3.2 Flashcards
Difference between internal and external economies of scale
Internal economies of scale occur as a result of the growth in the scale of production within the business
The firm can benefit from lower average costs (AC) generated by factors from inside the business
External economies of scale occur when there is an increase in the size of the industry in which the firm operates
The firm can benefit from lower average costs (AC) generated by factors outside of the business
6 types of internal economies of scale
Financial economies
Large firms often receive lower interest rates on loans than smaller firms as they are perceived as less risky
A cheaper loan lowers the cost per unit (average cost)
Managerial economies
Occurs when large firms can employ specialist managers who are more efficient at certain tasks and this efficiency lowers the average cost (AC)
Managers in small firms often have to fulfil multiple roles and are less specialised
Marketing economies
Large firms spread the cost of advertising over a large number of sales and this reduces the AC
They can also reuse marketing materials in different geographic regions which further lowers the AC
Purchasing economies
Occur when large firms buy raw materials in greater volumes and receive a bulk purchase discount which lowers the AC
Technical economies
Occur as a firm can use its machinery at a higher level of capacity due to the increased output thereby spreading the cost of the machinery over more units & lowering the AC
Risk bearing economies
Occur when a firm can spread the risk of failure by increasing its numbers of products i.e greater product diversification - less failure lowers AC
4 types of external economies of scale
Geographic Cluster
As an industry grows, ancillary firms move closer to major manufacturers to cut costs & generate more business
This lowers the AC e.g. car manufacturers in Sunderland rely on the service of over 2,500 ancillary firms
Transport Links
Improved transport links develop around growing industries to help get people to work & to improve the transport logistics
This lowers the AC e.g. Bangalore is known as India’s Silicon Valley & transportation projects have been successful in transforming the movement of people & goods
Skilled Labour
An increase in skilled labour can lower the cost of skilled labour, thereby lowering the AC
The larger the geographic cluster, the larger the pool of skilled labour
Favourable Legislation
This often generates significant reductions in AC as governments support certain industries to achieve their wider objectives
2 problems arising from growth
Diseconomies of scale
Occurs when a company grows too large, making it difficult to manage and control its operations. E.g It may face challenges in coordinating its various departments, managing its workforce, or maintaining quality control. The cost per unit ends up increasing as a result of these inefficiencies
Overtrading
Occurs when a company takes on more business than it can handle, leading to a strain on its resources or an inability to meet its financial obligations (lack of liquidity). This may cause cash flow problems or decreased customer satisfaction. E.g A company that expands too quickly may struggle to hire and train enough staff to handle increased demand, leading to a backlog of orders and dissatisfied customers
Difference between a merger and a takeover
A merger occurs when two or more companies combine to form a new company
The original companies cease to exist and their assets and liabilities are transferred to the newly created entity
A takeover occurs when one company purchases another company, often against its will
The acquiring company buys a controlling stake in the target company’s shares (>50%) and gains control of its operations
3 reasons why 2 firms may merge
Economies of scale
Growth creates economies of scale by allowing companies to reduce costs and increase efficiency through the consolidation of operations
Elimination of competition
Takeovers are often used to eliminate competition and the acquiring company increases its market share.
Shareholder value
Mergers and takeovers can also be used to create value for shareholders. By combining companies, shareholders can benefit from increased profits, dividends and stock prices
What is forward and backward vertical integration
Forward vertical integration involves a merger or takeover with a firm further forward in the supply chain
E.g. A dairy farmer merges with an ice cream manufacturer
Backward vertical integration involves a merger/takeover with a firm further backwards in the supply chain
E.g. An ice cream retailer takes over an ice cream manufacturer
2 adv and dis of vertical integration (inorganic growth)
Adv
Reduces the cost of production as middleman profits are eliminated lower costs make the firm more competitive
The quality of raw materials can be controlled
Dis
Diseconomies of scale occur as costs increase e.g. unnecessary duplication of management roles
There can be a culture clash between the two firms that have merged
2 adv and dis of horizontal integration (inorganic growth)
Adv
The rapid increase of market share
The firm may gain new knowledge or expertise
Dis
Diseconomies of scale may occur as costs increase e.g. unnecessary duplication of management roles
There can be a culture clash between the two firms that have merged
2 adv and dis of organic growth
Adv
The pace of growth is manageable
Less risky as growth is financed by profits and there is expertise in the industry
Dis
The pace of growth can be slow and frustrating
Not necessarily able to benefit from economies of scale
2 reasons small firms exist
They offer a more personalised service and focus on building relationships with their customers (excellent customer service)
They are unable to access finance for expansion
They provide a product that is in a niche market - smaller market size but can be very profitable
By remaining small, there is a high ability to respond quickly to changing customer needs/preferences
