Size and Growth of Firms Flashcards
(22 cards)
Principle-agent problem
Conflict between objectives of principles (shareholders) who want to maximise profit and directors (agents) who want to maximise sales
To solve the PA problem, firms can profit satisfice or offer shares to managers in order to incentivise them to maximise profit
Why owners want their firms to grow
Profitability - satisfy shareholders
Lower costs - internal or external economies of scale can be exploited
Increased market share - increased ability to price discriminate
Spread business risk
Altruism
Why firms might remain small
Avoid diseconomies of scale - increased LRAC = decreased profit
Niche markets - there is always room in a market for many small firms who can find a niche to perform better in than big firms - specialist skills / labour required
Lack of access to finance - firms unable to raise capital or borrow enough to invest
Different business objectives - some owners aim to make enough profit to maintain a certain standard of living, but don’t want to get any bigger
Government regulation - regulators can block mergers, put price caps in place and encourage contestability
Nature of the market - markets with low barriers to entry enable new firms to enter, limiting how much firms can grow
Organic growth
When a firm reinvests SNP back into itself to increase output
Money can come from reinvesting profits, selling market shares or from bank loans
e.g. Apple - reinvesting profit into production helping launch new products and increase output
Backward vertical integration
When a firm merges with another firm who is further away from the consumer in the same production process
Allows firms to cut costs as there is one step of production cut out so prices don’t have to be as high
e.g. Ford integrating with the tire company
Forward vertical integration
When a firm integrates with another firm who is closer to the consumer in the same production process
Allows firms to cut costs as there is one step of production cut out so prices don’t have to be as high
e.g. Ford integrating with showrooms, enabling consumers to see and buy cars
Horizontal integration
When a firm integrates with another firm in the same industry at the same stage of the production process
e.g. T-Mobile and Orange forming EE which is now Europe’s largest 4G provider
e.g. BA and Iberia
Conglomerate integration
When two firms in different industries merge together
Spreads business risks over multiple markets
e.g. Tata (Indian cotton company) and Starbucks merged to help sell coffee in India
Advantages of organic growth
Increase internal economies of scale → lower AC → increases profits
Increased market power → increased brand recognition → PED becomes more inelastic → price discrimination → higher profits
Disadvantages of organic growth
Much slower than external growth as you invest your own profits
Risk of diseconomies of scale → higher AC → reduced profitability
Advantages of vertical integration
Increased profit margins by removing ‘middle man’ → decreased costs → increased SNP
Benefits of cost synergies (overlap of departments) → decreased costs → increased SNP
Disadvantages of vertical integration
Lack of familiarity with market → lower productivity
Risk of overdependency due to a lack of diversification (too much focus on one market)
Advantages of horizontal integration
Increased market power → increased brand recognition → PED becomes more inelastic → price discrimination → higher profits
Reduces competition → increased sales → increased revenue → increased market share
Disadvantages of horizontal integration
Risk of diseconomies of scale → risk of conflicts in management styles → lower productivity
Greater monopoly power → lower consumer surplus
Advantages of conglomerate integration
Increases diversity → spreads risk to maintain profits
Quicker than organic growth
Disadvantages of conglomerate integration
Risk of diseconomies of scale (communication, difference in managerial styles / vision) → higher AC → lower profits
Lack of market knowledge → lower productivity
Demerger
When a firm splits into two or more separate, independent businesses
Benefits of a demerger for a firm
Demergers reduce the size of a firm, reducing diseconomies of scale as each new firm’s output decreases due to less alienation, less bureaucracy and more communication, resulting in lower costs and higher profits
Both new firms will specialise more and increase productivity in their own goods and services, increasing output, decreasing costs and increasing SNP
One division of the firm can be sold to make money which can be invested in R+D, increasing dynamic efficiency
Cultural differences are split up, removing tensions between departments, making workers more productive, increasing SNP
Benefits of a demerger for workers
Reduced cultural conflict due to less clash between departments → optimises efficiency → higher wages as SNP increasess
Costs of a demerger for workers
Lower job security
For workers not explicitly in one department or the other, they don’t know where they will be working and who for
If part of the firm is sold, all the people in that department will lose their job
Benefits of a demerger for consumers
Lower prices and increased quality
Workers become more specialised, so the quality of the good is higher, and more efficient due to less cultural conflict, decreasing cost of production and therefore price of goods and services
Costs of a demerger for consumers
Reduces economies of scale
By splitting one firm into smaller firms, each firms output decreases, reducing economies of scale
If a firm gets too small, output decreases further, meaning priced have to be raised, reducing economies of scale
