3.1 Business Growth Flashcards by Muaz Gull

Business Growth Reasons

Profit
Costs
Market Power
Diversification
Managerial Objectives

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Business Growth Reasons

Profit

Increase in size enables firms to produce more goods and services
Allows for an increase in sales which would boost revenue
Higher revenue => higher profit
Beneficial for firms

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Business Growth Reasons

Costs

Firm that increases in size often experiences lower unit costs => economies of scale
Lower unit cost => higher profit

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Business Growth Reasons

Market Power

Larger a firm becomes, the more market power they will have

Market power is ability of a firm to raise (control) prices and earn supernormal (abnormal) profit

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Business Growth Reasons

Diversification

Increasing range of products or markets served by a business
Degree of diversification depends on extent to which those products or markets are different from the existing products and markets served by the business

Firm may expand in size through entering foreign market or producing a new good/service
Diversification reduces risk

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Business Growth Reasons

Managerial Objectives

Managers often have renumeration packages that are determined by sales performance of firms
E.g. CEOs receive bonuses for meeting sales targets => provides incentives for managers to increase size of firm
Managers may also seek to increase the size of firms to satisfy their ego => leading a large firm can command respect and veneration from others

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Reasons Firms Choose to Remain Small

Worried about experiencing diseconomies of scale if they expand => occur when business grows so large that costs per unit increase
Firm’s owners do not want extra work and risks
Legal requirements differ by size of firm => smaller firms face less and more easily compliable regulations than larger firms

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Reasons Firms Must Remain Small

Unable to finance expansion => banks see them as risky borrowers so only offer credit on strict terms or none
Operate in niche market which has small customer base
Skills, knowledge, and expertise may be lacking
Firm may lack resources to cope with additional regulations and bureaucracy that expansion entails

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Principal Agent Problem

Firms owned by shareholders but run by managers
Both have different objectives
=> shareholders want to maximise short run profit
=> managers want to maximise their own benefit
Therefore one group (agents) make decisions on behalf of the other group (principals)
Theoretically, agents maximise other’s benefits but realistically they maximise their own
Leads to profit satisfice and not profit maximise

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Private Sector

Firms not owned by government
Owned by shareholders or family run
Also include sole proprietors and partnerships

Aim to make a profit to satisfy demands of owners

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Public Sector

Government owned as they could not survive without significant state funding or government wishes to determine direction taken by business

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Not For Profit Organisations

Consists of charities which exist to provide services to local, national and international communities
Do not see profit as main goal

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Organic Growth

Internal growth
Firm grows by increasing output
=> increased investment or more labour
Almost all growth of firms is organic

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Organic Growth

Advantages

Integration (inorganic growth) is expensive, time consuming and high risk. Evidence suggests long term share price of company falls after integration. Firms often pay too much and tends to be poorly managed with many key workers tending to leave after change
Firm is able to keep control over their business

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Organic Growth

Disadvantages

Another firm may have a market or asset which company would be unable to gain through organic growth
=> European company may not be able to enter Asian market
Organic growth may be too slow for directors who wish to maximise salaries
More difficult for firms to get new ideas

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Inorganic Growth

Forward and Backward Vertical Integration
Horizontal Integration
Conglomerate Integration

Inorganic Growth

Forward and Backward Vertical Integration

Integration of firms in the same industry but at different stages in the production process
If merger takes the firm back towards the supplier of a good, it is backwards integration
Forward integration is when firm is moving towards eventual consumer of a good

Inorganic Growth
Forward and Backward Vertical Integration
Advantages

Increased potential for profit as firm takes potential profit from a larger part of chain of production
Less risks as suppliers do not have to worry about buyers not buying goods and buyers do not have to worry about suppliers not supplying
With backwards integration, businesses can control quality of supplies and ensure delivery is reliable and don’t have to worry about high prices => low costs
Forward integration secures retail outlets and can restrict access to outlets for competitors

Inorganic Growth
Forward and Backward Vertical Integration
Disadvantages

Firms may have no expertise in industry they took over

Inorganic Growth

Horizontal Integration

Firms in same industry at same stage of production integration

Inorganic Growth
Horizontal Integration
Advantages

Helps reduce competition as competitor is taken out and market share increased => firm given more power to influence markets
Firms able to specialise and rationalise, reducing areas of businesses which are duplicated
Business able to growth in market where it already has expertise => more successful merger

Inorganic Growth
Horizontal Integration
Disadvantages

Increase risk for business if that particular market fails as they have nothing to fall back on and will have invested a lot of money in that area

Inorganic Growth

Conglomerate Integration

Firms in different industries with no obvious connections integration
Can sometimes be linked by common raw materials/technology/outlets

Inorganic Growth
Conglomerate Integration
Advantages

Useful for firms where there may be no room for growth in present market
Range of products reduces risk for firms and if whole industry fails, they can still survive due to other parts of the business
Make it easier for each individual part of business to expand than if they were on their own as finance can be easily obtained and managers can be transferred

Inorganic Growth Conglomerate Integration Disadvantages

Firms are going into market which they have no expertise | Often can be damaging for the business

Constraints of Business Growth

Size of the Market Access to Finance Owner Objectives Regulation

Constraints of Business Growth | Size of the Market

Market is limited to certain size so not all business are able to mass produce as goods would not be purchased Can happen no matter how bug market is and there will always be limits on growth Especially in niche markets and markers for luxury items or restricted prestige markets make it difficult for businesses to grow

Constraints of Business Growth | Access to Finance

Firms use two main ways to finance growth => retained profits and loans If firms do not make enough or give too much to shareholders, they cannot use retained profits to grow Banks may be unwilling to lend money so unable to use loans Therefore firms may not be able to grow if they cannot finance it

Constraints of Business Growth | Owner Objectives

Some owners may not want their business to grow any further as they are happy with the current profits and do not want the extra risk or work that comes with growth

Constraints of Business Growth | Regulations

In some markets, the government may introduce regulations which prevent businesses from growing

Demergers

Business strategy in which a single business is broken into two or more components, either to operate on their own, to be sold, or to be dissolved

Reasons for Demergers

Lack of Synergies Value of the Company / Share Price Focuses Companies Competition Authorities

Reasons for Demergers | Lack of Synergies

Different parts of the company have no real impact on each other and fail to make each other more efficient Lack of synergy means managers are splitting time between areas which are so different it could lead to diseconomies of scale Firms may split to avoid these diseconomies

Reasons for Demergers | Value of the Company / Share Price

Some companies demergers because the value of the separate parts of the company is worth more than company combined This is because some parts of the business are operating well and have potential to grow but the overall value is brought down because of lack of success or lack of potential for growth of other parts of the business Financial markets talk about creating value by splitting companies like this

Reasons for Demergers | Focussed Companies

Some people believe if company and the management are more focussed on individual markets, they become more efficient and successful => higher profits Management have limited time and skills and they are unable to spend required time to make all areas of a diverse business successful But focussing on one area, managers can improve skills and knowledge => more successful

Reasons for Demergers | Competition Authorities

Firms may split up as they may be getting too big and the market which they are in may have regulations against monopolies and other competition policies This leads to competition authorities getting involved As a result, firms may split to prevent their involvement

Demergers Impact | Workers

Workers could gain or lose through a demergers Separate firms may need their own managers and leaders so people could get a promotion However, the goal of making the firm more efficient may result in job losses

Demergers Impact | Businesses

Concentrating on a smaller core business may enable it to be more efficient and contraction may lead to more innovation and surviving higher competition However smaller size of business could lead to a loss of economies of scale and reduced efficiency

Demergers Impact | Consumers

Consumers could gain or lose Gain from innovation and efficiency, leading to better products and cheaper prices Demerged firms may be less efficient through loss of economies of scale or raise prices / reduce quality or range of goods as they become motivated by profit