1.6 Flashcards
Economies of scale
When average costs of a business decrease as output increases. When a business expands and produces greater quantity, fixed costs are spread over a greater quantity of units produces, reducing average costs. Uses growth as an opportunity to decrease average costs.
Diseconomies of Scale
When average costs increase as output increases. When a business expands and grows and experiences inefficiencies which cause average costs to increase such as communication issues.
Internal Economies of Scale
Technical
Managerial
Financial
Marketing
Purchasing
Risk bearing
Internal Economies of Scale: Technical
Bigger units of production can reduce costs because of the law of variable proportions (the increase in varible costs are spread against a set of fixed costs).
E.g. A truck will be cheaper to operate than two or three smaller vehicles.
Internal Economies of Scale: Managerial
A bigger business can afford to have managers specialising in one job rather than having to do multiple roles.
E.g. Instead of having a general manager, they can be hired by functions; marketing, finance.
Internal Economies of Scale: Financial
Bigger businesses tend to be less risky than smaller businesses.
E.g. Banks are most likely to give loans to big companies rather than sole traders.
Internal Economies of Scale: Marketing
Bigger businesses can direct more effective marketing campaigns.
E.g. Large businesses have better advertisement opportunities.
Internal Economies of Scale: Purchasing
Big businesses can gain discounts through bulk buying.
E.g. Walmart buys large quantities of food at very low prices from farmers.
Internal Economies of Scale: Risk bearing
Big businesses can afford to produce a bigger product range and spreading the risk of one product failing.
External Economies of scale
Improved infraestructure
Agglomeration
Research and development
Relocation of component suppliers
External Economies of Scale: Improved infraestructure
- Improved telecommunications makes it easier to communicate globally
- Improved road networks make it faster to deliver products
External Economies of Scale: Agglomeration
When lots of similar businesses locate within close proximity to each other, it makes working together easier.
External Economies of Scale: Research and development
Advancements in technology or a particular field mean all firms benefit from this development.
External Economies of Scale: Relocation of component suppliers
If suppliers are closer to business, main operation deliveries arrive faster and its cheaper.
Internal Diseconomies of Scale
Co-ordination and monitoring difficulties
Communicatin difficulties
Poor worker motivation
Purchasing
Financial
Technical
Internal Diseconomies of Scale: Co-ordination and monitoring difficulties
The larger the business the more difficult it is to coordinate stages in production, leading to shortages and wastage.
Internal Diseconomies of Scale: Communication difficulties
- As the business expands, communicating between different departments along the chain of command can be hard.
- There are more layers in the hierarchy that can distort messages due to a wider span of control for managers (less clear instructions for workers).
Internal Diseconomies of Scale: Poor worker motivation
- Workers can feel more isolated and less appreciated in larger businesses.
- This can lead to lower employee motivation, damaging output and quality.
Internal Diseconomies of Scale: Purchasing
Large businesses often buy too much stock and it may need to be sold off at a loss.
Internal Diseconomies of Scale: Financial
Large firms with huge amounts of surplus can make poor investment decisions.
Internal Diseconomies of Scale: Technical
An airplane may be too big to land in a smaller airport.
External Diseconomies of Scale
Scarcity of land
Increasing rents
Higher recruitment costs
Higher wages
Transportation problems
External Diseconomies of Scales: Scarcity of land
Very high demand for businesses to relocate their headquarters to the center of the city.
External Diseconomies of Scales: Increasing rents
Too many businesses wishing to locate their offices/factories in a certain area, increasing rent prices.
External Diseconomies of Scales: Higher recruitment cost
Since workers have greater choice from a large number of employers in the same area, it may take companies longer to sign new employees.
External Diseconomies of Scales: Higher wages
Due to higher demand for quality workers, businesses might be forced to offer increased wages.
External Diseconomies of Scales: Transportation problems
Traffic congestion results in too many businesses operating in the same area, increasing businesses costs and reducing revenues.
Big business advantages
Survival
Economies of scale
Higher status
Market leader status
Increased market share
Big business advantages: Survival
Less likely to be taken over by another business.
Big business advantages: Economies of scale
Lower costs per unit generally mean greater profit.
Big business advantages: Higher status
Larger firms have greater status.
Big business advantages: Market leader status
Market leaders have customer loyalty and a competitive advantage.
Big business advantages: Increased market share
Large companies have a higher market share and can control the market by determining prices.
Small business advantages
Competitive advantage
Less competition
Specialisation
Greater motivation
Small business advantages: Competitive advantage
A personalised service can be offered resulting in greater customer satisfaction.
Small business advantages: Less Competition
In niche markets there is less competition as large companies don’t see the benefit of being part of a small market segment.
Small business advantages: Specialisation
Higher prices can be charged due to the speciality of the product.
Small business advantages: Greater Motivation
Employees may be motivated by the thought that they are valued and matter to the business.
Internal Growth
- Opening up new sales outlets
- Increasing their workforce
- Developing new products increasing their market share
- Retaining profits
External Growth
When firms grow by integrating with another firm.
- Quick and riskier method of growth
- Requires significant external financing
- Can increase market share and decrease competition very quickly
-> Merger and acquisition or takeover
-> Joint Venture
-> Strategic Alliance
-> Franchise
Merger
Two businesses become integrated by joining together and forming a bigger combined business.
Acquisition
When one firm takes over another. When the acquisition is unwanted, it is known as a hostile takeover.
Types of Integration
Backward Vertical
Forward Vertical
Horizontal
Conglomerate/Diversifying
Horizontal Integration
Two firms producing the same typeof product or service combine:
- Eliminates competition and increases market share
- Raw materials cheaper due to bulk buying
- Achieve economies of scale
- Acquire the assets of other firms
- Becomes more strong and secure for hostile takeovers
- E.g. British Airways and Iberia
Backwards Vertical Integration
A bussines takes over a supplier:
- Guaranteed source of stock
- Control over supply and distribution of stock
- Profits are higher due to cutting out the middle man
- E.g. BMW and Continental tyres
Forward Vertical Integration
A business takes over a customer:
- Increases profits as they have a definite customer
- Controls the supply and distribution of its products
- E.g. Pepsi takes over Pizza Hut
Conglomerate
Businesses operating in different markets merge:
- Reduces the risk of business failure
- Overcome seasonal fluctuations (selling ice-cream or umbrellas)
- Makes business larger and financially secure
- E.g. Intercorp has Interbank, Plaza Vea, Inkafarma, Vivanda
M&A Disadvantages
- High legal and consulting fees
- Culture clash among employees and businesses
- Duplication of functions (two CEO, two finance departments)
Joint Ventures
Two businesses agree to combine resources for a specific purpose and a specific period of time:
- A separate business is created with funding by the two parent businesses
- After the period of time is over, the business is dissolved or incorporated into one of the parent businesses
- Sometimes one of the partners can play a dominant role and buy the other partner
Joint Ventures Benefits
- Both firms enjoy greater sales but neither loses its legal existence or identity
- Both firms bring different areas of expertise
Joint Ventures Costs
- Effectively a partnership, run the risk of disagreements
- Sometimes a firm can realise they could have achieved the goal alone
Strategic Alliance
Similar to joint ventures, they involve businesses collaborating together for a specific goal:
- More than 2 businesses can take part
- No new business is created, is an agreement to work together for mutual benefit
- More fluid and membership can change without destroying the alliance
Strategic Alliance Disadvantages
- The more businesses involved, the more challenging coordiation is
- All firms remain in competition with each other
- Can lack stability as membership is constantly changing
Franchise
A business arrangement where one firm pays for the right to trade under the name of another:
- Sells the idea
- Percentage of the profit has to be returned to the franchise
Franchiser
The business which sells the right to trade using its name to others.
Franchiser Advantages
- A quick way to increase market share
- Can cover wider geographical area
- Will earn percentage of the franchisees profits each year
- Risks are shared between the franchiser and franchisee
Franchiser Disadvantages
- Reputation depends upon how good the franchisees are
- Share of the profits are dependant on the ability of individual franchisees
- Franchiser needs to devote time and resources to support the franchisee
Franchisee
The person who buys the right to trade using the name of the mother company.
Franchisee Advantages
- Reduced risk as business exists and is established
- Franchiser will offer training and advice
- No need for individual franchisees to advertise, franchises will do it nationally
Franchisee Disadvantages
- Can be expensive to purchase and set up
- Restricts their actions, no control over menu, prices as they are bound by contracts
- Part of profit/turnover must be paid to franchiser
- The franchise agreement only lasts for a limited time period
Multinational Companies (MNC)
A business that operates in multiple countries.
Advantages of MNC host country
- Bring jobs to the area
- Can lead to the introduction of new management techniques
- Can lead to new businesses being set up locally
Disadvantages of MNC to host country
- Are very powerful and can influence the government of a country
- They may use up natural resources from the area
- Can force local firms out of business
- Profit made goes back to home country
