1.6 Growth and evolution Flashcards
Economies of scale
Reductions in a firm’s unit costs of production that result from an increase in the scale of operations
Scale of operation
The maximum output that can be achieved using the available inputs - this scale can only be increased in the long term by employing more of all inputs
5 cost benefits from economies of scale
Purchasing economies
Technical economies
Financial economies
Marketing economies
Managerial economies
Purchasing economies
Often known as but buying economies
Suppliers often offer substantial discounts for large orders
This is because it is cheaper for them to process and deliver one large order than several smaller ones
Technical economies
Large firms are more likely to be able to justify the cost of flow production lines. If these are worked at a high capacity leave, then they offer lower unit costs than other production methods.
Financial economies
Banks often show preference for lending to a big business with a proven track record and a diversified range of products
Interest rates charged to these firms are often lower than the rate charged to small, specially newly formed, businesses
Raising finance by ‘going public’ or by further public issues of shares for existing public limited companies is very expensive. Therefore, the average cost of raising the finance will be lower for larger firms selling many millions of dollars’ worth of shares
Marketing economies
Costs can be spread over a higher level of sales for a big firm and this offers a substantial economy of scale
Managerial economies
As a firm expands, it should be able to afford to attract specialist functional managers who should operate more efficiently than general managers, helping to reduce average costs
Diseconomies of scale
Factors that cause average costs of production to rise when the scale of operation is increased
3 main causes of diseconomies of scale
Communication problems
Alienation of the workforce
Poor coordination and slow decision making
What shape does an economies of scale graph make?
A U shape
Why are small firms important?
Many jobs are created
Often run by dynamic entrepreneurs
Create competition for larger business, prevents larger business from exploiting customers
Often supply specialist goods and services
All big businesses were small at one point
Advantages of small businesses
Can be managed and controlled by the owner
Often able to adapt quickly to meet changing customer needs
Offer personal service to customers
Find it easier to know each worker
Staff prefer to worker for a smaller business
Average costs can be low due to no diseconomies of scale
Easier communication with workers and customers
Advantages of large businesses
Can afford to employ specialist managers
Benefit from cost reductions from large scale production
Can set prices that other businesses have to follow
May be diversified in several markets and products, risks are spread
More likely to be able to afford research and development into new products and processes
Disadvantage of small businesses
Limited access to sources of finance
Owner carries a large burden of responsibility
May not be diversified
Can’t benefit from economies of scale
Disadvantage of large businesses
Difficult to manage especially if it is geographically spread
May have potential cost increases associated with large scale production
May suffer from slow decision making and commutation
What does the scale of operation (size of business) depend on?
Owner’s objectives
Capital available
Size of the market the firm operates in
Number of competitors
Scope for economies of scale
Internal growth
Expansion of a business by means of opening new branches, shops or factories
External growth
Business expansion achieved by means of merging with or taking over another business from either the same or different industry
Why do businesses seek to grow?
Increased profits
Increased market share
Increased economies of scale
Increased power and status of the owners and directors
Reduced risk of being a takeover target
Merger
An agreement by shareholders and managers of two businesses to bring both firms together under a common board of directors with shareholders in both businesses owning shares in the newly merged business
Takeover
When a company buys over 50% of the shares of another company and becomes the controlling owner - often referred to as ‘acquisition’
Horizontal integration
Integration with a firm in the same industry and at the same stage of production
Forward vertical integration
Integration with a business in the same industry but a customer of the existing business
