Business 1.5 Flashcards
Economies of scale
Increase in efficiency of production as the number of output increases
Average cost per unit decreases through increased production
Fixed costs are spread over an increased number of outputs
Cost per unit = (total variable costs + total fixed cost) ÷ units produced
Importance: customer enjoy lower prices due to the lower costs which in turn increases market share or business could choose to maintain its current price for its product and accept higher profit margins
Types of economies of scale
Internal – achieved by the organization itself
Purchasing (bulk-buying) economies
Wholesale discounts
Technical economies
Investing in technology to reduce costs
Financial economies
Easier for large companies to receive loans from banks
Marketing economies
More efficient to advertise a large number of products
Managerial economies
Larger firms are able to hire specialists who help improve efficiency
types of Diseconomies of scale
Internal diseconomies of scale:
Bureaucracy: too many procedures and paperwork may increase administrative costs.
Inert (not adaptive) working culture: change does not take place and organisation stagnates, resulting in outdated processes and inefficiencies.
Complacency (when company does not have a clear picture of reality and is overconfident in its success): for example, Kodak and Nokia thought they will remain market leaders and digital cameras and touch-screen smartphones are just a short trend in fashion.
Marketing DOS: marketing failure that impacts the entire product portfolio and results in low sales. For example, there was a scandal in China when D&G created an offensive ad where a Chinese lady is eating pizza with chopsticks. That resulted in a fall in sales revenue and having to apologise to the people of China.
Communication
External diseconomies of scale:
Infrastructure: roads, power supplies, transportation networks, etc. We’ve already talked about it, but from the positive perspective. If infrastructure leaves much to be desired, it can have the opposite effect in the entire industry and result in inefficiencies for all…
Educated workforce: higher education levels in the country result in increased labour costs for all. We talked about this one too. On the one hand, educated people are great, but on the other hand they demand higher salaries. That is why in many developed economies most of the secondary sector activities are outsourced to developed economies (if this sentence doesn’t make sense, please review this class).
Increased rents: as cities and their populations grow, rent increases. Shanghai was basically a small town about 100 years ago, so imagine how cheap land in Shanghai was back then and how expensive it is now when it turned into a megapolis.
Pollution: even though costs might not apply to businesses, employees and local community are affected negatively which will eventually have a detrimental effect on all business in a given industry
Importance of small businesses
Small firms create jobs
Small businesses are often run by dynamic and innovative entrepreneurs
Provides competition for big business
Supply specialists goods and services for specific industries
Small firms can become big businesses in the future
Advantages and disadvantages of small business and large business
Advantages
Small business
Easily managed & controlled by the owner
Quicker to adapt to changing customer needs and feedback
Offer personal service to customers
Establishes better employer-worker relationships
Large business
Can afford to employ specialist, professional managers
Benefit from more economies of scale
More access to varied sources of finance
Can diversify in several markets, thus spread out the risks
Can afford more formal research & development
Disadvantages
Small business
Can’t afford to employ specialist, professional managers
Doesn’t benefit from more economies of scale
Less access to varied sources of finance
Can’t diversify in several markets, thus spread out the risks
Can’t afford more formal research & development
Large business
Difficult to be managed & controlled by the owner
Slower to adapt to changing customer needs and feedback
Can’t offer personal service to customers
Establishes poorer employer-worker relationships
Internal growth
Occurs when businesses grow using its own resources to increase the scale of its operations and sales revenue
Methods used to achieve internal growth:
Change of pricing strategies
Increase advertising and promotions
Offer flexible financing schemes
Improve and innovate the product or service
Sell in different locations
Increase capital expenditure on production and technologies
Train and develop staff
Business organizations pursue internal growth for several reasons, including:
To foster brand awareness and brand loyalty
To increase market share
To maintain its corporate culture
To maintain ownership and control of the organization
To avoid the comparatively high expenses and risks associated with external growth.
Business organizations pursue external growth for several reasons, including:
To grow at a faster pace
To diversify their product portfolio
To gain market share
To gain customers in new and existing markets
To reduce competition in the industry.
External/inorganic growth
Occurs through dealings with outside organization
Vertical integration
The main business takes part in the primary, secondary, and tertiary aspect of business
Horizontal/lateral integration
Businesses unify under the same industry
Between firms who have the same operations, but do not necessarily compete with one another
e.g. Ford bought Jaguar, Ford is low to mid class while Jaguar is high class. They don’t compete and when they merge they now cater to a bigger market
External growth methods
Conglomerate mergers, takeovers, or acquisitions
Joint ventures
Strategic alliances
Franchising
Conglomerate mergers, takeovers, or acquisitions reaons and reasons for failure
Reasons for mergers:
They want to increase revenue
Fight the rising of prices together
Increased customer satisfaction (new and better content)
Bigger market
Economies of scale
Minimize risk
Reasons for failure:
The companies could not synergize
The competition was stronger than the merged business
Conflicting cultures
Poor management and leadership
Poor timing/recession
Joint venture advantages and disadvantages
Two companies join for a specific undertaking and set-up a new legal entity
Some of the advantages of joint ventures include:
entry to foreign markets,
synergy (same as in M&As),
splitting the costs and risks,
reduced competition.
Some of the disadvantages of joint ventures include:
too much reliance on a partner,
control and “final say” issues (having to agree on all decisions with a partner),
having to share certain expertise (for example, some methods of production or some secret technologies).
Strategic alliance advantage and disadvantage
Advantages of strategic alliances:
Pooling of resources: Sharing industry expertise, research and development, financial resources, distribution channels, and risk.
Retain individual corporate identities: No need to establish a new company with its own legal status, making setup quicker than joint ventures.
Cooperation over competition: Fosters cooperation among members, potentially leading to increased profits.
Flexibility and easy termination: Membership can change without terminating the alliance, and it is straightforward to terminate or demerge if needed.
Disadvantages of strategic alliances:
Easy entry and exit: Members may be less committed and more likely to pull out, leading to instability.
Short-term agreements: Limitation on external growth strategies for organizations.
Exposure to member firms’ mistakes or misconduct: Potential risks associated with the actions of other alliance members.
Potential conflicts and misunderstandings: Communication problems, cultural differences, and mistrust can lead to alliance failure.
Franchising
An individual buys the right to operate under another business’ name
Can be offered individuals or large businesses
Franchisee pays a franchise fee (royalties and supplies) and is given a license to operate by the franchiser
Franchisee is a different type of entrepreneur – much less risk compared to the normal entrepreneur
Franchiser provides marketing, training and equipment to set-up
Support to ensure business will have a good chance of success, retain good brand image, and maintain standard of product/service quality
Franchiser may take a portion of profits and has a say on how the business should be run
