7.7 Growth and survival of firms

Question 1

What is a cartel?

Answer 1

It is a group of 2 or more firms that have agreed to control prices, limit output, or prevent the entrance of new firms into the market. A famous example of a cartel is OPEC, which fixed their output of oil. This was possible as they control 70% of the supply of oil in the world. This reduces uncertainty for firms, which would otherwise exist.

Cartels can lead to higher prices for consumers and restricted outputs. Some cartels might involve dividing the market up, so firms agree not to compete in each others markets

Question 2

What is a price war?

Answer 2

This is when firms are constantly cutting their prices below that of their competitors. Their competitors then lower their prices to match

Question 3

What is price leadership?

Answer 3

Occurs when one firm changes theiur price, and others follow. This firmm is usually the dominant firm in the market. Other firms are often forced to change their prices otherwise they risk losing their market share. This explains why there is price stability in an oligopoly

Question 4

What are the reasons for different size firms?

Answer 4

Economies of scale relative to market size
Diseconomies of scale
Small firms as monopolists
Profit motive
Market power
Diversification
Owners

Question 5

How does economies of scale relative to market size affect the size of a firm?

Answer 5

Large firms might only experience small economies of scale relative to their size since the extent of economies of scale might be limited in the industry. This could make their costs higher than firms that choose to stay smaller

Question 6

How does diseconomies of scale affect the size of a firm?

Answer 6

Larger firms would face high costs of production because they have grown too quickly. There could be poor organisation, x inefficiency, or because firms in large, formal markets tend to have to pay higher wages

Question 7

How does small firms as monopolists affect the size of a firm?

Answer 7

Small firms could hold some degree of monopoly power since they provide a more personal, local service. Their opening hours might suit a small town, such as those of a corner shop, and some consumers might prefer to make smaller purchases. Small firms might also create a niche market, where they can use their relatively price inelastic demand to charge higher prices.

Question 8

How does profit motive affect the size of a firm?

Answer 8

By growing, firms get the opportunity to earn higher profits. Growing also allows firms to take advantage of economies of scale, providing they don’t grow so large that they experience diseconomies of scale

Question 9

How does market power affect the size of a firm?

Answer 9

Large firms have more dominance over the market, which allows them to gain price setting powers and discourage the entrace of new firms. They might also gain monopsony power, which can allow them to buy stock at a lower price

Question 10

How does diversification affect the size of a firm?

Answer 10

By growing and expanding the product range, firms reduce the risk of making huge losses, since they have an area of the market to fall back on.

Question 11

How do owners affect the size of a firm?

Answer 11

Managers of a firm might have the motive of larger bonuses, more holidays or leisure time, which encourages them to expand the firm

Question 12

What is organic growth? (diversification)

Answer 12

This is when firms grow by expanding their production through increasing output, widening their customer base by developing a new product or by diversifying their range. Firms might use market penetration to sell more of their products to existing consumers. They might also invest in R&D, technology or production capacity. This will allow sales to increase and the volume of output to expand

Question 13

What is inorganic growth? (Mergers and Takeovers)

Answer 13

It is the acquisition or taking over of another firm

Question 14

What are the advantages/disadvantages of organic growth?

Answer 14

It is a long-term strategy and it is significantly slower than growing inorganically. This could mean competitors gain more market power by expanding in the meantime. It can make shareholders unhappy if they prefer faster growth.
Firms might rely on the strength of the markets to grow, which could limit how much and how fast they grow.
It is less risky than inorganic growth
Firms grow by building on their strengths and using their own funds like retained profits to fund growth. This means the firm is not building up debt and the growth is more sustainable
Moreover, existing shareholders retain control over the firm, which might reduce conflicts in objectives that are possible when there is a takeover

Question 15

What is vertical integration?

Answer 15

It occurs when a firm merges with or takes over another firm in the same industry, but a different stage of production

Question 16

What is Forward Vertical integration?

Answer 16

This occurs when a firm integrates with anither firm closer to the consumer. This involves taking over a distributor. For example, a coffee producer might buy the cafe where the coffee is sold.

Question 17

What is Backward Vertical integration?

Answer 17

This occurs when a firm integrates with a firm closer to the producer. This involves gaining control of suppliers. For example, a coffee producer might buy a coffee farm.

Question 18

What are the advantages and disadvantages of vertical integration?

Answer 18

Firms can increase their efficiency, by gaining economies of scale, which could reduce their average costs. This could result in lower prices for consumers

Firms can gain more control of the market. Backward integration can mean that firms control the price they pay for supplies, and they could raise the price for other firms. This could give a cost advantage over other consumers.

Firms have more certainty over their production, with factors such as quality, quantity and price.

The disadvantages associated with diseconomies of scale should be considered

Vertical integration could create barriers to entry which might discourage or limit the entrance of new firms. This could lead to a less efficient market, since firms have little incentive to lower their average costs when their market share is high

Question 19

What is horizontal integration?

Answer 19

This is the merger of 2 firms in the same industry and the same stage of production. For example, if a car manufacturer merges with another car manufacturers.

Question 20

What are the advantages and disadvantages of of horizontal integration?

Answer 20

Firms can grow quickly, which can give them a competitive edge over other firms in the market. However, this could lead to monopoly power and there is the potential of lower efficiency as a result.

There could be disagreements in the objectives of the 2 firms which merged

Firms can increase output quickly, so they can take advantage of economies of scale.

The 2 firms will have expertise in the same industry, so the merged firm can gain advantages, such as in marketing

Question 21

What is conglomerate integration?

Answer 21

This is the combining of 2 firms with no common connection. For example, Associated British Foods owns Primark.

Question 22

What are the advantage and disadvantage of conglomerate integration?

Answer 22

It can help both firms become stronger in the market than if they were individual.

The conglomerate can reach out to a wider customer base, and market competition could be reduced.
The advantages of economies of scale can be considered

There is a risk of spreading the product range too thinly, and here might not be sufficient focus on each range. This might reduce quality and increase production costs

Question 23

What are some constraints on business growth?

Answer 23

Size of the market
Access to finance
Owner objectives
Regulation (red tape)

Question 24

How is the size of a market a constraint in business growth?

Answer 24

A small market might only have limited opportunities for business expansion, since firms can only access a limited consumer market and there will be only limited opportunities for innovation and expansion

Larger markets have a much wider scope for innovation and firms can take huge advantage of selling opportunities

Question 25

How is access to finance a constraint in business growth?

Answer 25

Smaller and newer firms tend to be less able to get finances than larger more established firms. This is because they are deemed to be more risky. Moreover, banks have become more risk averse since the global financial crisis, which has limited the number and size of loans on the market. Without sufficient access to credit, firms can’t invest and grow as much.

Question 26

How are owner objectives a constraint in business growth?

Answer 26

Owners might have different objectives. Philanthropic owners may decide to maximise social welfare or have strong CSR (corporate social responsibility) with objectives for the environment in mind. Some owners might aim to maximise profits, whilst others aim for a bigger personal gain in the form of bonuses and reputation.

Question 27

How is regulation a constraint in business growth?

Answer 27

Excessive regulation (red tape) can limit the quantity of output that a firm produces. Environmental laws, and taxes might result in firms only being able to produce a certain quantity before exceeding a pollution permit. Excessive taxes, might discourage firms earning above a certain level of profit, since they don’t keep much of it. This might limit the size that a firm chooses to grow to

Question 28

What is the principle agent problem?

Answer 28

The principal-agent problem is a conflict in priorities between the owner of an asset and the person to whom control of the asset has been delegated.