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
Backward vertical integration
Integration with a business in the same industry but a supplier of the existing business
Conglomerate integration
Merger with or takeover of a business in a different industry
Advantages horizontal integration
Eliminates one competitor
Possible economies of scale
Increased poser over suppliers
Disadvantages of horizontal integration
Rationalisation may bring bad publicity
May lead to monopoly investigation if it is too big
Effect of horizontal integration on stakeholders
Consumers have less choice
Workers may lose job security as a result of rationalisation
Advantages of forward vertical integration
Business is able to control the promotion and pricing of its own products
Secures an outlet for the firm’s products
Disadvantage of forward vertical integration
consumers may suspect uncompetitive activity and react negatively
Lack of experience in this sect or the industry
Impact of forward vertical integration on stakeholders
Workers may have greater job security because the business has secure outlets
There may be more varied career opportunities
Consumers may resent lack of competition in the retail outlet because of the withdrawal of competitor products
Advantages of backward vertical integration
Gives control over the quality, price and delivery times of supplies
Encourages joint research and development into improved quality of supplies of components
Business may control supplies of materials to competitors
Disadvantages of backward vertical integration
May lack experience of managing a supplying company
Supplying business may become complacent having a guaranteed customer
Impact of backward vertical integration on stakeholders
Possibility of greater career opportunities for workers
Consumers may obtain improved quality and more innovative products
Control over supplies to competitors may limit competition and chose for consumers
Advantages of conglomerate integration
Diversifies the business away from its original industry and markets
This should spread risk and may take the business into a faster growing market
Disadvantages of conglomerate integration
Lack of management experience in the acquired business sector
There could be a lack of clear focus and direction now that the business is spread across more than one industry
Impact of conglomerate integration on stakeholder
Greater career opportunities for workers
More job security because risks are spread across more than one industry
Joint venture
Two or more businesses agree to work closely together on a particular project and create a separate business division to do so
Reasons for joint ventures
Costs and risks are shared
Different companies may have different strengths and experiences
They might have their major markets in different countries, exploit these with the new product more effectively
Risk of joint ventures
Errors might lead to one company blaming the other
Styles of management might be different that they don’t work well together
One partner failing would put the whole project at risk
Strategic alliances
Agreements between firms in which each agrees to commit resources to achieve an agreed set of objectives
Franchise
A business that uses the name, logo and trading systems of an existing successful business
Advantages of franchises
Grow cheaply and quickly
Less manpower to directly manage
Income from franchise fee, royalties, and supply purchases
Disadvantages of franchises
Not easy to revoke
Less control over quality or performance of franchise
Conflict in profit vs. volume
Franchisee benefits
Known brand results in strong start-up sales
Support from franchisor
Easy financing options
Lower cost of supplies because of economies of scale (though sometimes the franchisor charges high for supplies)
Franchisee downsides
Little freedom/flexibility in running
Franchise/start up fee may be too costly
Bad management in headquarters affects all branches
Still not guaranteed success
Globalisation
The growing integration of countries through increased freedom of global movement of goods, capital and people
Free trade
No restrictions of trade barriers exist that might prevent or limit trade between countries
Protectionism
Using barriers to free trade, such as tariffs and quotas, to protect a country’s own domestic industries
Multinational company or business
Business organisation that has its headquarters in one country, but with operating branches, factories and assembly plants in other countries
Advantages of being multinational
Closer to main markets - lower transport costs for the finished goods, better market information about consumer
Lower costs of production
Avoid import restrictions by producing in the local country
Access to local natural resources
Issues with being multinational
Culture, language and legal differences
Need to train local employees - expensive
Poor communication with headquarters
Benefits of multinational operation to host country
Will bring in foreign currency
Employment opportunities will be created
Local firms are likely to benefit from supplying services and components to the new factory, additional jobs
Tax revenues
Economy will grow
Local firms will have to up their quality and productivity to international standards
Drawbacks of multinational operation to host country
Exploitation of the local workforce
Pollution from plants might be higher than allowed in other countries
Local firms might run out of business
Imposing their culture on the country
Profits sent back to the company’s country
Depletion of the limited natural resources
