3.1 Business Growth Flashcards
firms
- a firm is a production unit that brings together various factors of production and transforms them into output (goods and services)
reasons why some firms choose to grow
- profits; desire for higher profits so owners / shareholders get a better return
- costs; desire to reduce costs of production by benefitting from economies of scale
- market power; desire for stronger market power and dominance (monopoly) to increase profits
- reducing risk; firms may want to diversify, so if they drop sales in one market, they have another market to generate sales
- managerial motives; senior managers may want to grow so they can control a larger business
reasons why some firms choose to stay small
- lack of finance for expansion
- providing products in a niche market (target specific section of large markets) - smaller market size but can be very profitable as there’s less need for high output
- to avoid diseconomies of scale (when increase in output causes higher costs per unit), which can be caused by rapid growth
- they offer a more personalised service and focus on building relationships with their customers
- owner’s goal is profit satisficing, rather than profit maximising (they’d rather have an acceptable quality of life)
- many small markets operate in mass markets with low barriers to entry
divorce of ownership and control
- the separation between the owners and the managers (appointed to control day-to-day running of the business)
- this gives rise to the principal agent problem
the principal agent problem
- when one group (the agent - managers) make decisions on behalf of another group (the principal - owners), but act in their own interests, rather than those of the principal
- e.g. shareholders and managers may have different, conflicting objectives - shareholders want to maximise their profits but managers want to maximise their salaries
- the issue is enhanced by info gaps, as agents have more info than owners and can control that flow of information
- to try and diminish the problem, principals may grant share options to managers, who will then be more likely to align their interests with those of the owners
public sector organisations
- owned and controlled by the govt.
- their goal is not profit maximisation, but to provide a service, so social welfare may be a priority
- e.g. the NHS
- private sector industries may be ‘nationalised’ to become part of the public sector - e.g. UK railway industry after 1945
- natural monopolies may occur within this sector, e.g. only one firm will provide water as it’s inefficient to have multiple sets of water pipes
- some public sector industries yield strong positive externalities, e.g. using public transport reduces congestion and pollution
private sector organisation
- owned and controlled by private individuals (left to the free market)
- the goal of most is profit maximisation
- free market economists argue that private sector firms give profit incentives which increases efficiency with higher levels of productivity, which increases economic welfare
- e.g. British Airways
profit organisations
- most firms aim to make profits for the owners so they don’t go out of business (even if their goal isn’t to maximise profits)
not-for-profit organisations
- they aim to maximise social welfare, rather than profits
- they use any profits they generate to further their objectives, e.g. British Heart Foundation
- they can exist in both the public and private sector
- e.g. all charities are not-for-profit organisations
- the govt. exempts these organisations from paying direct taxes
how businesses grow
- organic (internal) growth; driven by internal expansion using reinvested profits or loans
- inorganic (external) growth; occurs as a result of mergers or takeovers
organic growth
- when a firm grows by increasing their production and scale through;
- increasing output and gaining more market share, e.g. by cutting prices
- widening their customer base by developing new products / diversifying their range
- investing in research and development, technology, or production machinery
- using profits or loans to fund investment
- e.g. lego - they’ve never made an acquisition, but have tripled their revenue since 2007, as it focuses on using new product development and innovation as the main driver of revenue and profits
organic growth - advantages and disadvantages
+ pace of growth is slower and more manageable than growing inorganically
+ less risky and more sustainable than inorganic growth, as firms are building upon their own funds and not building up debt
+ avoids diseconomies of scale (occur from rapid growth)
+ existing shareholders retain control over a firm which can reduce conflicts in objectives, which are likely to occur when there’s a takeover
- pace of growth can be slow and frustrating if shareholders want faster growth
- access to finance may be limited
- not necessarily able to benefit from economies of scale
inorganic growth
- usually takes place in one of 3 ways;
- forwards or backwards vertical integration
- horizontal integration
- conglomerate integration
forwards and backwards vertical integration
- vertical integration occurs when a firm merges with / takes over another firm in the same industry but at a different stage of production
- forwards VI; when the firm integrates with another firm closer to the consumer, i.e. retailers (e.g. coffee producer buying a cafe)
- backwards VI; when the firm integrates with another firm closer to the producer, i.e. suppliers (e.g. coffee producer buying a coffee farm)
- e.g. disney’s acquisition of pixar for $7.4 billion in 2006 led to increased market share and profits as disney’s creative stagnation and pixar’s innovative vision and cutting edge technology led to a brand-new generation of animated movies
vertical integration - advantages and disadvantages
+ firms can increase efficiency through gaining economies of scale, by linking successive stages of production, which can reduce their average costs and may result in lower prices for consumers
+ lower costs for firms make them more competitive
+ with backwards VI, firms have greater control over supply, greater certainty about their access to raw materials, and a cost advantage over other firms as they can control the prices they pay and raise prices for other firms
+ forward integration can increase brand visibility
- diseconomies of scale may occur as costs increase, e.g. with duplication of management roles
- the price paid for the new firm may take a long time to regain
- it may create barriers to entry, as it can be hard for non-integrated firms to enter, which can lead to a less efficient market as firms have little incentive to reduce their average costs when they have a high market share
- there may be a culture clash between the 2 firms
- some firms may have little expertise so they won’t perform as well as the other firm
