3.1 Business Growth

Question 1

Reasons why some firms tend to remain small

Answer 1

• To avoid diseconomies of scale (rapid growth can have negative impacts on business eg. communication suffers due to increase in ppl and business hierarchy structure)
• They operate in niche markets (don’t have sufficient demand for goods / services they sell to grow business)
• Barriers to entry (difficult for firms to expand into different markets eg. some markets dominated by large businesses with lower operating costs so can’t offer competitive prices in that market)
• Small can be a selling point (small businesses can offer things big businesses can’t eg. better customer service as customer makes up larger percentage of revenue in smaller retail stores)

Question 2

Reasons why some firms grow

Answer 2

• Profits (generate more sales revenue so greater chance of achieving high levels profit which can be reinvested to expand further)
• Economics of scale (bigger firms have more benefits eg. Lower interest rates so reduced cost of borrowing)
• Increased market share (likely to increase revenue sales so increase in market share = increased market setting powers so can generate larger profit margin)
• Diversification (more profit to expand so can enter into new markets so can diversify product portfolio so can spread risk across multiple markets & products so increased chance of survival if 1 product fails)
• Managerial motives (owner’s ambition to own large businesses & receive benefits eg. larger salaries, increased leisure time as can hire managerial directors)

Question 3

The principal-agent problem (significance of the divorce of ownership from control)

Answer 3

• as business grows, share holds (principals) appoint managers (agents) to run business day to day (financial managers, sales managers)
• but managers have different objectives (to maximise revenue) from shareholders (to profit maximise to maximise dividends they’re paid)
• stems from asymmetric info as shareholds don’t know how agents behave or decisions they make (may be in own self interest)

Question 4

How do businesses reduce the principal-agent problem

Answer 4

• Put in place schemes that help align principal’s objectives with agents

Eg. Owners give managers percentages of business’s shares so managers switch objectives from sales maximisation to profit maximisation to maximise the dividends they receive

Question 5

Public vs private sector organisations

Answer 5

Public sector organisation run by gov (NHS)
Don’t have incentives as act in society’s interest & dont face competition = less efficiency

Private sector firms run by private individuals, left to free market
Have profit motive as need to make high profits to stay in market, encourages firms to be efficient to cut costs & survive

Question 6

Profit vs not-for-profit organisations

Answer 6

Profit organisations main objective is profit, to maximise dividends given to shareholders
So decisions have negative impacts on society but profitable

Not-for-profit organisations main objectives differ from profit eg. to help local community
Profits made go towards main objective to help improve society

So not-for-profit firms exempt from certain taxes profit firms have to pay

Question 7

Ways businesses grow:

Answer 7

• organic growth
• forward & backward vertical integration
• horizontal integration
• conglomerate integration

Question 8

Stages of production

Answer 8

Primary sector (extraction of raw materials eg. mining)

Secondary sector (manufacturing things eg. cars)

Tertiary sector (provision of services eg. retailers)

Question 9

Organic growth

(definition, advantages & disadvantages)

Answer 9

= businesses expand internally through increasing output Eg. expanding into international markets, launching new products, increased investment, more labour, open new stores

+ reduced risk (that mergers & takeovers may experience eg. clash of business cultures), firms can keep control of business

+ avoid diseconomies of scale (businesses can grow at more sustainable pace = less chance of business experiencing increased costs from diseconomies of scale)

• slow growth (takes longer for business to increase market share but competition may have grown quicker by merger/takeover & be dominating market so less profit)
• sometimes unable to enter markets or assets they have no expertise in other firms can through integration (European company expanding into Asian market)

Eg. LEGO (introduced Lego friends & board games to expand customer base)

Question 10

Forward & backward vertical integration

Answer 10

= business merges or takes over another business in different stage of production

Vertical forward integration: merging / taking over of firm at stage ahead of business in production process (eg. fishing business merging/taking over fish&chip chain)

Vertical backward integration: merging / taking over of firm at stage behind them in production process (eg. coffee shop merging/taking over coffee bean supplier)

Question 11

Vertical (forward & backward) integration advantages & disadvantages:

Answer 11

+ Guarantees source of raw materials (backward) / outlet for product (forward)

+ Greater control over supply chain (business able to control supply of their products if vertical backwards integration, can change suppliers business model to make more efficient so reduced production costs = increased competitiveness in market)

+ better access to raw materials (can control supply of raw materials through vertical backwards integration so during times of increased demand, manufacturer can increase their supply of raw materials through shifting more resources towards primary sector business)

+ vertical forward integration secures retail outlets & can restrict access to these outlets from competitors

• firms may have no expertise in industry they take over / merge with so may fail or struggle (eg. car manufacturing company with no knowledge of selling cars) = high risk & expensive
• difference in business cultures amongst the two businesses (can lead to more disputes amongst employers and overall inefficiencies) incompatibility between the two businesses can lead to increase in costs of production which forces price of their goods/services up

Question 12

Horizontal integration

(definition, advantages & disadvantages)

Answer 12

= business takes over / merges wit business in same industry or at same stage of production process

Eg. supermarket merging with another supermarket,
AstraZeneca acquired ZS Pharma for $2.7bn in 2015 = gave them access to new compounds intended to strengthen a specific sector of their business.

+ reducing competition (taking over/merging with business that was competitor, so increased share of total sales revenue in market as forces customers to shop elsewhere, some will shop at this business, gives firms power to influence markets)

+ reduction of costs (integration of departments in different businesses reduces costs (specialising & rationalising), businesses reduce no. of employees so reduction in staff wages

+ business can grow in market where it already has expertise, integration more likely to be successful

• increased risk for business if market they are in fails, invested lots of money in integration
• difference in business cultures amongst the two businesses (can lead to more disputes amongst employers and overall inefficiencies) incompatibility between the two businesses can lead to increase in costs of production which forces price of their goods/services up

Question 13

Conglomerate integration

Answer 13

= businesses expand through merging / taking over business in another industry, gives them chance to expand into different markets which are hard to compete in through organic growth

+ reduces risk through diversification (business doesn’t rely on 1 market, so if that market fails they aren’t affected as poorly and can move more resources to other business in different market (eg. retail industry & tech industry)

+ useful for firms with no room for growth in present market

• lack of knowledge (entering new market very risky as business owner has no experience or expert knowledge of market, may make poor decisions or be unable to attract new customers) which can damage business
• difference in business cultures amongst the two businesses (can lead to more disputes amongst employers and overall inefficiencies) incompatibility between the two businesses can lead to increase in costs of production which forces price of their goods/services up

Question 14

Constraints on business growth:

Answer 14

• Size of the market (businesses that operate in small/niche markets have limited demand so little room for business to expand so less chance of economies of scale)
• Harder to access finance (for small businesses or start-ups as higher risk which halts investment in business eg. higher interest rates as borrow smaller amounts of money & higher risk, larger businesses can diversify product range & operate in different markets
• Owner objectives (business owner may not have objective of growth eg. may aim for corporate social responsibility, increases cost of production so reduces profit
• Regulation (eg. monopoly power, blocked by competition & markets authority if integration gives business too much power so they abuse price setting owners (monopoly))

Question 15

Demergers (definition)

Answer 15

Occurs when business sells one or more businesses it owns resulting in business turning into separate company

Question 16

Reasons for demergers

Answer 16

• Cultural differences between 2 businesses (can cause inefficiency & lack of integration if business can’t operate together so demerge to improve business operations)
• Reducing risk of diseconomies of scale (reduces negative risks of becoming too big too fast, demerge to reduce levels of business hierarchy so communication faster so increased efficiency which reduces business costs)
• Increased focus (merges can make business lose focus of key objectives, (conglomerate mergers take business focus into new market so harder to become dominant in one market as resources are shifted between markets))
• Remove loss making parts (some areas of business making much more profit than others parts which may be loss making, sell loss making business to increase overall profits)
• Raising money from asset sales (can sell assets (demerge) to raise money for shareholders or increase reinvestment so business can expand within its core market, increasing market share
• To meet equipments of competition authority regulators (business can become too dominant in market, too much market share so market authorities force them to demerge so they don’t exploit consumers due to lack of competition)

Question 17

Impact of demergers on businesses

Answer 17

+ Increased efficiency (reduces problems from diseconomies of scale eg. remove layers of business hierarchy so communication faster)

+ Increased profit (business can remove loss making parts of business so increases overall level of profit)

• Reduction in market share (if demergers with another business in same industry, can lose some of market share as reduction in sales revenue)

Question 18

Impact of demergers on workers

Answer 18

• Increased job security (loss making parts of business demerged so increase in stability of business as increase in profit so redundancies are less likely)
• Reduced conflict between cultures (demerger reduces disputes between workers as each part of business has own values & work ethic so workers get along better & work more efficiently)
• Increased focus on business (demerging allows workers to focus on core business & increases chance of business becoming dominant in their market)

Question 19

Impact of demergers on consumers

Answer 19

• Lower prices (when businesses forced to demerge by competition & markets authority as they have too much market share, competition increases so businesses offer lower prices, higher quality goods, better customer service to gain customers)
• Better meet consumer needs (demerging increases focus on core business so keep on top of changing consumer tastes & trends so meets customer needs better so meets consumer demands)