business 23

Profit Is the Sign That the Entrepreneur Is Adding Value 23

Profit Results from the Entrepreneur’s Choices 23

Seven Rules for Building a Successful Business 24

The Team Approach 24

Chapter 2 The Business Plan: Road Map to Success 34 Feasibility Analysis: Does My Idea Work? 36

Analyzing Product and/or Service Feasibility 36

Analyzing Market and Industry Feasibility 37

Analyzing Financial Feasibility 39

Creating a Business Model Canvas 40 What Is a Business Plan? 43 Why Do You Need a Business Plan? 44

Writing a Business Plan Early Will Save You Time and Money 44

Your Business Plan Is the Key to Raising Capital 45

The Business Plan Is an Operations Guide 45

Business Plan Components 45 Cover Page and Table of Contents 46

Executive Summary: A Snapshot of Your Business 46

Mission and Culture: Your Dreams for the Organization 47

Company Description—Background and Track Record 48

Opportunity Analysis and Research— Testing Ideas 48

Marketing Strategy and Plan: Reaching Customers 49

Management and Operations: Making the Plan Happen 50

Financial Analysis and Projections: Translating Action into Money 51

Funding Request and Exit Strategy: The Ask and the Return 55

Appendices: Making the Case in Greater Detail 56

Contents

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CONTENTS

Business Plan Suggestions 56 Presenting Your Business Plan 57 Business Plan and Venture Competitions 59

Honest Tea Business Plan 65

Chapter 3 Creating Business from Opportunity 92 Apple and the Personal Computer 93 Business Definition 94 What Sort of Organization Do You Want? 95

Your Company’s Core Values 95

Your Company’s Mission Is to Satisfy Customers 96

Your Company’s Vision Is the Broader Perspective 97

Your Company’s Culture Defines the Work Environment 97

The Decision Process 98

Your Competitive Advantage 99 Find Your Competitive Advantage by Determining What Consumers Need and Want 100

You Have Unique Knowledge of Your Market 100

The Six Factors of Competitive Advantage 101

Is Your Competitive Advantage Strong Enough? 101

Checking Out the Competition 102

The Most Chocolate Cake Company 103 Competitive Strategy: Business Definition and Competitive Advantage 105

Feasibility Revisited: The Economics of One Unit as a Litmus Test 106

Defining the Unit of Sale 107

Cost of Goods Sold and Gross Profit 107

Your Business and the Economics of One Unit 108

The Cost of Direct Labor in the EOU— An Example 110

Hiring Others to Make the Unit of Sale 110

Going for Volume 111

Determining the Value of a Business 113

Asset Valuation Method 113

Earnings Valuation Method 113

Cash Flow Valuation Method 114

Unit 1 Entrepreneurial Pathways: SPANX—Idea to Entrepreneurial Opportunity 123

UNIT 2 Integrated Marketing 127

Chapter 4 Exploring Your Market 128 Markets and Marketing Defined 130

A Business That Markets versus a Market-Driven Business 130

Research Prepares You for Success 130 Research Your Market Before You Open Your Business 130

Types and Methods of Research 131

Getting Information Directly from the Source: Primary Research 131

Getting Information Indirectly: Secondary Research 133

Research Helps You Know Your Customer 135

Customer Research 135

Industry Research: The 50,000-Foot Perspective 137

Make Research an Integral Part of Your Business 138

How Customers Decide to Buy 139 Owning a Perception in the Customer’s Mind 140

Features Create Benefits 140

Home Depot: Teaching Customers So They Will Return 141

Which Segment of the Market Will You Target? 141

Successful Segmenting: The Body Shop 142

Applying Market Segmentation Methods 142

The Product Life Cycle 144

Is Your Market Saturated? 146

Market Positioning: Drive Home Your Competitive Advantage 146 Developing a Marketing Plan 147

Chapter 5 Developing the Right Marketing Mix and Plan 156 The Four Marketing Factors 157 Product: What Are You Selling? 158

Create Your Total Product or Service Concept 158

Focus Your Brand 159

Ford’s Costly Failure: The Edsel 159

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CONTENTS

Chapter 6 Smart Selling and Effective Customer Service 196 Selling Skills Are Essential to Business Success 197

Selling Is a Great Source of Market Research 198

The Essence of Selling Is Teaching 198

The Principles of Selling 198

The Sales Call 200 Electronic Mail, Blogs, and Social Networks 200

Prequalify Your Sales Calls 201

Focus on the Customer 201

The Eight-Step Sales Call 202

Three Call Behaviors of Successful Salespeople 203

Analyze Your Sales Calls to Become a Star Salesperson 204

Turning Objections into Advantages 204

Use Technology to Sell 205

Successful Businesses Need Customers Who Return 206

Customer Service Is Keeping Customers Happy 206

The Costs of Losing a Customer 206

Customer Complaints Are Valuable 207

Customer Relationship Management Systems 208

Why Does CRM Matter? 209

Components of CRM for the Small Business 210

How Technology Supports CRM 211

Unit 2 Integrated Marketing: Kitchen Arts & Letters, Inc.—An Independent Bookstore Defies Industry Odds 219

UNIT 3 Show Me the Money: Finding, Securing, and Managing It 223

Chapter 7 Understanding and Managing Start-Up, Fixed, and Variable Costs 224 What Does It Cost to Operate a Business? 225 Start-Up Investment 226

Brainstorm to Avoid Start-Up Surprises 226

Keep a Reserve Equal to One-Half the Start-Up Investment 227

Predict the Payback Period 228

Estimate Value 229

Ford’s Focus on Success: The Mustang 160

How to Build Your Brand 160

Price: What It Says about Your Product 162

Strategies and Tactics for Effective Pricing 162

Place: Location, Location, Location! 164 Key Factors in Deciding on a Location 165

Promotion: Advertising + Publicity 165 Use Integrated Marketing Communications for Success 165

Reinforce the Company’s Unique Selling Proposition 166

Promotional Planning 167 Determine a Promotional Budget 167

The Advertising Advantage 169 Types of Advertising 170

Media Planning and Buying: Focus on Your Customer 170

Marketing Materials Should Reinforce Your Competitive Advantage 171

Sales-Promotion Solutions 172 When to Use Promotional Tools 172

Advertising Specialties 172

Trade Show Exhibits 172

Mall Carts or Kiosks 173

Alternative Marketing 174 Other Media Venues 175

E-Active Marketing 175 Publicity Potential 179

Generating Publicity 179

Telling the Story 179

Sample Press Release 180

Follow Up a Press Release 180

Public Relations 180

The Fifth P: Philanthropy 182 Cause-Related Marketing 182

Gaining Goodwill 183

Not-for-Profit Organizations 183

What Entrepreneurs Have Built 184

You Have Something to Contribute 184

Developing a Marketing Plan 184 Marketing Analysis 185

Marketing as a Fixed Cost 185 Calculate Your Breakeven Point 186

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CONTENTS

Rules to Keep Cash Flowing 289

Noncash Expenses Can Distort the Financial Picture 289

The Working Capital Cycle 289 The Cyclical and Seasonal Nature of Cash Flow 290

Reading a Cash Flow Statement 292

The Cash Flow Equation 292

Forecasting Cash Flow: The Cash Budget 292

Creating a Healthy Cash Flow 293

Managing Inventory to Manage Cash 295

Managing Receivables to Manage Cash 297

The Cash Effects of Accounts Receivable 297

The Life Cycle of Accounts Receivable 297

The Financing of Accounts Receivable 298

Managing Accounts Payable to Manage Cash 299

Negotiating Payment 299

Timing Payables 299

Capital Budgeting and Cash Flow 300 The Burn Rate 301

The Value of Money Changes Over Time 301

The Future Value of Money 301

The Present Value of Money 303

Taxes 304 Cash Flow and Taxes 304

Filing Tax Returns 304

Collecting Sales Tax 305

Tax Issues for Different Legal Structures 305

Make Tax Time Easier by Keeping Good Records 306

Chapter 10 Financing Strategy & Tactics 316 Going It Alone Versus Securing Financing 317

How Often Do Small Businesses Really Fail? 318

What Is the Best Type of Financing for You and Your Business? 318 Gifts and Grants 319 Debt Financing 320

Debt Financing: Pros and Cons 320

Equity Financing 322 Equity Financing: Pros and Cons 323

Fixed and Variable Costs: Essential Building Blocks 230 Calculating Critical Costs 230

Calculating Total Gross Profit (Contribution Margin) 231

Calculating EOU When You Sell Multiple Products 231

Fixed Operating Costs 233

Fixed Operating Costs Do Change Over Time 233

Allocate Fixed Operating Costs Where Possible 234

The Dangers of Fixed Costs 235

Using Accounting Records to Track Fixed and Variable Costs 235

Three Reasons to Keep Good Records Every Day 236

Cash versus Accrual Accounting Methods 238

Recognizing Categories of Costs 239

Chapter 8 Using Financial Statements to Guide a Business 250 Scorecards for the Entrepreneur: What Do Financial Statements Show? 251 Income Statements: Showing Profit and Loss Over Time 252

Parts of an Income Statement 252

A Basic Income Statement 253

The Double Bottom Line 253

An Income Statement for a More Complex Business 254

The Balance Sheet: A Snapshot of Assets, Liabilities, and Equity at a Point in Time 256

Short- and Long-Term Assets 257

Current and Long-Term Liabilities 258

The Balance Sheet Equation 258

The Balance Sheet Shows Assets and Liabilities Obtained through Financing 258

The Balance Sheet Shows How a Business Is Financed 259

Analyzing a Balance Sheet 260

Depreciation 262

Financial Ratio Analysis: What Is It and What Does It Mean to You? 262

Income Statement Ratios 262

Balance-Sheet Analysis 265

Chapter 9 Cash Flow and Taxes 286 Cash Flow: The Lifeblood of a Business 287

The Income Statement Does Not Show Available Cash 288

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xiii CONTENTS

The Uniform Commercial Code (UCC) 364 The Law of Agency 364 Bankruptcy 365 Protecting Intangible Assets: Intellectual Property 367

Trademarks and Service Marks 367

Copyright 369

Electronic Rights 369

Patents 370

Protecting Tangible Assets: Risk Management 371

Insurance Protects Your Business from Disaster 371

Basic Coverage for Small Business 371

How Insurance Companies Make Money 372

Protect Your Computer and Data 373

Disaster Recovery Plans 373

Licenses, Permits, and Certificates 374

Chapter 12 Operating for Success 384 Operations Permit Businesses to Deliver on Their Promises 386 The Production-Distribution Chain 386 Supply Chain Management 387

Finding Suppliers 388

Managing Inventory 388

Facilities, Location and Design 390 Key Factors in Deciding on a Location 391

Facilities Design and Layout 394

Special Considerations for Home-Based Businesses 398

Special Considerations for Web-Based Businesses 398

Defining Quality: It Is a Matter of Market Positioning 399

Profits Follow Quality 399

Organization-Wide Quality Initiatives 400 Benchmarking 400

ISO 9000 401

Six Sigma 402

Total Quality Management 402

Malcolm Baldrige Award 402

Using Technology to Your Advantage 403 Computer Access Is Essential 403

Capture the Potential of the Telephone 404

Identify Market-Specific Software and Technology 404

Electronic Storefront (Web Site) 405

Where and How to Find Capital That Works for You 324

Having an Excellent Business Plan Goes a Long Way 324

How Capital Sources Read Your Business Plan 324

Family and Friends 324

Financial Institutions and Dimensions of Credit 324

Community Development Financial Institutions (CDFIs) 328

Venture Capitalists 329

Angels 330

Insurance Companies 331

Vendor Financing 331

Federally Supported Investment Companies 331

Financing for Rural/Agricultural Businesses 332

Self-Funding: Bootstrap Financing 332

Accessing Sources Through Online Networking 332 Investors Want Their Money to Grow: Can You Make It Happen? 333

How Stocks Work 334

How Bonds Work 335

Unit 3 Show Me the Money: Finding, Securing, and Managing It— Lee’s Ice Cream 346

UNIT 4 Operating a Small Business Effectively 351

Chapter 11 Addressing Legal Issues and Managing Risk 352 Business Legal Structures 353

Sole Proprietorship 353

Partnership 355

Corporation 356

Tips for Entrepreneurs Who Want to Start a Nonprofit Organization 358

Contracts: The Building Blocks of Business 361

Working with an Attorney 361

Drafting a Contract 362

Letter of Agreement 363

Breach of Contract 363

Small Claims Court 363

Arbitration 363

A Contract Is No Substitute for Trust 363

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CONTENTS

UNIT 5 Cashing in the Brand 457

Chapter 14 Franchising, Licensing, and Harvesting: Cashing in Your Brand 458 What Do You Want from Your Business? 459

Continuing the Business for the Family 460

Growth through Diversification 460

Growth through Licensing and Franchising 461

Focus Your Brand 461

When Licensing Can Be Effective 461

Franchising Revisited from the Franchisor Perspective 462

How a McDonald’s Franchise Works 462

Do Your Research before You Franchise 463

Harvesting and Exiting Options 463 When to Harvest Your Business 463

How to Value a Business 464

The Science of Valuation 465

Creating Wealth by Selling a Profitable Business 465

Harvesting Options 466

Exit Strategy Options 468 Investors Will Care about Your Exit Strategy 469

Unit 5 Cashing in the Brand: Honest Tea— From Start-Up to Harvest 477

Appendix 1 Sample Student Business Plan 483 Appendix 2 BizBuilder Business Plan 511 Appendix 3 Resources for Entrepreneurs 519 Appendix 4 Useful Formulas and Equations 525

Glossary 527 Index 533

Chapter 13 Management, Leadership, & Ethical Practices 416 The Entrepreneur as Leader 417

Leadership Styles That Work 417

How Entrepreneurs Pay Themselves 418

Manage Your Time Wisely 419

Business Management: Building a Team 420

What Do Managers Do? 421

Adding Employees to Your Business 421 Growing Your Team 427

Creating and Managing Organizational Culture 428

Determining Organizational Structure 428

Getting the Best Out of Your Employees 430

Human Resources Fundamentals 430 Performance Management 432

Firing and Laying Off Employees 434

Ethical Leadership and Ethical Organizations 434

An Ethical Perspective 435

Establishing Ethical Standards 435

Corporate Ethical Scandals 436

Doing the Right Thing in Addition to Doing Things Right 438

Balancing the Needs of Owners, Customers, and Employees 438

Social Responsibility and Ethics 438 Leading with Integrity and Examples 439

Encourage Your Employees to Be Socially Responsible 439

Unit 4 Operating a Small Business Effectively: ONLC Training Centers—Virtual IT Training in a Classroom 453

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Entrepreneurship: Starting and Operating a Small Business (ESOSB), Fourth Edition, is the newest edition in a line of entrepreneurship textbooks written by Steve Mariotti, founder of the Network for Teaching Entrepreneurship (NFTE). Once again, it is written with professor and entrepreneur Caroline Glackin, and it promotes entrepreneurship as a career option for college students.

Business students, as well as those from other disciplines, can benefit from ESOSB. For business students, it recasts their prior learning from a typical corporate context and focuses it on small and entrepreneurial enterprises. For students in such fields as hospitality, the arts, engineer- ing, and fashion merchandising, the text introduces key business con- cepts and provides examples from a broad range of careers. Cases from hospitality, technology, retail, manufacturing, distribution, real estate, finance, and not-for-profit organizations bring a wealth of learning oppor- tunities. Most importantly, ESOSB 4e is a balanced mix of the academic and applied components of entrepreneurship education. Students are introduced to the theories, methods, and knowledge and skills required of entrepreneurs and are immediately given practical examples and discus- sion opportunities. Using the Application Exercises and Exploring Online features at the end of each chapter, they are encouraged to take this new knowledge and apply it in their own lives, so that the course materials are reinforced and internalized.

Highlights of New Content and Changes Entrepreneurship: Starting and Operating a Small Business, Fourth Edition, contains new content and some changes, including the following:

■ Three new Chapter Openers include Mercedes, University Parent, and inDinero.

■ Nine new short End-of-Chapter Case Studies: Urban Decay, Gat Creek Furniture, Gentle Rest Slumber, Dr. Farrah Gray, Happy Belly Curbside Kitchen, BNI, Gelato Fiasco, The Bun Company, and Anago Cleaning Systems.

■ Seven new longer End-of-Chapter Case Studies: Foursquare, Empact, Amazon.com, Damon White Party Promotions, Airbnb, AYZH, and iContact.

■ All new Unit Cases. These are more interesting and relatable for students and include: Spanx, Kitchen Arts & Letters, Inc., Lee’s Ice Cream, ONLC Training Centers, and Honest Tea.

■ Step into the Shoes, Entrepreneurial Wisdom, BizFacts, and Global Impact Features. These have been updated and expanded with 16 new featured items, including 12 Step into the Shoes and 4 Global Impact Features. Among the newly featured people and organiza- tions are: Indeed.com, In-N-Out Burgers, Sweet dis(Solve), Twitter, ContextMedia, Mental Floss, Zhang Xin, P’Kolino, Jack Threads,

Preface

Helping Students Own Their Future

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PREFACE

Rent the Runway, Tom’s, Vostu, American Public University, and TechWorld These features connect chapter content to business facts and examples to reinforce learning.

■ Honest Tea Featured Business Plan. From its early stage funding search, this example provides students with an interesting start-up plan for a company that is also featured in the Unit 5 case. This bookends the contents of the text.

■ Business Model Canvas. The Osterwalder and Pigneur Business Model Canvas is introduced in Chapter 2 with the example of the University Parent Business Plan that is included in Appendix 1. Students are encouraged to develop a business model and to explore the Lean Startup process.

■ BizBuilder Business Plan Questions. These have been modified to clarify the work and connect the content to student work using the business plan templates.

■ Chapter Learning Objectives. The objectives have been revised to conform more fully to the categories of knowledge acquisition, comprehension, application, analysis, synthesis, and evaluation commonly assessed in higher education.

Combining Street Smarts and Academic Smarts Entrepreneurship: Starting and Operating a Small Business, Fourth Edition, is an extension of the academic programs developed by Steve Mariotti under the auspices of NFTE. Since 1987, NFTE has reached over 500,000 graduates and trained more than 5,000 teachers in 15 countries to impart its innovative entrepreneurship curriculum through its 17 U.S. sites and 8 international program partners. NFTE is widely viewed as a world leader in promoting entrepreneurial literacy and has a proven track record of helping young people start a great variety of successful ventures.

This textbook unites Steve Mariotti’s experience with relevant aca- demic theory and practice, supported by a rich variety of examples and stories. Caroline Glackin brings years of experience in the university class- room, as a lender to small and microbusinesses, and as an entrepreneur and small business owner. Together, these two authors have produced a text that is practical, useful, and academically strong.

Organization Entrepreneurship: Starting and Operating a Small Business, Fourth Edition, is organized to follow the life cycle of an entrepreneurial venture from con- cept through implementation into harvesting or replication. It is a compre- hensive text written in light of the reality that college students often take only one course in entrepreneurship and the topic is covered in a multitude of ways. For instructors who will teach the course as a “business plan,” ESOSB 4e offers step-by-step content to build a plan over a semester or a quarter. For those who focus on the management of small and entrepre- neurial ventures, there is an abundance of high-quality material on the critical topics of management, human resources, marketing, and opera- tions for such ventures. For those charged with teaching a comprehensive introductory course, all of the components are provided.

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Chapter Learning System Chapter Openers Set the Stage

Each chapter starts with an inspirational quote, an introduction, and Learning Objectives that provide a “road map” so readers know where they are headed. Readers connect with a story of a real business in the opening vignette that sets the stage for upcoming material.

Entrepreneurs Recognize Opportunities

CH AP

TE R

1 Learning Objectives 1. Summarize what entrepre-

neurs do.

2. Examine how free-enterprise economies work and how entrepreneurs fit into them.

3. Identify and evaluate opportunities to start your own business.

4. Explain how profit works as a signal to the entrepreneur.

T om Szaky was a 20-year-old college student in need of inspiration for a business plan competition, when he happened to visit friends who were using red worms to compost waste that they then used as plant fertilizer. The idea captured his imagina- tion, and he created a business plan for an environmentally friendly company that would convert trash into fertilizer. Although he finished in fifth place in the competi- tion, Szaky moved ahead to make the company a viable venture. 1