3.1 - Business growth Flashcards
Reasons why some firms grow (3)
- Economics of scale - this will decrease their cost of production
- Greater market share - gives ability to influence prices and restrict new firms from entering the market (deter new entrants)
- More security - the assets/cash built up can be used during financial difficulty as well as selling bigger range of goods in more than 1 local/national market would mean they are less affected by individual products or places
Why some firms remain small (4)
- Size of the market
- Access to finance
- Owner’s objectives
- Regulation
What is the principal agent problem
When there is a conflict of interests between the shareholders (principals) and the managers (agents).
Shareholders want to maximise the returns on their investment (short run profit maximisation)
Managers want to maximise their own benefit in the form of higher sales or revenue
What is the solution to the principal agent problem
Shareholders can give managers the shares of the business or link their bonuses to profits
This means that they personally gain from higher profits - therefore incentivising to produce as much profit as possible
Case study for failed principal agent problem
The executives (Kenneth Lay and Jeffrey Skilling) used the Mark to Market (M2M) accounting strategy to hide billions of debt from the Board of Directors.
Shareholders filed a lawsuit to the firm and executives after share price dropped from nearly $100 to below $1 in just over a year
What are the two types of growth
- Organic growth - where the firm grows by increasing their output (e.g. increased investment or more labour)
- Integration (Inorganic growth) - where the firm grows by merger or takeover rather than an increase in the company’s own business activity
Case study of organic growth
LEGO
They introduced new products (e.g. lego friends) and board games to expand their customer base
Advantages of organic growth (2)
- Integration is often expensive, time consuming and high risk - they are poorly managed with key workers tending to leave after the change
- Preserves sovereignty - the firm is able to keep control of their business
Disadvantages of organic growth (3)
- Firm’s market restricts expansion through organic growth - integration would allow a European company to expand its customer base in the Asian market
- It may be too slow for directors who wish to maximise their salaries
- Difficult for firm to get new ideas
What is Vertical Integration
The integration of firms in the same industry at different stages in the production process
Difference between forward and backward integration
Forward integration - when the firm is moving towards the eventual consumer of a good
Backward integration - when the firm is moving back to the supplier of a good
Case study for successful vertical integration
Tesco’s £3.7 billion takeover of Booker in 2018 - it led to increased in sales for Tesco
Advantages of vertical integration (4)
- Increased potential for profits
- Less risk
- With backward integration, business control the quantity of supplies + don’t worry about high prices - this keeps costs low and allow for lower consumer prices (which increases competitiveness and sales)
- Forward integration secures retail outlets and restricts assess to these outlets to competitors
Disadvantage of vertical integration
- Firms may have no expertise in the industry
E.g. car manufacturing company would have deep knowledge in the car manufacturing but little of selling cars and visa versa
What is Horizontal Integration
This is when firms in the same industry at the same production process integrate
