Theme 3: Business Growth Flashcards
Why do some firms decide to stay small?
- Economies of scale relative to market size- large firms might only experience small economies of scale compared to their size so might make their costs higher.
- Diseconomies of scale- large firms could have higher costs
- Small firms as monopolists- small firms could hold some monopoly power as they provide a more personal, local service.
- Owners- Managers might decide they don’t want to grow
Why do firms decide to grow?
- Profit motive- By growing firms get the opportunity to earn higher profits. Economies of scale.
- Market power- More dominance over a market so they can discourage new entrants.
- Diversification- By expanding product range firms reduce their risk of making huge losses.
- Owners- Managers might want higher incomes, more holiday or more leisure time.
Principle agent theory
The agent makes the decision for the principal, but the agent is inclined to act in their own interests, rather than those of the principal. EG shareholders and mangers have different objective which might conflict, eg bonus for manager over dividend for shareholder.
Public sector distinctions
- Government has control
- Natural monopolies eg water
- Some public sector industries yield strong positive externalities eg public transport reduces congestion and pollution.
- Public sector has different objectives, social welfare might be a priority and fairer distribution of resources.
Private sector distinctions
- Left to the free market and private individuals
- Private sector gives firms incentives to operate efficiency which increases economic welfare. As they have a profit incentive.
Profit organisation
aims to maximise the financial benefits of its shareholders and owners. The goal of the organisation is to earn maximum profits.
Not-for-profit organisations
Has a goal which aims to maximise social welfare. They can make profits, but they cannot be used for anything apart from this goal and the operation of the organisation.
4 ways firms grow?
- Organic growth (or internal)
- Forward and backward vertical integration
- Horizontal integration
- Conglomerate integration
Organic growth
When firms grow through expanding their production through increasing output, widening their consumer base, by developing a new product or by diversifying their range.
Advantages of organic growth
- Less risky than inorganic growth
- Firms grow through building on their strengths and using their own funds such as retained profits to fund the growth. So the firm is not building up debt and the growth is more sustainable.
- Existing shareholders retain control so reduce conflicts in objectives that are possible in a takeover.
Weaknesses of organic growth
- Slower which could allow another firm to out compete or upset shareholders.
- Might rely on strength of market to grow which could limit how much and fast they can grow.
Forward vertical intergration
When a firm integrates with another firm closer to the consumer eg taking over a distributor. Such as a coffee producer taking over a café.
Backward vertical intergration
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.
Advantages of forward and backward vertical integration
- Increase efficiency, through gaining economies of scale, which could reduce their average costs. Resulting in lower costs for consumers.
- Gain more control of the market. Backwards integration can mean that firms can control the price they pay for their supplies.
- Firms can have more certainty over their production with factors such as quality, quantity and price.
Disadvantages of forward and backward vertical integration
- Diseconomies of scale
- Create barriers to entry which could discourage new entrants of new firms which could lead to a less efficient market.
