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Edexcel A - Microeconomics: Theme 1 & 3 > 3.1 - Business growth > Flashcards

3.1 - Business growth Flashcards

1
Q

State 5 reasons as why to some firms grow

A

1) To benefit from economies of scale
2) To increase market power
3) To minimise risk
4) To meet managerial objectives
5) To raise profits

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2
Q

Explain how benefiting from economies of scale enables a firm to grow

A

Increasing returns leads to a fall in long run average costs. This is important in establishing and maintaining a competitive advantage, as they will be able to sell more goods and therefore make more revenue.

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3
Q

Explain how increasing market power enables a firm to grow

A
  • Market dominance gives a business increased pricing power in specific markets. Monopolies for e.g. can engage in price discrimination where different market segments are charged different prices.​
  • This also increases sales, increase market share and brand awareness and exploit new markets.​ Therefore the threat of competition is reduced.
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4
Q

Explaining how minimising risks enables a firm to grow

A

(Firms specialising one product face the issue that if demand falls, they may be forced out of business)

  • Larger firms are less exposed to risk if they expand to diversify their product offering, this is known as “economies of scope”.​
  • By diversifying the brand into different sectors, creating new products, this spreads the risk and increases target market
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5
Q

Explain how meeting managerial objectives enables a firm to grow

A
  • The decisions and strategies of managers employed by a firm might be different from those with an equity stake in the business.
  • Therefore, firms may wish to grow because the pay and bonuses of the managers are related to the sales revenue and sales volume of the business.
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6
Q

Explain how raising profits enables a firm to grow

A

Firms may be driven by stock market expectations as well shareholders looking for capital gains, from rising share prices, and regular income from share dividends. Therefore profits are raised to meet this.

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7
Q

Explain how the divorce between ownership and control creates the principal-agent problem

A
  • Shareholders (‘principals’) own most larger businesses and they appoint directors and and managers (‘agents’) to control business on their behalf.
  • Principals want to maximise short-run profits to maximise their dividends and increase the capital value of their shares.

Whereas agents might have different motives, such as wanting to increase sales and revenue (maximise their salaries), to grow the business over a longer period of time.

  • Therefore, the principal-agent problem is created when the aims of the principals and agents diverge and conflict with each other.
  • For this reason many firms are not run to
    profit-maximise but to profit satisfice.
  • The problem is exacerbated by information gaps as agents tend to hold asymmetric information about the business, in which they can control the flow of it to the head stakeholders.
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8
Q

State the 5 reasons as to why some firms remain small

A

1) Size of the market
2) Lack of economies of scale
3) Limited access to finance
4) Owner objectives
5) Regulations

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9
Q

Explain how the size of a market can restrict a firm to remain small

A

If a firm is operating in a very niche or bespoke market, because the product is specialist and demand is low, then the firm is likely to remain small. For e.g. personal trainers or nail bars. These goods/services have a low PED or high YED.

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10
Q

Explain how the lack of economies of scale can restrict a firm to remain small

A
  • There may be no incentive for a firm to grow if there are no potential cost savings.
  • This occurs at the minimum efficient/constant returns to scale, where output increases by the same proportion as input. Average costs are therefore flat.
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11
Q

Explain how limited access to finance can restrict a firm to remain small

A

Small firms might be regarded as high risk to banks, therefore making them unwilling to lend to them. This hinders a firm from investing in the expansion of the business through technology, for example.

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12
Q

Explain how the principal-agent problem can be resolved

A
  • One way that principals attempt to diminish the problem is by granting share options to managers. If managers are shareholders, then they will be likely to align their interests more with those of the owners.
  • Another way is by linking their bonuses (performance related pay) to certain organisational sales, revenue or profit. This will mean that they personally will gain from higher profits.
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13
Q

Explain how owner objectives can restrict a firm to remain small

A

Owners may want to retain complete control of their business and so be unwilling to expand.

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14
Q

Explain how regulations can restrict a firm to remain small

A

Interventions by the Competition and Markets Authority to prevent a merger going ahead.

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15
Q

Define a public sector firm

A

A part of the economy owned by the government. They aim to provide a service for citizens and don’t always have a profit maximising objective, as the government can make up any short fall in revenues from taxation.

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16
Q

State examples of public sector organisations.

A
  • Broadcasting TV such as BBC and channel 4
  • NHS
  • State schools
  • Civil service departments such as police & education
  • Regulatory bodies such as the General Dental Council
  • TFL
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17
Q

Define a private sector firm

A

A part of the economy owned by individuals or groups, including sole traders and PLCs. They usually aim to make sufficiently high rate profit to satisfy shareholders, the ultimate owner of the business.​

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18
Q

State examples of a private sector organisations

A

Samsung, Tesco, Barclays ect.

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19
Q

Define sole traders

A

This is the simplest form of legal structure and most common type of business structure in the UK. One individual owns the business.​

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20
Q

Define private limited company (LTD)

A

A business owned by private investors. The shareholders are usually family members or close friends that may be directors too.

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21
Q

Define public limited company (PLC)

A

A business owned by public investors. The shareholders are the general public, often institutions such as investment companies and pension funds.

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22
Q

Explain what means for shareholders to have limited liability.

A
  • Their their liability is limited to the amount that they invest when purchasing their shares. ​
  • If a limited company becomes insolvent (a state of financial distress) the shareholders’ personal assets (other than their initial payment for the shares) are protected.​
  • This is because, unlike sole traders, the business and the shareholder have separate legal identities.​
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23
Q

Define non-profit organisations

A

Organisations that operate in the private sector to provide a service or meet a need. Any profit they do generate is used to support their aim of maximising social welfare. Hence, the government exempts them from paying direct tax.

For example, charities which are regulated by the UK Charity Commission.

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24
Q

Define organic growth

A

The internal growth of a business through the increase in output and sales of a business using internal resources.

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25
Q

State examples of ways a business can organically grow

A
  • Product diversification
  • Gaining greater market share
  • Opening new locations
  • Investing in new tech/machinery
  • International expansion (operate in foreign markets)
  • Increase working hours
  • Higher more workers
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26
Q

State the advantages of organic growth

A

1) FC of bank loan may be relatively smaller than inorganic FC of buying entire share capital whilst still making snp could be DE [SHIFT AC DOWN - COMPARING]

2) Steady and controlled rate of growth [ MIN EFFICIENT SCALE]

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27
Q

State the disadvantages of organic growth

A

1) LRAC may remain high and profit margins fall therefore may not be able to benefit from EOS - relatively small increase in output and AC would not fall by much

2) The firm might get too specialised in areas that are becoming out of date and therefore lose innovation.​ Demand may fall. [SHIFT MR + AR LEFT - SNP fall]

28
Q

Define inorganic growth

A

The external growth of a business either through a merger, acquisitions or takeover.

29
Q

Define merger

A

When two previously separate organisations join together to form one, new entity.​

30
Q

Define acquisition

A

When one business (the bidder) buys another business (the target) with the bidder’s permission. This takes place either by purchasing the entire share capital of the business or all of its assets. ​

31
Q

Define joint venture

A

When two independent businesses join together for the purpose of carrying out a particular business activity.​

32
Q

State the 3 ways inorganic growth occurs through

A
  • Vertical integration (forwards and backwards)
  • Horizontal integration
  • Conglomerate Integration
33
Q

Define forward vertical integration

A
  • The purchase of one firm by another at a later point in the supply chain i.e. the firm is moving towards the eventual consumer of a good.
  • For example, a manufacturer purchases a retailer.
  • It involves with customer firms to ensure retail outlets for products.
34
Q

Define backwards vertical integration

A
  • The purchase of one firm by another at an earlier point in the supply chain i.e. the firm is moving towards the supplier of a good.
  • For example, a manufacturer purchases its supplier.
  • Involves integrating with an input supplier to reduce supply costs or guarantee quality.
35
Q

Define horizontal integration

A

The purchase of one firm by another at the same point in the supply chain and in either the same or different industries.

36
Q

Define conglomerate integration

A

The purchase of one firm by another which is unrelated in terms of its business activity, in order to form a large and highly diversified corporation.

37
Q

State the stages of the supply chain

A

1) Commodity producers
2) Suppliers
3) Manufacturers
4) Retailers
5) Consumers

38
Q

State the advantages of vertical integration

A

1) Greater control over the supply chain
2) Cost reduction
3) Quality management
4) Increased barriers to entry
5) Increased control over the retail market

39
Q

State the disadvantages of vertical integration

A

1) Increase costs
2) Poor decision-making
3) New combined firm may be too large

40
Q

Explain how increased costs is a disadvantage of vertical integration

A

Firms may need to appoint more staff to run the new parts of the business, buy more machinery, equipment and premises.

41
Q

Explain how poor decision-making is a disadvantage of vertical integration

A

This is a result of inexperience in the new stage of the supply chain. For example, lack of knowledge/expertise and specialist production.

42
Q

Explain how the size of the firm is a disadvantage of vertical integration

A

The new combined firm may be too large causing it to become inefficient. This could result in communication problems across the organization. Diseconomies of scale and x-inefficiency may arise.

43
Q

State the objective of shareholders and explain 2 motives

A

The objective of s/h is profit maximisation.

1) Gain dividends = A share of the profit in proportion to ownership.
2) Increase capital value of shares by selling them.

44
Q

Explain what it means for a sole trader to have unlimited liability

A
  • The owner is personally liable for the debts of the business and must pay for any losses made by the business.
  • This means that if the business has lots of debts, a sole trader must pay off these debts, even if it means selling their personal possessions. ​
  • This is because, often, a sole trader will have used their house or other personal possessions as security for a business loan.
45
Q

Define shareholder

A

An individual or business who has purchased shares in a business.

46
Q

Define share

A

A unit of equity ownership in a corporation.

47
Q

Define share capital

A

The total value of the money invested into a company by its shareholders.

48
Q

Define dividend

A

A share in a company’s profits in proportion to ownership.

49
Q

Explain how greater control over the supply chain is an advantage of vertical integration

(quantity)

A

Backwards - When retailers decide to acquire or develop a manufacturing business, they obtain more control over the production part of the distribution process. Quantity is guaranteed which means that shortages do not occur. Other competing retailers can also be prevented from buying supplies.

50
Q

Explain how cost reduction is an advantage of vertical integration

(mark-ups)

A

In the traditional distribution process, every step in product movement involves mark-ups so the reseller can earn profit. By selling directly to end buyers, manufacturers can “eliminate the middle man,” removing one or more steps of mark-ups along the way. Therefore there’s a cost reduction (shifting down AC and MC ).

51
Q

Explain how quality management is an advantage of vertical integration

A

Controls the quality and delivery of materials right through the production process to ensure that the final product is of sufficient quality; enables accurate stock control which increases customer satisfaction.

52
Q

Explain how increased barriers to entry is an advantage of vertical integration

A

Backward vertical integration allows businesses to restrict the access of the rival firms to suppliers. British Gas has been criticised for raising whole sale prices of gas and electricity; Royal Mail has recently been fined £50m by the CMA for abusing its dominant position as a wholesaler.

53
Q

Explain how increased control over the retail market is an advantage of vertical integration

A

Forward vertical integration provides a business with the ability to sell the manufacturer’s product in retail stores owned by the same company. It can therefore take control over the marketing mix of the good/service (product, price, place – distribution, promotion).

54
Q

State the advantages of horizontal integration

A
  • A merger reduces the risk of being bought out by a rival company.
  • To gain economies of scale; if prices fall there’s increased consumer surplus.
  • Increased revenue for the business as a result of having a larger customer base.
  • Cost savings through “synergy”. Synergy is the concept that the value and performance of two companies combined will be greater than the sum of the separate individual parts​
  • The business is able to grow in a market where it already has expertise , which is
    more likely to make the merger successful.
55
Q

State the disadvantages of horizontal integration

A
  • Incompatibility of management styles, structures and cultures., therefore clashes may occur.
  • Diseconomies of scale may exist as LRAC increase. For example, duplication of roles, resulting in redundancies and so poor staff motivation.​ As well as workers losing their jobs.
  • High failure rate. Forbes estimates that 83% of mergers/acquisitions fail.
  • Duplication of assets, resulting in assets not being used or being sold off at a low price.​ This causes wastefulness.
  • Buyout is very expensive; High cost of purchasing the entire share capital of the target. Therefore, the valuation of target’s shares may be too high for acquirers.
56
Q

Define conglomerate

A

A business which sells a wide range of unrelated, diversified goods/services.​

57
Q

State the advantages of conglomerate integration

A

1) It spreads the risk through diversification therefore benefiting from EOSCOPE therefore profitable areas can cross-subsidise loss making areas. [AC + MC falls SNP increases - DE]

2) Greater revenue stability therefore increasing market share and brand loyalty [AR + MR shifts right SNP increases - DE]

3) move way from DEOS to EOS so pass on lower costs to consumers - PE

58
Q

State the disadvantages of conglomerate integration

A

1) May not be DE if they’re operating as a monopoly so protected by BTE instead pressure from shareholders to pay out their dividends

2) Shifting its focus from a core business activity to other area, they may dismiss poor performance in that sector [DEOS - PE]

59
Q

State the constraints on business growth

A
  1. The size of the market
  2. Access to finance
  3. Owner objectives
  4. Regulations
60
Q

Define de-merger

A

When a firm decides to split into separate firms by selling parts of the business.

61
Q

Define partial de-merger

A

The parent company retains a stake in the demerged business.​

62
Q

Define supply chain

A

Shows the path through which a commodity passes from inception through to its eventual delivery to the end user.

63
Q

State the reasons to demerge

A

1) TO FOCUS ON CORE BUSINESS - Perhaps conglomerate integration has led to the dilution of brands/a lack of focus within the organisation.​ By developing on one area managers can improve their skills and knowledge; gaining the benefits of specialisation. Therefore costs can be streamlined and profit margins in those business units are improved. [GRAPH MC + AC SHIFT DOWN, LARGER SNP - DE]

2) PE - moving away from DEOS improving communication in company

64
Q

State the reasons not to demerge

A

1) UNLIKELY TO BE DE IF THEY’RE OPERATING AS A MONOPOLY - protected by high barriers to entry therefore pay be pressure to increase returns to shareholders in form of dividends

2) going to small means level EOS achieved may be very low compared to a monopoly in a concentrated market, therefore may only achieve MES

65
Q

Define conglomerate integration

A

The purchase by one firm of another firm which is unrelated in terms of its business activity, in order to form a large and highly diversified corporation.​

66
Q

advantages of inorganic growth

A

1) Greater variety of management skills and expertise to lead the firm in a new strategic direction [RIGHT SHIFT IN MR + AR SNP INCREASES]

2) Increase market share and reduce competition; price setting ability [MONOPOLY GRAPH]

3) EOS

67
Q

disadvantages of inorganic growth

A

1) HIGH FC of buying entire share capital [AC SHIFTS UP]

2) lack of control/communication/coordination if grows too large [DEOS]

3) duplication of roles - workers may feel less valued and dispensable so may lead to organisational slack/x-inefficiency [ATC SHIFTS UP]

Edexcel A - Microeconomics: Theme 1 & 3 (10 decks)

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