3.1 Business Growth Flashcards
Reasons why some firms tend to remain small
- To avoid diseconomies of scale (rapid growth can have negative impacts on business eg. communication suffers due to increase in ppl and business hierarchy structure)
- They operate in niche markets (don’t have sufficient demand for goods / services they sell to grow business)
- Barriers to entry (difficult for firms to expand into different markets eg. some markets dominated by large businesses with lower operating costs so can’t offer competitive prices in that market)
- Small can be a selling point (small businesses can offer things big businesses can’t eg. better customer service as customer makes up larger percentage of revenue in smaller retail stores)
Small firms as monopolists- 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 consumer might prefer making smaller purchases, than the larger ones expected at bigger stores. Small firms might also create a niche market, where they can use their relatively price inelastic demand to charge higher prices. An example could be a small café over a multinational corporation.
Reasons why some firms grow
- Profits (generate more sales revenue so greater chance of achieving high levels profit which can be reinvested to expand further). Selling more goods and services will increase a firms revenue. As a firm grows it will also be able to benefit from economies of scale that will lower LRAC. Both of these will allow greater profits
- Economics of scale (bigger firms have more benefits eg. Lower interest rates so reduced cost of borrowing)
- Increased market share (likely to increase revenue sales so increase in market share = increased market setting powers so can generate larger profit margin)
- Diversification (more profit to expand so can enter into new markets so can diversify product portfolio so can spread risk across multiple markets & products so increased chance of survival if 1 product fails)
- Managerial motives (owner’s ambition to own large businesses & receive benefits eg. larger salaries, increased leisure time as can hire managerial directors)
The principal-agent problem (significance of the divorce of ownership from control)
DEFINITION- possible conflicts of interest that may result between the shareholders (principal) and the management ( agent) of a firm
The owners - maximise the returns on their investment so will want to short run profit maximise. However, directors and managers are unlikely to want the same thing: they will want to maximise their own benefits.
- as business grows, share holds (principals) appoint managers (agents) to run business day to day (financial managers, sales managers)
- but managers have different objectives (to maximise revenue) from shareholders (to profit maximise to maximise dividends they’re paid)
- stems from asymmetric info- agent makes decisions for the principal, but the agent is inclined to act in their own interests, rather than those of the principal. For example, shareholders and managers have different objectives which might conflict.
Public vs private sector organisations
PUBLIC SECTOR DEFINITION- Company owned by local or central government
Public sector organisation run by gov (NHS)
Don’t have incentives as act in society’s interest & dont face competition = less efficiency
PRIVATE SECTOR DEF- all privately owned businesses and organisations. These businesses usually aim to return a profit to the owners
Private sector firms run by private individuals, left to free market
Have profit motive as need to make high profits to stay in market, encourages firms to be efficient to cut costs & survive
Profit vs not-for-profit organisations
Profit organisations main objective is profit, to maximise dividends given to shareholders
So decisions have negative impacts on society but profitable
Not-for-profit organisations main objectives differ from profit eg. to help local community
Profits made go towards main objective to help improve society
So not-for-profit firms exempt from certain taxes profit firms have to pay
How do businesses reduce the principal-agent problem
- Put in place schemes that help align principal’s objectives with agents
Eg. Owners give managers percentages of business’s shares so managers switch objectives from sales maximisation to profit maximisation to maximise the dividends they receive
Ways businesses grow:
- organic growth ( internal)
EXTERNAL:
- forward & backward vertical integration
- horizontal integration
- conglomerate integration
Stages of production
Primary sector (extraction of raw materials eg. mining)
Secondary sector (manufacturing things eg. cars)
Tertiary sector (provision of services eg. retailers)
Organic growth
(definition, advantages & disadvantages)
DEF- growth as a result of a firms increasing the levels of factors of production it uses- increasing output by building a larger factory, hiring more workers, increasing raw materials
ADVANTAGES: a firms has control over exactly how this growth occurs, less risk than inorganic growth
-Integration is expensive, time-consuming , with evidence suggesting that the long-term share price of the company falls following integration. Firms often pay too much for takeovers and integration is often poorly managed with many key workers tending to leave after the change.
- Existing shareholders retain their control over the firm, which might reduce conflicts in objectives that are possible when there is a takeover.
- Firms grow by building upon their strengths and using their own funds, such as retained profits, to fund the growth. This means that the firm is not building up debt, and the growth is more sustainable
DISADVANTAGES: SLOW
Sometimes another firm has a market or an asset which the company would be unable to gain through organic growth. For example, integration would allow a European company to expand into the Asian market which it has no expertise in.
- Organic growth may be too slow for directors who wish to maximise their salaries, rapid growth of revenues and profits
-It will be more difficult for firms to get new ideas.
- Difficult to build market share if one business is already a clear leader
-Firms might rely on the strength of the market to grow, which could limit how much and how fast their can grow.
Eg. LEGO (introduced Lego friends & board games to expand customer base)
Forward & backward vertical integration
DEF: the integration of firms in the same industry but at different stages in the production process
Vertical forward integration- merging / taking over of firm at stage ahead of business in production process (eg. fishing business merging/taking over fish&chip chain)
Vertical backward integration: merging / taking over of firm at stage behind them in production process (eg. coffee shop merging/taking over coffee bean supplier)
Vertical (forward & backward) integration advantages & disadvantages:
ADVANTAGES: Firms can increase their efficiency, through gaining economies of scale- reduce their average costs= lower prices
- Firms have more control of the market. Removing suppliers, crucial information from competitors- market less contestable, taking market intelligence away. Vertical- can sell directly to public
§ Backwards integration- firms can control the price they pay for their supplies, and they could raise the price for other firms= cost advantage over their competitors.
§ Backwards vertical- tighter control of supply chain, can dictate who you supply to
§ Backwards integration- Businesses can control the quality of suppliers, ensure delivery is reliable. Do not have to
worry about being exploited by suppliers, keeping costs low, lowering prices for consumers- increase comp and sales
§ Firms have more certainty over their production, with factors such as quality, quantity and price.
§ Less risk as suppliers do not have to worry about buyers not buying their goods and buyers do not have to worry about
suppliers not supplying their goods
§ Forward integration secures retail outlets and can restrict access to these outlets for competitors. Better control over retail distribution channels , build revenues
DISADVANTAGES:
- firms may have no expertise in industry they take over / merge with so may fail or struggle (eg. car manufacturing company with no knowledge of selling cars) = high risk & expensive
- difference in business cultures amongst the two businesses (can lead to more disputes amongst employers and overall inefficiencies) incompatibility between the two businesses can lead to increase in costs of production which forces price of their goods/services up
- Vertical integration- barriers to entry- might discourage or limit the entrance of new firms- lead to a less efficient market- firm has little incentive to reduce average costs when their market share is high.
Horizontal integration
(definition, advantages & disadvantages)
DEF: combining firms that are at the same stage of the production process in the same industry– e.g. a merger between 2 pharmaceutical companies
Eg. supermarket merging with another supermarket,
AstraZeneca acquired ZS Pharma for $2.7bn in 2015 = gave them access to new compounds intended to strengthen a specific sector of their business.
ADVANTAGES:
- This helps to reduce competition as a competitor is taken out and increases market share, giving firms more power to influence markets, increasing long run pricing power
- Firms can grow quickly, which can give them a competitive edge over other firms in the market
-Firms will be able to specialise and rationalise, reducing the areas of the businesses which are duplicated.(cost savings)
- The business can grow in a market where it already has expertise, which is more likely to make the merger successful.
- Monopsony power, which can allow them to buy their stock at a lower price, increasing efficiency.
- Firms can increase output quickly, so they can take advantage of economies of scale. (lower LRAC)
-The two firms will have expertise in the same industry, so the merged firm can gain advantages, such as in marketing.
§ Wider range of products – diversification creates opportunities for economies of scope
§ Buying an existing and well-known brand can be cheaper in the long-run than organically growing a brand – this can
then make entry barriers higher for potential rivals and lead to higher long-run monopoly profits.
DISADVANTAGES:
- Increase risk for the business as if that particular market fails, waste of investment
§ Risk of diseconomies of scale - clashes of management style and culture, and wider problems with integrating businesses that operate in very different ways
§ Mergers risk destroying shareholder value - because the synergies never materialize. Most large-scale mergers fail to
achieve the gains in shareholder value
§ Risk of attracting investigation from the competition authorities who might be worried that a horizontal merger
might lead to a substantial lessening of competition in a market - fall in consumer welfare.
§ Recued flexibility- more personnel -need for transparency, accountability slow down the rate of innovation
-
Conglomerate integration
DEF- Combining firms which operate in completely different markets
ADVANTAGES:
- It is useful for firms where there may be no room for growth in the present market.
- The range of products reduces the risk for firms and if a whole industry fails, they will still survive due to the other parts of the business.
- It will make it easier for each individual part of the business to expand than if they were on their own as finance can be easily obtained and managers can be transferred from company to company within the firm.
DISADVANAGES:
- lack of knowledge (entering new market very risky as business owner has no experience or expert knowledge of market, may make poor decisions or be unable to attract new customers) which can damage business
- difference in business cultures amongst the two businesses (can lead to more disputes amongst employers and overall inefficiencies) incompatibility between the two businesses can lead to increase in costs of production which forces price of their goods/services up
Constraints on business growth:
SIZE OF THE MARKET- A small market -limited opportunities for business expansion, only access a limited consumer market, might be limited opportunities for innovation and expansion. Larger markets scope for innovation, and firms can take advantage of huge selling opportunities.
- HARDER TO ACCESS FINANCE: Smaller and newer firms- less access to finance than larger, more established firms. This is because they are deemed riskier than established firms. Without sufficient access to credit, firms cannot invest and grow, and firms cannot innovate as much.
- OWNER OBJECTIVES- Owners might have different objectives. Philanthropic owners might aim to maximise social ,welfare, (CSR). Some owners might aim to maximise profits, whilst others might a bigger personal gain in the form of bonuses and reputation. Therefore, some owners might not have business growth as an important objective.
- REGULATION ( RED TAPE)-
Excessive regulation is also called ‘red tape’. It can limit the quantity of output that a firm ,produces. For example, environmental laws and taxes might result in firms only being able to produce a certain quantity before exceeding a pollution permit. Excessive taxes, such as a high rate of corporation tax, might discourage firms earning above a certain level of profit, since they do not keep as much of it. This might limit the size that a firm chooses, or is able to, grow to.
Demergers (definition)
- a business strategy in which a single business is broken into two or more components, either to operate on their own, to be sold or to be dissolved.
